-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KuOwOYLHz0DP8UuUVd2LJNBLP2GDVXDBx4uOp5LwrEcqRYGZvPkQafl3le9NUMr0 e+F+6RkM+PDDQuzykCRNXA== 0000950124-97-004764.txt : 19970918 0000950124-97-004764.hdr.sgml : 19970918 ACCESSION NUMBER: 0000950124-97-004764 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 3 FILED AS OF DATE: 19970917 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOTEL DISCOVERY INC CENTRAL INDEX KEY: 0001044738 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 311487885 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: SEC FILE NUMBER: 333-34235 FILM NUMBER: 97681814 BUSINESS ADDRESS: STREET 1: 7701 FRANCE AVENUE SOUTH #217 CITY: EDINA STATE: MN ZIP: 55435 BUSINESS PHONE: 6128416363 MAIL ADDRESS: STREET 1: 7701 FRANCE AVENUE SOUTH #217 CITY: EDINA STATE: MN ZIP: 55435 SB-2/A 1 FORM SB-2/A 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 17, 1997 REGISTRATION NO. 333-34235 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT NO. 1 TO FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 HOTEL DISCOVERY, INC. (Name of Small Business Issuer in its Charter) MINNESOTA 5812 31-1487885 (State or other jurisdiction (Primary standard industrial (I.R.S. Employer of incorporation) classification code number) Identification Number)
7701 FRANCE AVENUE SOUTH, SUITE 217 EDINA, MINNESOTA 55435 (612) 841-6363 (Address and Telephone Number of Principal Executive Offices) STEPHEN D. KING, CHAIRMAN AND CHIEF EXECUTIVE OFFICER HOTEL DISCOVERY, INC. 7701 FRANCE AVENUE SOUTH, SUITE 217 EDINA, MINNESOTA 55435 (612) 841-6363 (Name, Address, and Telephone Number of Agent For Service) Copies to: WILLIAM M. MOWER, ESQ. GIRARD P. MILLER, ESQ. GAY L. GREITER, ESQ. DOHERTY RUMBLE & BUTLER, P.A. MASLON EDELMAN BORMAN & BRAND, LLP 3500 FIFTH STREET TOWERS 3300 NORWEST CENTER 150 SOUTH FIFTH STREET MINNEAPOLIS, MINNESOTA 55402-4140 MINNEAPOLIS, MINNESOTA 55402-4235 (612) 672-8200 (612) 340-5555 FAX (612) 672-8397 FAX (612) 340-5584
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] CALCULATION OF REGISTRATION FEE ================================================================================
TITLE OF EACH CLASS ADDITIONAL PROPOSED MAXIMUM PROPOSED MAXIMUM OF SECURITIES TO AMOUNT TO BE OFFERING PRICE AGGREGATE AMOUNT OF BE REGISTERED REGISTERED(1)(2) PER UNIT OFFERING PRICE REGISTRATION FEE - ---------------------------------------------------------------------------------------------------------------------- Units, each consisting of one share of Common Stock, $.01 par value, and one Class A Warrant to purchase one share of Common Stock........................... 345,000 Units(3) $5.00 $1,725,000 $517.50 - ---------------------------------------------------------------------------------------------------------------------- Common Stock, $.01 par value(4)... 345,000 Shares $6.50 $2,242,500 $672.75 ======================================================================================================================
(1) Pursuant to Rule 416 under the Securities Act, this registration statement also covers such additional securities as may become issuable upon exercise of the Class A Warrants. (2) Represents additional securities registered with Amendment No. 1. A filing fee of $8,816.66 was previously paid. (3) Includes 45,000 Units subject to an option granted to the Underwriter to cover over-allotments, if any. (4) Issuable upon exercise of the Class A Warrants. ------------------------ 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, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. ================================================================================ 2 Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. SUBJECT TO COMPLETION, DATED SEPTEMBER 17, 1997 [HOTEL DISCOVERY, INC. LOGO] 2,500,000 Units Consisting of 2,500,000 Shares of Common Stock and 2,500,000 Redeemable Class A Warrants ------------------------- Hotel Discovery, Inc. (the "Company") is offering 2,500,000 units (the "Offering"), each unit consisting of one share of Common Stock, $.01 par value (a "Share") and one redeemable Class A Warrant at an initial public offering price of $5.00 per unit (a "Unit"). The Class A Warrants are immediately exercisable and, commencing 10 trading days after the Effective Date (as hereinafter defined), transferable separate from the Common Stock. Each Class A Warrant entitles the holder to purchase at any time until four years following the date that the Registration Statement relating to this Prospectus has been declared effective by the Securities and Exchange Commission (the "Effective Date"), one share of Common Stock at an exercise price of $6.50 per Warrant, subject to adjustment. The Class A Warrants are subject to redemption by the Company for $.01 per Warrant at any time 90 days after the Effective Date, on 30 days' written notice, provided that the average closing bid price of the Common Stock exceeds $7.00 (subject to adjustment) for any 14 consecutive trading days prior to such notice. See "Description of Securities." Prior to this Offering, there has been no market for the Company's securities. See "Underwriting" for information relating to the factors considered in determining the Price to Public. The Company has applied for listing its Common Stock, Class A Warrants and Units on the Nasdaq SmallCap Market under the symbols HOTD, HOTDW and HOTDU, respectively. ------------------------- THIS OFFERING INVOLVES A HIGH DEGREE OF RISK AND SUBSTANTIAL DILUTION. SEE "RISK FACTORS" COMMENCING ON PAGE 6 AND "DILUTION" ON PAGE 12. THESE ARE SPECULATIVE SECURITIES. ------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
==================================================================================================================== UNDERWRITING PROCEEDS TO PRICE TO PUBLIC DISCOUNT(1) COMPANY(2) - -------------------------------------------------------------------------------------------------------------------- Per Unit................................. $5.00 $0.40 $4.60 - -------------------------------------------------------------------------------------------------------------------- Total(3)(4).............................. $12,500,000 $1,000,000 $11,500,000 ====================================================================================================================
(1) The Underwriter will receive a sales commission equal to 8% of the Total Price to Public from the sale of the Units. The Company has also agreed to pay the Underwriter a nonaccountable expense allowance equal to 2% of the Total Price to Public. The Company has also agreed to sell to the Underwriter, for nominal consideration, a 5-year warrant to purchase up to 250,000 shares at 120% of the Price to Public (the "Underwriter's Warrant"). In addition, the Company has agreed to indemnify the Underwriter against certain liabilities. See "Underwriting." (2) Before deducting expenses of the offering estimated at $220,000, which does not include the 2% nonaccountable expense allowance described in Note 1 above and assumes no exercise of the Underwriter's over-allotment option. (3) The Company has granted the Underwriter a 45-day option to purchase up to 375,000 additional Units from the Company solely to cover over-allotments, if any. If such option is exercised in full, the Total Price to Public, Total Underwriting Discount and Total Proceeds to Company will be $14,375,000, $1,150,000 and $13,225,000, respectively. See "Underwriting." (4) At the request of the Company, up to 10% of the Units offered hereby may be reserved for sale to persons designated by the Company at the Price to Public. The Units are offered by the Underwriter, subject to receipt and acceptance by it, its right to reject orders in whole or in part and to certain other conditions. It is expected that delivery of the certificates representing the Units will be made on or about , 1997 in Minneapolis, Minnesota. [RJ Steichen & Company Logo] The date of this Prospectus is , 1997. 3 [PICTURES TO COME FROM THE COMPANY] IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP MEMBERS) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK, UNITS AND CLASS A WARRANTS ON NASDAQ IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "PLAN OF DISTRIBUTION." 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and financial statements (including the notes thereto) appearing elsewhere in this Prospectus. Unless otherwise indicated, the information in this Prospectus assumes no exercise of the Underwriter's over-allotment option. