
Dear Shareholders:
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:
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Historical Performance
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October 1998
- December 2007
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Asset Class
Annualized Total Return
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Meritage
Hospitality Group Inc.
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+19.8%
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Nasdaq
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+5.0%
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S & P 500
Index
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+4.9%
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10-Year
Treasury
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+4.2%
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30-Year
Treasury
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+5.1%
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Sources:
Stifel Nicolas and Meritage
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Present
management was put into place 10/6/1998.
Annualized total return calculated 10/6/1998 through
12/31/2007.
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Fiscal 2007 Review
Systematic
Long-Term Changes in the Michigan Economy
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.
Liquidity
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:
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A premier over-the-counter trading venue with enhanced visibility for each listed company.
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A trading support system comparable to a traditional exchange but at lower cost.
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Access to both national and international investors.
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Ongoing commitment to providing credible and useful disclosure.
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Designed specifically for small to medium-sized public companies in a post-Sarbanes-Oxley environment.
Today, Meritage has at least seven broker/dealers
making a market in the Company’s common shares:
| UBSS |
UBS Securities LLC |
| HILL |
Hill Thompson Magid & Co. |
| DOMS |
Domestic Securities, Inc. |
| NITE |
Knight Equirt Markets, LP |
| JEFF |
Jefferies & Co., Inc. |
| HDSN |
Hudson Securities, Inc. |
| ETRD |
E-Trade Capital Markets |
One of our primary goals remains to provide liquidity
to our shareholders.
Business Segment Review
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.
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Gezon Parkway in Wyoming,
Michigan -
Breakfast Grand Opening
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Wendy’s
of Michigan:
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%).
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Note:
Wendy’s of Michigan data (i) excludes franchise fees and
(ii) includes the impact of occupancy costs which rose from 8.6% of sales in
2002 to 13.6% of sales in 2007, primarily as a result of sale-leaseback
transactions. To be consistent
with data provided by Wendy’s International, depreciation expenses are
excluded.
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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.
Wendy’s of Michigan

International Development Opportunity:
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.
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(Listed from left to right:
Jorge Perez-Chairman,
The Related Group, Honorable
Hurbert Ingram- Prime Minister of The Bahamas,
Robert Schermer-CEO,
Meritage Hospitality Group,
Mike Maier-President, Rockford Development)
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Jorge Perez
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
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
People
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
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.
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Lighthouse Point - 884 Acres
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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.
The Internet
Technology & Marketing: 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.
Looking Forward
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.
I look to improving performance and expanding
opportunities in the years ahead.
Very truly yours,
Robert E. Schermer, Jr.
President & CEO
March 24, 2008 |