Meritage Hospitality

This year’s letter has two objectives. First, I want to review the Company’s achievements in the preceding year. Second, I want to highlight what I believe will be important building blocks of value creation for our Company in the years ahead.

Before that, I would like to quickly comment on our long-term results. Since present management took over operations in 1998, sales have more than doubled – growing from approximately $27,000,000 to $59,300,000. Our common shares have provided an annualized total return in excess of 19% over this time - outperforming the Nasdaq, the S&P 500 Index, the 10-year Treasury, and the 30-year Treasury:

Historical Performance
October 1998 - December 2007

Asset Class Annualized Total Return

Meritage Hospitality Group Inc.	+19.8%

Nasdaq	+5.0%
S & P 500 Index	+4.9%
10-Year Treasury	+4.2%
30-Year Treasury	+5.1%
Sources: Stifel Nicolas and Meritage
Present management was put into place 10/6/1998. Annualized total return calculated 10/6/1998 through 12/31/2007.

We reported improvements in 2007 sales and consolidated EBITDA due in large part to cost reductions and operating efficiencies implemented by management. Fiscal 2007 sales increased 2.9% to $59.3 million. Our consolidated EBITDA was $2.8 million - a 300% increase over last year. Also contributing to the increase was our “deregistration transaction” that was approved by 74% of voting shareholders in January 2007. This transaction allowed the Company to terminate the registration of its common shares with the SEC and avoid the heavy costs associated with implementing Sarbanes Oxley Act requirements which disproportionately affect smaller public companies.

2007 was also an extraordinary year for Meritage as we successfully navigated our fixed-base retail business through a very difficult external operating environment for franchise retailers. Among other things, we faced (i) a national Wendy’s franchise system with operating margins near a five year low, (ii) a weakened middle-income consumer that has been negatively influenced by higher energy costs and a credit crisis in the financial mortgage markets, and (iii) Michigan’s continuing and unprecedented seven-year “single state recession” giving Michigan one of the highest unemployment rates and foreclosure rates in the nation.

In 2007, a new premium trading, quotation and disclosure service for over-the-counter securities began called the OTCQX. This electronic, community-based trading platform was created for issuers like Meritage who wanted to avoid the heavy Sarbanes Oxley Act costs but were still willing to make thorough financial and business disclosures. Meritage is a founding OTCQX company. Characteristics of the OTCQX Premium listing include:

Today, Meritage has at least seven broker/dealers making a market in the Company’s common shares:

O’Charley’s Restaurants: We currently operate four O’Charley’s restaurants. We are obviously disappointed that since the inception of our O’Charley’s restaurant development, we have generated net losses in this concept. In 2007, we successfully settled a dispute with our franchisor relating to our results. This should put us in a position to generate a break-even cash flow going forward. We will continue to evaluate our future options relating to this concept.

Wendy’s International, the franchisor of our 49 Wendy’s restaurants, has been on the “auction block” exploring strategic options including a sale of the concept, during most of 2007 and into 2008. Since the passing of its founder, Dave Thomas, in 2002, the Wendy’s franchise restaurant brand has been in a five-year downward margin cycle. Compounding the margin cycle headwinds is a severe and unprecedented negative economic climate in Michigan, the worst consecutive seven-year economic cycle for a single state in recorded U.S. history. This is “not your father’s economic cycle” occurring in Michigan, but rather a long-term systematic change to the economic base of the Michigan economy, driven by globalization and changes to the manufacturing industry which have anchored Michigan’s economy for years. University of Michigan economists released forecasts predicting net job growth will not occur before 2009 or 2010.

Despite these seemingly difficult odds, Meritage continues to deliver solid relative operating and financial results in the Wendy’s restaurant business. Of particular note is management’s proven ability to harness results in Michigan (a significantly “below average” market) as demonstrated in the following performance graph which compares Meritage’s historical unit-level restaurant operating results to the Wendy’s International restaurant system.

From our view, there are times to build units, times to purchase units, and times to sell units and “take chips off the table” for investors. We predict that a new management team at Wendy’s International will provide a stronger consumer product focus and develop a margin recovery plan aimed at returning Wendy’s restaurant margins to 15% - the quick-service restaurant industry average (compared to the Wendy’s system’s current 10.7%).

While a discussion about margin cycles in the Wendy’s franchise system may seem trivial for some, for Meritage a 2% difference in our operating margins equates to more than $1.0 million in free cash flow available for investment or distribution. This $1.0 million represents a material difference in Meritage being able to make cash distributions from existing restaurant operations – a stated goal in years past. Therefore, the Wendy’s franchise system’s margin recovery program will be critical to our future ability to make distributions from franchise restaurant operations.

Margin recovery is also an important function of a restaurant’s business value which is often described as “enterprise” or “intrinsic” value. Generally speaking, the higher the EBITDA, the higher the enterprise/intrinsic value.