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed under the heading "Risk Factors", which investors should carefully consider. THE COMPANY The business of Hotel Discovery, Inc. (the "Company") is to develop, own and operate theme restaurants with a retail component designed to appeal to the upscale casual dining market. The Company opened its first restaurant in the Kenwood Shopping Center in Cincinnati, Ohio (the "Kenwood Unit") on December 19, 1996, and a second restaurant to be located at the Mall of America in a suburb of Minneapolis, Minnesota (the "Mall of America Unit") is under development. In October 1995, a limited partnership raised $2.5 million to build the Kenwood Unit which, at 17,000 square feet and up to 360 seats, represents the first embodiment of the Hotel Discovery theme concept. In conjunction with a reorganization of the Company, the assets of the limited partnership were directly contributed to the Company in November 1996 in consideration of Common Stock of the Company. See "Reorganization." The Company subsequently raised approximately $7 million in private placements which concluded in June and July 1997, the proceeds of which were used to complete and add special features to the Kenwood Unit, begin development of the Mall of America Unit and for working capital purposes. Management has spent more than four years in the development stage of the Hotel Discovery concept. The Company's officers bring substantial restaurant experience to the Company, with significant hands-on multi-location operating experience as well as extensive site selection and development experience. Hotel Discovery is a concept restaurant that offers the themes of adventure, imagination, exploration and innovation as entertainment. In the Kenwood Unit, these themes are embodied in the Safari Room, the Artist Loft, the Observatory and the Mapping Room. Specially designed furnishings and decorations, as well as the sights and sounds of state-of-the-art video and audio systems, transport guests along imaginative dining journeys. Imaginary places filled with myths and legends provide a unique blend of awareness, enjoyment, and entertainment to guests of Hotel Discovery. The Hotel Discovery menu offers a broad range of cuisine from around the world, including "cultural fusion" menu items such as Barcelona Spring Rolls and Asian Tacos. Features include American, Asian, Jamaican, West Indian, Mexican and European tastes and textures. Menu items are freshly made, using only the highest quality fresh meats, produce, spices and other ingredients. The menu mirrors the exploratory journey and adventure society themes of the restaurant itself. The Company targets the upscale casual segment of the dining-out industry, for which quality food pleasingly presented is an important consideration. Management expects that future restaurants will be located in highly visible, upscale malls or resort areas which feature upper and upper middle class demographics and a high level of tourist traffic. The Company is considering potential sites in Las Vegas and Chicago, but no assurances can be given that attractive sites will be located in those cities or that negotiations to build or lease such sites will be successfully concluded. The Company began operations as Hotel Mexico, Inc. ("HMI"), which was incorporated in Ohio in January 1994. The Kenwood Restaurant Limited Partnership, an Ohio limited partnership (the "Kenwood Partnership") was formed in June 1995 to own and operate the Kenwood Unit. HMI's operations and the net assets of the Kenwood Partnership were combined in November 1996, and in August 1997 HMI was reorganized as Hotel Discovery, Inc., a Minnesota corporation. See "Reorganization." The Company's 3 5 executive offices are located at 7701 France Avenue South, Suite 217, Edina, Minnesota 55435 and its telephone number is (612) 841-6363. THE OFFERING Securities Offered............ 2,500,000 Units, each Unit consisting of one share of Common Stock and one redeemable Class A Warrant at an initial public offering price of $5.00 per Unit. Each Class A Warrant is immediately exercisable and, commencing 10 trading days after the Effective Date, transferable separately from the Common Stock. Each Class A Warrant entitles the holder to purchase, at any time until four years after the Effective Date, one share of Common Stock at an exercise price of $6.50 per Warrant, subject to adjustment. The Class A Warrants are subject to redemption by the Company for $.01 per Warrant at any time 90 days after the Effective Date, on 30 days' written notice, provided that the average closing bid price of the Common Stock exceeds $7.00 (subject to adjustment) for any 14 consecutive trading days prior to such notice. Common Stock Outstanding Before this Offering........ 5,399,289 Shares Common Stock Outstanding After this Offering......... 7,899,289 Shares(1) Proposed Nasdaq SmallCap Market Symbols: Common Stock................ HOTD Warrants.................... HOTDW Units....................... HOTDU Use of Proceeds............... The Company intends to utilize the proceeds for further concept development, to complete development and construction of a second Hotel Discovery restaurant at the Mall of America in Bloomington, Minnesota (the "Mall of America Unit") and a third Hotel Discovery restaurant at an unidentified site, and for working capital. - ------------------------- (1) Does not include (i) 375,000 Units subject to the Underwriter's over-allotment option; (ii) 250,000 shares of Common Stock issuable upon exercise of the Underwriter's Warrant at 120% of the Price to Public; (iii) 2,500,000 shares of Common Stock which are issuable upon the exercise of the Class A Warrants at an exercise price of $6.50 per Warrant; (iv) 214,955 shares of Common Stock issuable upon exercise of warrants at an exercise price of $3.75 per warrant; (v) 750,000 shares of Common Stock reserved for issuance under the Company's 1997 Stock Option and Compensation Plan, of which options relating to 502,666 shares are currently outstanding at exercise prices ranging from $3.00 to $3.34 per share; and (vi) 50,000 shares of Common Stock issuable upon exercise of directors' stock options at an exercise price of $3.34 per share. 4 6 SUMMARY FINANCIAL INFORMATION
TWENTY-SIX WEEKS ENDED YEAR ENDED YEAR ENDED ------------------------- DECEMBER 31, DECEMBER 29, JUNE 30, JUNE 29, 1995 1996 1996 1997 ------------ ------------ -------- -------- (UNAUDITED) STATEMENT OF OPERATIONS DATA: Net sales................................... $ 0 $ 104,129 $ 0 $ 1,864,564 Restaurant costs and expenses............... 0 309,563 0 2,525,472 Selling, general and administrative expenses.................................. 14,775 138,209 44,122 765,573 Pre-opening and development costs........... 923,482 1,970,452 413,889 189,423 Other (income) expense...................... 2,209 13,507 (10,950) 65,787 ---------- ----------- ---------- ----------- Net loss.................................. $ (940,466) $(2,327,602) $ (447,061) $(1,681,691) ========== =========== ========== =========== Net loss per share.......................... $ (.28) $ (.53) $ (.10) $ (.33) ========== =========== ========== =========== Shares used in per share calculations....... 3,362,611 4,355,187 4,286,100 5,058,240 ========== =========== ========== ===========
JUNE 29, 1997 ------------------------------------------ PRO FORMA PRO FORMA AS ACTUAL (1) ADJUSTED(2) ------ --------- ------------ BALANCE SHEET DATA: Working capital (deficiency).......................... $(1,684,117) $ (284,117) $10,745,883 Total assets.......................................... 6,972,765 7,572,765 18,602,765 Total liabilities..................................... 5,065,966 4,265,966 4,265,966 Accumulated deficit................................... (5,123,427) (5,123,427) (5,123,427) Stockholders' equity.................................. 1,906,799 3,306,799 14,336,799
- ------------------------- (1) Assumes completion on June 29, 1997 of the sale of 499,804 shares of Common Stock at $3.00 per share for net proceeds of approximately $1.4 million that actually occurred in July 1997. (2) As adjusted for the sale of the Units offered hereby and the anticipated application of the net proceeds therefrom. Does not include: (i) 375,000 Units subject to the Underwriter's over-allotment option; (ii) 250,000 shares of Common Stock issuable upon exercise of the Underwriter's Warrant at 120% of the Price to Public; (iii) 2,500,000 shares of Common Stock which are issuable upon the exercise of the Class A Warrants at an exercise price of $6.50 per Warrant; (iv) 214,955 shares of Common Stock issuable upon exercise of warrants at an exercise price of $3.75 per warrant; (v) 750,000 shares of Common Stock reserved for issuance under the Company's 1997 Stock Option and Compensation Plan, of which options relating to 502,666 shares are currently outstanding at exercise prices ranging from $3.00 to $3.34 per share; and (vi) 50,000 shares of Common Stock issuable upon exercise of directors' stock options at an exercise price of $3.34 per share. 5 7 RISK FACTORS An investment in the Shares offered hereby is highly speculative and involves a high degree of risk. Investors could lose their entire investment. Prospective investors should carefully consider the following factors, along with the other information set forth in this Prospectus, in evaluating the Company, its business and prospects before purchasing the Shares. LACK OF SIGNIFICANT OPERATING HISTORY The Company's first restaurant, the Kenwood Unit, opened on December 19, 1996 and, accordingly, the Company faces all of the risks, expenses and difficulties frequently encountered in connection with the operation and development of a new business enterprise, including the lack of a significant operating history. Management anticipates net losses to continue for the foreseeable future. There can be no assurance that the Company will be able to generate significant revenues or operate profitably. Future revenues and profits, if any, will depend upon various factors, including market acceptance of the Hotel Discovery concept, the quality of restaurant operations, the ability to expand to multi-unit locations and general economic conditions. Furthermore, to the extent the Company's expansion strategy is successful, there is no assurance that the Company will successfully manage the transition to higher volume operations, control its operating expenses, attract necessary additional personnel, or attract the required capital. Unless otherwise stated, all historical financial results for the Company are derived solely from the Kenwood Unit, which may not be indicative of other locations. LIMITED BASE OF OPERATIONS The Company currently operates one restaurant, the Kenwood Unit, and plans to open the Mall of America Unit in the second quarter of 1998. During the Company's initial development stage, the combination of a relatively small number of locations and the significant investment associated with each new restaurant may cause the operating results of the Company to fluctuate significantly and adversely affect the profitability and cash flow of the Company. Due to the small number of current and planned locations and the large expenditure required to open each new unit, poor operating results at any one unit or a delay in the planned opening of a unit would materially affect the profitability and cash flow of the entire Company. Future growth in revenues and profits will depend to a substantial extent on the Company's ability to increase the number of its restaurants and on its choice of locations. Because of the substantial financial requirements associated with opening new units, the investment risk related to any one Hotel Discovery unit is much larger than that associated with most other restaurant companies' venues. DEPENDENCE ON KEY PERSONNEL The Company will be largely dependent upon the personal efforts and abilities of Stephen D. King, Chairman and Chief Executive Officer, and Ronald K. Fuller, President and Chief Operating Officer. The loss or unavailability to the Company of either of these individuals could have a material adverse effect upon the Company's business. See "Management." NEED FOR ADDITIONAL MANAGEMENT The success of the Company will depend in large part upon the Company's ability to supplement its existing management team. While both Messrs. King and Fuller have significant restaurant and multi-location restaurant management experience, the Company will need to hire other corporate level and management employees to help implement and operate its expansion plans, including a chief financial officer. The failure to obtain, or delays in obtaining, key employees could have a material adverse effect on the Company. See "Management." DEPENDENCE ON DISCRETIONARY CONSUMER SPENDING The success of the Company's operations depends to a significant extent on a number of factors including discretionary consumer spending, economic conditions affecting disposable consumer income, the overall 6 8 success of the malls, entertainment centers and other venues where Hotel Discovery restaurants are or will be located, and the continued popularity of theme restaurants generally and the Company's concept in particular. Theme restaurants are more susceptible to shifts in consumer preferences and frequently experience a decline of revenue growth or of actual revenues as consumers tire of the related theme. RISKS OF NEW CONSTRUCTION Construction projects, including the opening of additional restaurant locations, entail risks, including shortages of materials or skilled labor, unforeseen environmental, engineering or geological problems, work stoppages, weather interference, floods, difficulties with regulatory agencies and unanticipated cost increases, any of which could give rise to delays and cost overruns. LIMITED FINANCIAL RESOURCES; ADEQUACY OF PROCEEDS AND NEED FOR ADDITIONAL FINANCING The Company's ability to execute its business strategy depends to a significant degree on its ability to obtain substantial equity capital and other financing to fund the development of additional restaurants. The proceeds of this Offering will provide the Company with the financing required to develop and open the Mall of America Unit and for working capital purposes. The total cost of developing the Kenwood Unit was approximately $4.7 million, which included $3.5 million for building design and construction and $1.2 million for equipment, furniture and fixtures. The Company estimates that the total cost of developing the planned Mall of America Unit will be approximately $4.5 million, net of landlord contributions. Although the Company estimates that the proceeds from this Offering will be sufficient to develop and open both the Mall of America Unit and a third Hotel Discovery restaurant, there can be no assurance that both of such restaurants can be developed at such estimated costs. If the proceeds of this Offering are not sufficient to develop a third unit, the Company may be required to seek additional funds through an additional offering of the Company's equity securities or by incurring indebtedness. If additional funds are required, there can be no assurance that any additional funds will be available on terms acceptable to the Company or its shareholders. New investors may seek and obtain substantially better terms than were granted its present investors and the issuance of such securities would result in dilution to existing shareholders. Furthermore, as the Company prepares to open additional restaurants, it will expend a relatively higher amount on administrative expenses than would a mature company with similar operations. EXPANSION STRATEGY The Company's ability to open and successfully operate additional restaurants will also depend upon the hiring and training of skilled restaurant management personnel and the ability to successfully manage growth, including monitoring units and controlling costs, food quality and customer service. The Company anticipates that the opening of additional restaurants will result in additional expenses associated with managing operations located in multiple markets. Furthermore, the Company believes that competition for unit-level management has become increasingly intense as additional restaurant chains expand to new markets. Achieving consumer awareness and market acceptance will require substantial efforts and expenditures by the Company. An extraordinary amount of management's time may be drawn to such matters and may adversely affect operating results. The Company is considering potential sites in Las Vegas and Chicago, but there can be no assurance that the Company will be able to enter into any other contracts for development of additional restaurants on terms satisfactory to the Company or at all. Accordingly, there can be no assurance that the Company will be able to open new restaurants or that, if opened, those units can be operated profitably. RESTAURANT AND RETAIL INDUSTRY COMPETITION The restaurant and specialty retail businesses are highly competitive. The restaurant industry is highly competitive with respect to price, service, quality and location and, as a result, has a high failure rate. There are numerous well-established competitors, including national, regional and local restaurant chains, possessing substantially greater financial, marketing, personnel and other resources than the Company. There can be no assurance that the Company will be able to successfully respond to various competitive factors affecting the restaurant industry. The restaurant industry is also generally affected by changes in consumer preferences, 7 9 national, regional and local economic conditions and demographic trends. The performance of restaurant facilities may also be affected by