In August 2007, Meritage engaged Stifel Nicolaus to assist the Company in investigating and evaluating value-creating alternatives and strategic options relating to its Wendy’s business. Under consideration was everything from the sale of existing units to expansion through acquisitions of existing Wendy’s restaurants in countercyclical and economically healthier markets. It appears that expansion within the Wendy’s system appears to be a strategy that would work well given our strengths as an efficient operator, and would allow us to leverage our back-of-house infrastructure. This strategy also allows us to diversify the Company’s geographic risk profile away from its heavy concentration in Michigan which has unjustifiably high minimum wages and business taxes on service providers.

Our operating and development skills are an increasingly valuable (and perhaps underappreciated) aspect of our management team’s capabilities. Throughout the past five years, in the areas where it has control, Meritage has consistently driven down costs. In 2007, we saw improving results with steadily increased EBITDA. Also of note is our food variance results. Food variance is the difference between the theoretical cost of a food product and the actual cost that the Company incurs. The optional food variance target in the quick-service industry is 1.25%. Meritage operated at 1.2% in 2007.

Strategic Partnership with The Related Group. Meritage recently announced that it entered into a strategic partnership with The Related Group in a joint venture called TRG-Meritage Bahamas LLC. Under this joint venture, Meritage will co-market and co-develop a world-class, ultra-luxury destination resort community on the Island of Eleuthera, in the Bahamas. The Related Group is owned by North America’s preeminent developers Jorge Perez and Stephen M. Ross.

Jorge Perez is the Chairman and co-founder of The Related Group of Florida, formed in 1979. Mr. Perez graduated from the University of Michigan with a master’s degree in urban planning and development. The Related Group of Florida is the largest Hispanic-owned business in the United States with a current portfolio of over $10.7 Billion. Mr. Perez is known for innovative partnerships, and is currently developing projects in North, South and Central America. Mr. Perez has been the recipient of many awards, most recently honored with the “Icon in Real Estate Award of Excellence” in Cannes, France, the first American developer to ever achieve such an honor. Mr. Perez was a significant stakeholder of Kerzner International which owns the Atlantis Resort on Paradise Island in the Bahamas.

Stephen M. Ross is the Chairman, CEO and founder of The Related Group. Mr. Ross formed the Company is 1972. Today, the company includes 2,000 professionals who oversee a real estate portfolio valued in excess of $15 billion. Mr. Ross obtained his business administration degree from the University of Michigan, a law degree from Wayne State University Law School, and a masters of law in taxation from New York University School of Law. In 2004, the University of Michigan renamed its business school the Stephen M. Ross School of Business at the University of Michigan. Mr. Ross was Chairman of the Real Estate Board of New York (REBNY), and a director of Kerzner International which owns the Atlantis Resort on Paradise Island in the Bahamas.

I believe The Related Group’s pre-eminent track record and investment experience with the $1.6 billion Atlantis Resort in the Bahamas, the largest and most successful resort in the Caribbean, significantly increases Meritage’s probability of success in this venture. Development of Lighthouse Point is anticipated to begin in 2009. I believe our property assemblage will go down in history as a “one-in-a-generation” opportunity that will assist in creating future shareholder value for Meritage shareholders.

People, Land & the Internet
Three Building Blocks of Value Creation of our Company

Our 2,000 employees are our most important asset. They are value engineers for our Company. We aggressively seek out talented and self-motivated individuals to serve our customer needs. We are proud that our employees have chosen Meritage as their professional home.

Land is the foundation of value creation in our development efforts. I believe our Board has demonstrated incredible foresight to acquire an interest in the ocean front property on Eleuthera Island, which represents a 10-year development inventory for the Company.

We began our Bahamas development focus a few years ago, recognizing early the vast economic implications for our Company. Today, we have interests in unique properties that, I believe, will create millions of dollars of long-term value for our shareholders.

A significant and evolving trend is the use of newly applied internet technologies in marketing, profiling and selling international resort property. Some studies suggest as much as 50% of international residential resort real estate will be sold or researched through the internet. Our collaborative sales and marketing efforts will create real and measurable economic momentum in South Eleuthera. That should expand and energize opportunities for real estate appreciation and sales. We are seeking the best creative, technical and administrative tools available in our projects to create and market the out-island lifestyle of tomorrow.

As I conclude and consider the opportunities that lie ahead, I am grateful for your patient investor support. The combination of the “Michigan malaise” and the decreasing Wendy’s margin cycle have presented a unique and difficult challenge for our existing restaurant businesses and for our management team. As the CEO and the Company’s largest shareholder, I want you to know that I am as committed as anyone to seeing improved results; having incurred personal risk by guaranteeing some of the Company’s bank financing and its franchise agreements. I ask for your continued patience as the Michigan economy works itself out and as we diversify outside of Michigan. I believe we are embarking on a journey which holds incredible promise. We are fortunate to have attracted such preeminent development partners as Jorge Perez and Steven M. Ross - both known for their passion and vision in the world of real estate development. I believe Meritage will emerge as a true industry visionary.

Finally, I believe Meritage is on the right side of the historic “baby boomer” cycle. Our unique positioning at both ends of the consumer spectrum (quick-service restaurants on the low end and exclusive island resort properties on the high end) promises to be a winning strategy for value creation in the years ahead.