factors such as traffic patterns, demographic considerations, and the type, number and location of competing facilities. In addition, factors such as inflation, increased labor and employee benefit costs, and the availability of experienced management and hourly employees may also adversely affect the restaurant industry in general and the Company in particular. Restaurant operating costs are further affected by increases in the minimum hourly wage, unemployment tax rates and similar matters over which the Company has no control. The theme retail business is also highly competitive, particularly in locations experiencing an oversupply of retail businesses. Hotel Discovery would compete with a number of well-established specialty retailers possessing significantly greater financial, marketing, personnel and other resources than the Company. LONG-TERM, NON-CANCELABLE LEASES The Company has entered into long-term leases relating to the Kenwood Unit and the Mall of America Unit. These leases are non-cancelable by the Company (except in limited circumstances) and range in term from 12 to 15 years. Additional restaurants developed by the Company are likely to be subject to similar long-term, non-cancelable leases. If the Kenwood Unit, the Mall of America Unit or any other future restaurant does not perform at a profitable level and the decision is made to close that unit, the Company may nonetheless be committed to perform its obligations under the applicable lease, which would include, among other things, payment of the applicable base rent for the balance of the respective lease term. If such a termination were to occur at one or more of these locations, the Company could lose a restaurant without necessarily receiving an adequate return on its investment. See "Description of Leases." CONTROL OF THE COMPANY Following this offering, Stephen D. King will control approximately 28.5% of the Company's Common Stock, assuming all of the shares offered hereunder are sold. See "Principal Shareholders." Thus Mr. King will have the ability to substantially influence the election of members of the Board of Directors and to direct the operations and financial affairs of the Company. GOVERNMENT REGULATION The restaurant business is subject to various federal, state and local government regulations, including those relating to the sale of food and alcoholic beverages. The failure to maintain food and liquor licenses would have a material adverse effect on the Company's operating results. In addition, restaurant operating costs are affected by increases in the minimum hourly wage, unemployment tax rates, sales taxes and similar costs over which the Company has no control. Many of the Company's restaurant personnel will be paid at rates based on the federal minimum wage. Increases in the minimum wage would result in an increase in the Company's labor costs. The Company will be subject to "dram shop" statutes in certain states, including Minnesota and Ohio, which generally provide a person injured by an intoxicated person the right to recover damages from the establishment that served alcoholic beverages to the intoxicated person. The Company has obtained liability insurance against such potential liability. TRADEMARKS The Company's ability to successfully implement its Hotel Discovery concept will depend in part upon its ability to protect its trademarks. The Company has filed a trademark application with the United States Patent and Trademark Office to register the "Hotel Discovery" mark and design. There can be no assurance that the Company will be granted trademark registration for any or all of the proposed uses in the Company's applications. In the event the Company's mark is granted registration, there can be no assurance that the Company can protect such mark and design against prior users in areas where the Company conducts or will conduct operations. There is no assurance that the Company will be able to prevent competitors from using the same or similar marks, concepts or appearance. 8 10 SUBSTANTIAL DILUTION Purchasers of the securities offered hereby will experience immediate substantial dilution of $3.25 per share in net tangible book value per share of Common Stock if all of the shares offered hereby are sold. See "Dilution." DIVIDENDS NOT LIKELY At the present time, the Company intends to use earnings, if any, to finance further growth of the Company's business. Accordingly, investors should not purchase the shares with a view toward receipt of dividends. LACK OF PUBLIC MARKET; DETERMINATION OF OFFERING PRICE Prior to this Offering, there has been no public market for the Company's securities. Although the Company has applied for listing of the Common Stock on the Nasdaq SmallCap Market, there can be no assurance that an active public market will develop or be sustained. In addition, the SmallCap Market may be significantly less liquid than the Nasdaq National Market. If the Company fails to maintain the standards for quotation, the Company's securities could be removed from the market and traded in the over-the-counter market. As a result, an investor would find it more difficult to dispose of, or obtain accurate quotations as to the price of, the securities. In addition, if the Company fails to maintain its qualification for the Units to trade on the Nasdaq SmallCap Market, the Units will be subject to certain rules of the Securities and Exchange Commission relating to "penny stocks." Such rules require broker-dealers to make a suitability determination for purchasers and to receive the purchaser's prior written consent for a purchase transaction, thus restricting the ability of purchasers and broker-dealers to sell the stock in the open market. The offering price of the Units has been arbitrarily determined by negotiation between the Company and the Underwriter and bears no relationship to the Company's current operating results, book value, net worth or financial statement criteria of value. The factors considered in determining the offering price included an evaluation by management of the history of and prospects for the industry in which the Company competes and the prospects for earnings of the Company. Such factors are largely subjective, and the Company makes no representation as to any objectively determinable value of the Units offered hereby. See "Underwriting". CURRENT PROSPECTUS AND STATE REGISTRATION REQUIRED TO EXERCISE WARRANTS; POSSIBLE REDEMPTION OF WARRANTS Purchasers of Units will be able to exercise the Class A Warrants only if a current prospectus relating to the shares of Common Stock underlying the Class A Warrants is then in effect and only if such securities are qualified for sale or exempt from qualification under the applicable securities laws of the states in which the various holders of Class A Warrants reside. Although the Company will use its best efforts to (i) maintain the effectiveness of a current prospectus covering the shares of Common Stock underlying the Class A Warrants and (ii) maintain the registration of such Common Stock under the securities laws of the states in which the Company initially qualifies the Units for sale in the Offering, there can be no assurance that the Company will be able to do so. The Company will be unable to issue shares of Common Stock to those persons desiring to exercise their Class A Warrants if a current prospectus covering the shares issuable upon the exercise of the Class A Warrants is not kept effective or if such shares are not qualified nor exempt from qualification in the states in which the holders of the Warrants reside. The Class A Warrants are subject to redemption at any time by the Company at $.01 per Warrant 90 days after the Effective Date, on 30 days' prior written notice, if the average closing bid price of the Common Stock shall exceed $7.00 (subject to adjustment), for 14 consecutive trading days, at any time prior to such notice and provided a current prospectus covering the shares is then effective under federal securities laws. If the Class A Warrants are redeemed, Warrant holders will lose their right to exercise the Warrants except during such 30-day redemption period. Redemption of the Class A Warrants could force the holders to 9 11 exercise the Class A Warrants at a time when it may be disadvantageous for the holders to do so or to sell the Class A Warrants at the then market price or accept the redemption price, which is likely to be substantially less than the market value of the Class A Warrants at the time of redemption. See "Description of Securities -- Class A Warrants." UNDERWRITER'S WARRANT The Company has agreed to sell to the Underwriter, for nominal consideration, a five-year warrant to purchase up to 220,000 shares of Common Stock at 120% of the Price to Public. As long as the Underwriter's Warrant or other outstanding warrants remain unexercised, the Company's ability to raise additional capital may be adversely affected. See "Underwriting." UNDESIGNATED STOCK The Company's authorized capital consists of 100,000,000 shares of capital stock. The Board of Directors, without any action by the Company's stockholders, is authorized to designate and issue shares in such classes or series (including classes or series of preferred stock) as it deems appropriate and to establish the rights, preferences and privileges of such shares, including dividends, liquidation and voting rights. The Company currently has 5,399,289 shares of Common Stock outstanding and has authorized the issuance of an additional 2,875,000 shares of Common Stock in contemplation of this Offering. A further 4,139,955 shares of Common Stock have been authorized for the following: (i) 2,500,000 shares issuable upon the exercise of the Class A Warrants being issued as part of this Offering (2,875,000 if the Underwriter's over-allotment option is exercised in full), (ii) 250,000 shares issuable upon the exercise of the Underwriter's Warrant, (iii) 214,955 shares of Common Stock issuable upon exercise of warrants; (iv) 750,000 shares reserved for issuance under the Company's 1997 Stock Option and Compensation Plan, of which options relating to 502,666 shares are currently outstanding, and (v) 50,000 shares of Common Stock issuable upon exercise of directors' stock options. No other class of common stock or preferred stock is currently designated and there is no current plan to designate or issue any such securities. The rights of holders of preferred stock and other classes of common stock that may be issued may be superior to the rights granted to the holders of the Units. The ability of the Board of Directors to designate and issue such undesignated shares could impede or deter an unsolicited tender offer or takeover proposal regarding the Company. Further, the issuance of additional shares having preferential rights could adversely affect the voting power and other rights of holders of Common Stock. SHARES ELIGIBLE FOR FUTURE SALE The sale, or availability for sale, of substantial amounts of Common Stock in the public market subsequent to this offering may adversely affect the prevailing market price of Common Stock and may impair the Company's ability to raise additional capital by the sale of its equity securities. The Company and its directors, executive officers and 5% shareholders have agreed that they will not sell nor grant any option for the sale of or otherwise dispose of any shares of Common Stock for 180 days after the Effective Date without the prior written consent of the Underwriter. It is expected that 4,438,288 shares of the Company's Common Stock which were sold in reliance on "private placement" exemptions under the Securities Act of 1933, as amended (the "1933 Act") will become eligible for sale pursuant to Rule 144 under the 1933 Act as follows: 1,857,001 shares on the Effective Date (except that holders of 1,510,933 of such shares have agreed not to sell or otherwise dispose of such shares for 90 days after the Effective Date), 1,092,400 shares in the fourth quarter of 1997 (except that the holders of such 1,092,400 shares have agreed not to sell or otherwise dispose of such shares for 90 days after the Effective Date), 800,685 shares in the second quarter of 1998, and 739,203 shares in the third quarter of 1998. See "Description of Securities -- Shares Eligible for Future Sale." In connection with this Offering, certain officers and directors of the Company have agreed to escrow a portion of their shares with the State of Minnesota for three years or until (i) the Company meets certain earnings requirements established by the State of Minnesota, or (ii) the State of Minnesota determines that the escrow agreement is no longer necessary. 10 12 MINNESOTA ANTI-TAKEOVER LAW The Company is subject to Minnesota statutes regulating business combinations and restricting voting rights of certain persons acquiring shares of the Company, which may hinder or delay a change in control of the Company. USE OF PROCEEDS The net proceeds to be received by the Company from this Offering, after deducting estimated costs and expenses of the Offering, are estimated to be approximately $11,030,000 ($12,717,500 if the Underwriter's over-allotment option is exercised in full). The Company intends to utilize the net proceeds as follows: Further concept development................................. $ 300,000 Development and construction of the Mall of America Unit.... 4,500,000 Development and construction of a third Hotel Discovery restaurant at an unidentified site........................ 4,500,000 Working capital............................................. 1,730,000 ----------- Total....................................................... $11,030,000 ===========
NEW FACILITIES The Company intends to apply at least $9,000,000 of the net proceeds to develop and open two new Hotel Discovery restaurants. The Company currently estimates that the average cost of developing and opening new Hotel Discovery restaurants, including equipment, furniture, fixtures and pre-opening expenses, will range from $4,000,000 to $4,500,000 per facility, net of landlord contributions, depending upon location, site conditions, construction costs, and the level of landlord contributions to a facility. There can be no assurance that the Company will be able to develop and open new Hotel Discovery restaurants at such costs. GENERAL The foregoing represents the Company's best estimate of its allocation of the net proceeds of this Offering, based upon the current state of its business operations, its current plans and current economic and industry conditions. These estimates are subject to change based on unanticipated levels and types of competition, adverse market trends and new business opportunities. Any material revisions in the allocation of proceeds will be made at the discretion of the Board of Directors. The Company believes the net proceeds from this Offering, together with cash generated from operations, will be sufficient to meet the Company's capital needs for at least 12 months, in connection with the Company's plans to develop the Mall of America Unit and the third restaurant Unit. Pending the use of the proceeds of this Offering, the Company intends to invest the proceeds in short-term, high quality, interest-bearing instruments. If the Underwriter exercises the over-allotment option in full, the Company will realize additional net proceeds of approximately $1,687,500. Such additional net proceeds will be added to the Company's working capital. 11 13 DILUTION As of June 29, 1997, the Company's net tangible book value was $1,886,799 or approximately $0.39 per share of Common Stock. "Net tangible book value" represents the tangible assets of the Company less all liabilities. Without giving effect to any other changes in net tangible book value after June 29, 1997, other than to give effect to (i) the sale of the securities offered hereby (assuming the entire offering price of the Units is allocated to the Common Stock), and (ii) the application of the net proceeds therefrom, the tangible book value as of June 29, 1997 would have been $12,916,799, or approximately $1.75 per share. This represents an immediate increase to existing shareholders in net tangible book value of approximately $1.36 per share and an immediate dilution to new shareholders of $3.25 per share. "Dilution" represents the difference between the amount per share paid by purchasers in this Offering and pro forma net tangible book value per share of the Common Stock after this Offering. The following table illustrates the per share dilution to new investors as of June 29, 1997: Public offering price....................................... $5.00 Net tangible book value before offering..................... $0.39 Increase in net tangible book value attributable to new investors................................................. 1.36 ----- Pro forma net tangible book value after the offering........ 1.75 ----- Dilution in net tangible book value to new investors(1)..... $3.25 =====
- ------------------------- (1) The dilution in net tangible book value per share to new investors, assuming the Underwriter's over-allotment option is fully exercised, would be $3.12. The following table summarizes the differences between the existing shareholders and the new investors with respect to the number of shares of Common Stock purchased from the Company, the total cash consideration paid, and the average cash consideration per share of Common Stock paid (assuming the entire offering price of the Units is allocated to the Common Stock).
TOTAL CASH SHARES PURCHASED(1) CONSIDERATION ------------------- --------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ------ ------- ------ ------- ------------- Founding Investors....................... 3,000,000 38.0% $ 2,500,000 11.3% $0.83 Private Placement Investors.............. 2,399,289 30.4 7,197,867 32.4 3.00 New Investors............................ 2,500,000 31.6 12,500,000 56.3 5.00 --------- ----- ----------- ----- Total............................... 7,899,289 100.0% $22,197,867 100.0% ========= ===== =========== =====
- ------------------------- (1) The foregoing table takes into account the July 1997 sale of 499,804 shares of Common Stock at $3.00 per share but does not take into consideration: (i) 375,000 Units subject to the Underwriter's over-allotment option; (ii) 250,000 shares of Common Stock issuable upon exercise of the Underwriter's Warrant at 120% of the Price to Public; (iii) 2,500,000 shares of Common Stock which are issuable upon the exercise of the Class A Warrants at an exercise price of $6.50 per Warrant; (iv) 214,955 shares of Common Stock issuable upon exercise of warrants at an exercise price of $3.75 per warrant; (v) 750,000 shares of Common Stock reserved for issuance under the Company's 1997 Stock Option and Compensation Plan, of which options relating to 502,666 shares are currently outstanding at exercise prices ranging from $3.00 to $3.34 per share; and (vi) 50,000 shares of Common Stock issuable upon exercise of directors' stock options at an exercise price of $3.34 per share. 12 14 DIVIDEND POLICY The Company has never declared or paid any cash dividends on its Common Stock, and the Board of Directors presently intends to retain all earnings, if any, for use in the Company's business for the foreseeable future. Any future determination as to declaration and payment of dividends will be made at the discretion of the Board of Directors. CAPITALIZATION The following table sets forth the capitalization of the Company as of June 29, 1997, as further adjusted to give effect to the sale of the Units offered hereby and the anticipated application by the Company of the proceeds therefrom.
PRO FORMA ACTUAL PRO FORMA(1) AS ADJUSTED(2) ------ ------------ -------------- Long-term debt: Long-term debt, net................................. $ 895,870 $ 895,870 $ 895,870 Convertible debt(3)................................. 150,000 150,000 150,000 ----------- ----------- ----------- Total long-term debt........................... 1,045,870 1,045,870 1,045,870 ----------- ----------- ----------- Stockholders' equity: Common stock, $.01 par value; 100,000,000 shares authorized; 4,899,485 shares issued and outstanding; 5,399,289 pro forma; 7,599,289 as adjusted......................................... 48,995 53,993 78,993 Additional paid-in capital.......................... 7,581,231 8,976,233 19,981,233 Common stock subscribed............................. (600,000) (600,000) (600,000) Accumulated deficit................................. (5,123,427) (5,123,427) (5,123,427) ----------- ----------- ----------- Total stockholders' equity..................... 1,906,799 3,306,799 14,336,799 ----------- ----------- ----------- Total capitalization........................... $ 2,952,669 $ 4,352,669 $15,382,669 =========== =========== ===========
- ------------------------- (1) Assumes completion on June 29, 1997 of the sale of 499,804 shares of Common Stock at $3.00 per share for net proceeds of approximately $1,400,000 which was completed in July 1997. (2) As adjusted for the sale of the Units offered hereby and the anticipated application of the net proceeds therefrom. Does not include: (i) 375,000 Units subject to the Underwriter's over-allotment option; (ii) 250,000 shares of Common Stock issuable upon exercise of the Underwriter's Warrant at 120% of the Price to Public; (iii) 2,500,000 shares of Common Stock which are issuable upon the exercise of the Class A Warrants at an exercise price of $6.50 per Warrant; (iv) 214,955 shares of Common Stock issuable upon exercise of warrants at an exercise price of $3.75 per warrant; (v) 750,000 shares of Common Stock reserved for issuance under the Company's 1997 Stock Option and Compensation Plan, of which options relating to 502,666 shares are currently outstanding at exercise prices ranging from $3.00 to $3.34 per share; and (vi) 50,000 shares of Common Stock issuable upon exercise of directors' stock options at an exercise price of $3.34 per share. (3) Convertible into 39,600 shares of Common Stock at maturity on July 1, 1999. 13 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in connection with the Company's financial statements and related notes thereto included elsewhere in this Prospectus. OVERVIEW The Company was formed in January 1994 as an Ohio corporation to develop, own and operate upscale, casual theme restaurants under the name "Hotel Discovery." The Company opened its first restaurant in the Kenwood Shopping Center in Cincinnati, Ohio in December 1996. Prior to opening the Kenwood Unit, the Company had no revenues and its activities were devoted solely to development. The Company is presently developing a unit in the Mall of America in Bloomington, Minnesota. Future revenue and profits, if any, will depend upon various factors, including market acceptance of the Hotel Discovery concept, the quality of the restaurant operations, the ability to expand to multi-unit locations and general economic conditions. The Company's present sources of revenue are limited to its existing unit. There can be no assurances the Company will successfully implement its expansion plans, in which case it will continue to be dependent on the revenues from the existing unit. The Company also faces all of the risks, expenses and difficulties frequently encountered in connection with the expansion and development of a new and expanding business. Furthermore, to the extent that the Company's expansion strategy is successful, it must manage the transition to multiple site operations, higher volume operations, the control of overhead expenses and the addition of necessary personnel. The Company has adopted a 52/53 week accounting period ending on the Sunday nearest December 31 of each year. RESULTS OF OPERATIONS The Company had no revenues or operations during the period from January 13, 1994 (Inception) to December 19, 1996 (the opening of the Kenwood Unit). Accordingly, comparisons to periods prior to December 19, 1996 are not meaningful. Total Revenues -- The Kenwood Unit opened in December 1996. For the year ended December 29, 1996, the Company had total sales of $104,129 compared with $1,864,564 for the 26 weeks ended June 29, 1997. Costs and Expenses -- For the year ended December 31, 1995, the Company had a net loss of $940,466. For the year ended December 29, 1996, the Company had a net loss of $2,327,602 compared with a net loss of $1,681,691 for the 26 weeks ended June 29, 1997. The net losses for 1995 and 1996 are largely attributable to concept development and pre-opening costs totaling $923,482 and $1,970,452 for each period, respectively. The net loss for the 1997 period is largely attributable to additional expenses as the Company increases its corporate overhead structure for the development of additional locations supported by revenues from a single operating unit. On February 1, 1997, the Company entered into an employment agreement with an executive officer requiring the payment of annual compensation totaling $200,000 per year. This agreement, and continued increases in the Company's corporate overhead, will impact general and administrative expenses on an ongoing basis. 14 16 OPERATING RESULTS OF THE KENWOOD UNIT During the period from the commencement of Kenwood Unit operations (December 19, 1996) to December 29, 1996, food and beverage costs were $43,324 or 41.6% of sales compared with $612,115 or 32.8% of sales for the June 29, 1997 period. The improvement in food and beverage costs as a percentage of sales is due primarily to improved operating efficiencies. Labor, benefits and other direct restaurant operating expenses were $241,239 or 231.7% of sales during the period from the commencement of Kenwood operations (December 19, 1996) to December 29, 1996, compared to $1,638,357 or 87.9% of sales during the 26 weeks ended June 29, 1997. This improvement in restaurant operating expenses as a percentage of sales is due primarily to improved labor management and other operating efficiencies and increased sales. Although no assurances can be given, management believes that the Kenwood Unit's current level of sales, trained workforce and general operation will continue to improve unit level performance in future periods. LIQUIDITY AND CAPITAL RESOURCES The Company has met its capital requirements through the sale of Common Stock to and borrowings from its principal shareholder, Stephen D. King, the private placement of common stock and debt, and through revenues from operations. During the period from January 13, 1994 (Inception) through September 1995, the Company's predecessor sold 1,750 shares of Common Stock to Mr. King and another individual for nominal consideration, which shares were split 825-to-1 in November 1996. During the years ended December 29, 1996 and December 31, 1995, the maximum amount of borrowings from Mr. King outstanding at any time was $1,213,469 and $862,891, respectively. At year end December 29, 1996, and December 31, 1995, the amount of such outstanding indebtedness was $447,787 and $862,891, respectively. Included in these amounts were concept development costs reimbursed to a demonstration restaurant owned and operated by Mr. King in the amount of $278,101 for the year ended December 29, 1996 and $433,996 for the year ended December 31, 1995. The Company paid interest of 11.5% on all such advances. In October 1995, Kenwood Restaurant Limited Partnership, an Ohio limited partnership formed in June 1995 (the "Kenwood Partnership"), raised $2.5 million in a private placement of 250 shares of Common Stock of the Company's predecessor (which shares were split 825-to-1 in November 1996, and now represent 206,250 shares of the Company) and limited partnership interests in the Kenwood Partnership. In a reorganization of the Company which occurred in November 1996, the Kenwood Partnership contributed all of its assets to the Company's predecessor, including the Kenwood Unit, in exchange for 1,350,000 shares of Common Stock of the Company. From November 1996 through July 1997, the Company's predecessor completed private placements of an aggregate of 2,392,889 shares of Common Stock at $3.00 per share. The net proceeds were approximately $5.9 million. Such proceeds have been, and will be, used for new and additional features for the Kenwood Unit, repayment of indebtedness, working capital and development of the planned Mall of America Unit. For the year ended December 31, 1995, the year ended December 29, 1996 and the 26 weeks ended June 29, 1997, the Company used $932,549, $1,024,187 and $2,387,424, respectively, in cash flow for operating activities. Since Inception, the Company's principal capital requirements have been the funding of (i) the development of the Company and the Hotel Discovery concept, (ii) the construction of the Kenwood Unit and the acquisition of furniture, fixtures and equipment therein and (iii) the development of the Mall of America Unit. Total capital expenditures for the Kenwood Unit were approximately $4.7 million. When completed, the Company estimates that capital expenditures for the Mall of America Unit will be approximately $4.5 million, net of landlord contributions of $1.6 million. The unit is expected to be complete in the second quarter of 1998. 15 17 The Company borrowed $1.0 million under a leasehold mortgage term loan from a bank, which is personally guaranteed by Mr. King. This financing was used for the Kenwood Unit. Principal and interest are due monthly through October 1999, at which time the remaining balance is due in full. This loan had an outstanding principal balance of $965,290 on June 29, 1997. In December 1996, the Company borrowed an additional $2.5 million under a mortgage term loan from a bank. Payments of interest only were due through January 1998, at which time the entire principal balance was due. This loan was paid in full on January 31, 1997. In May 1997, the Company borrowed $2.0 million on a 13-month term note, with interest only payable monthly at the rate of 7.15%. This note was guaranteed by Mr. King and was fully secured by substantially all of the Company's assets. This note was repaid in full in July 1997. On June 23, 1997, the Company borrowed $800,000 from Provident Bank, which is fully secured by substantially all of the Company's assets. The loan bears interest at 2% over the bank's reference rate payable monthly. The loan was personally guaranteed by Mr. King. This loan was repaid in full in July 1997. After development of the two units funded by this offering, future development and expansion will be financed through cash flow from operations and other forms of financing such as the sale of additional equity and debt securities, capital leases and other credit facilities. There are no assurances that such financing will be available on terms acceptable or favorable to the Company. 16 18 BUSINESS GENERAL Hotel Discovery, Inc. is a Minnesota corporation which was formed to develop, own and operate upscale casual theme restaurants. The Company was formed in January 1994 as an Ohio corporation, prior to reorganizing as a Minnesota corporation, and operates one Hotel Discovery restaurant in the Kenwood Shopping Center in Cincinnati, Ohio, which opened in December 1996. A second restaurant to be located at the Mall of America in a suburb of Minneapolis, Minnesota, is currently under development. The Company also has a license agreement with Eastgate Restaurants, Inc., a corporation wholly-owned by Stephen D. King, for the operation of a demonstration and test restaurant in Cincinnati which opened in June 1994. HOTEL DISCOVERY CONCEPT Hotel Discovery restaurants will serve the rapidly emerging upscale casual segment of the restaurant industry. Each Hotel Discovery restaurant will combine two contemporary trends within the restaurant industry by incorporating the entertainment features of restaurants such as Planet Hollywood, Rainforest Cafe and Dave & Buster's with the upscale casual attributes of restaurants like Palomino and The Cheesecake Factory. The Hotel Discovery concept is carefully designed to provide guests with a new and innovative dining concept providing noteworthy food, superior service and genuinely imaginative surroundings and special effects. Hotel Discovery restaurants will contain visual and audio effects providing a unique sight and sound experience. Management believes the Hotel Discovery restaurant ambiance and entertainment quality strongly differentiate its concept from traditional casual segment restaurants such as Applebee's, Bennigan's, Chili's and Friday's and goes beyond the simple food service-only concept of a typical theme restaurant. THE CONCEPT AND THE KENWOOD UNIT Hotel Discovery is designed around the concepts of adventure, imagination, exploration and invention. It is based on a foundation of superior food and excellent service coupled with soft, sophisticated, non-intrusive entertainment. The surroundings and extensive self-entertainment aspects within Hotel Discovery restaurants, such as videos corresponding to each dining room, provide guests with soft discovery experiences that allow them to actively and passively participate in quality dining experiences. Imaginary places, myths, and legends intended to pique guests' individual interests provide a unique land of awareness, enjoyment, and entertainment to guests of Hotel Discovery. Specially designed furnishings and decorations, along with specially arranged audio-visual presentations, are carefully orchestrated to transport guests along imaginative dining journeys. The guest's voyage begins the moment he or she enters the restaurant and sees a hologram of an old-time sailing ship rocking on ocean waves. The guest is greeted by the concierge and then introduced to his or her adventure guide, who seats the guest in one of four distinctly different dining rooms: the Mapping Room, the Safari Room, the Artist Loft, or the Observatory. Features of Hotel Discovery include the sights and sounds of state-of-the-art video and audio systems, as well as more tangible entertainment items such as aquariums, waterfalls, a 25-foot moving whale's tail, space shuttle, a star dome with fiber optic lights, an artist's work in progress and African masks with moving eyes. While guests venture through the many different aspects of Hotel Discovery at their leisure, they are able to experience destinations both real and imaginary within any of the four dining rooms. ADDITIONAL CONCEPT DEVELOPMENT In July 1997, the Company entered into an agreement with The Cuningham Group, an architectural and engineering firm based in Minneapolis, Minnesota, to assist the Company with Hotel Discovery concept development and rollout. The Cuningham Group offers full design and build services and the Company believes that it is a leading firm in the growing restaurant entertainment segment. Clients of The Cuningham Group in the restaurant and entertainment industries include Rainforest Cafe, Grand Casinos, Hilton Hotels, Paramount Studios, Steven Spielberg, MCA, IMAX Corporation, Harrah's Entertainment, Knott's Berry Farm, Walt Disney Company, Universal Studios and Six Flags. 17 19 THE CONCEPT AND THE MALL OF AMERICA UNIT The Company has obtained a lease for a 16,000-square-foot Hotel Discovery restaurant to be located on the third floor of the Mall of America in Bloomington, Minnesota, a suburb of Minneapolis (the "Mall of America Unit"). The Mall of America Unit will feature a 200-foot-long, curved front elevation that is planned to include waterfalls, stone masonry, brick and stucco which will symbolize the evolution of building materials through the centuries. As currently under development, the entrance will be very open and inviting, with a large replica of a sailing ship framing the retail merchandise area on one side and a half wall of rock with water fountains leading into the Discovery Club Bar on the other. The bar will be used to entertain guests who are waiting to be seated in the dining rooms and is expected to feature a stylized, partially open globe that will be large enough for guests to actually sit inside and enjoy sound and lighting effects. [FLOOR PLAN OF THE MALL OF AMERICA UNIT*] [BLUEPRINT OF MALL OF AMERICA UNIT] * subject to change. The themes of imagination, invention, adventure and exploration will be carried forward and expanded to represent a period and place for each of three dining rooms. As currently planned, the Atlantis Room will transport diners to a sanctum submerged beneath the ocean. The Serengheti Room will recall the natural splendor of the famous Serengheti plains from the vantage point of a luxuriously appointed veranda. The Machu Picchu Room, with massive stone ruins and primitive wooden structures, will evoke the mysterious Incan city in the clouds. RETAIL COMPONENT The retail area of a Hotel Discovery restaurant is located at the entrance of the facility. All restaurant patrons will have to pass by merchandise on their way to and from the dining areas. The retail component of the Hotel Discovery concept at the Kenwood Unit includes a collection of adult and children's casual clothing, including T-shirts, sweat shirts, shirts and caps, and a limited amount of other logo merchandise. The Mall of America Unit will display a much larger selection of merchandise which will be centered around the four themes of imagination, invention, exploration and adventure as expressed in the four dining rooms. Such merchandise is expected to include educational toys and games, stationery, prints, telescopes, art materials, jewelry, primitive musical instruments, gift items and travel and hotel memorabilia. The Company believes that its unique theme will generate significant consumer identification similar to the retail items sold by other restaurant/retail facilities. 18 20 EXPANSION PLANS; LOCATION SELECTION Management believes the Hotel Discovery concept is ideally targeted to the upscale mall and resort area customer segment. Future expansion activities will be concentrated in locations which exhibit large upper and upper middle class demographics and malls containing upscale, quality retailers and upscale casual restaurants. In addition, the large size of planned Hotel Discovery restaurants will necessitate locations in areas with significant tourist as well as local traffic. Several leading leasing managers of upscale malls have expressed interest in having a Hotel Discovery restaurant as a tenant. The Company currently intends to aim future expansion at upscale malls or resort areas. AWARD-WINNING MENU The Hotel Discovery menu features items from around the world. In the 1997 Taste of Cincinnati festival, Hotel Discovery's Ebony Butterfly Medallions won "Best Entree" and another Hotel Discovery menu entry won honorable mention in the vegetarian category. Menu offerings include a variety of freshly prepared steaks, chicken, seafood, entree salads and pastas, all with an eclectic, international flair. The menu mirrors the exploratory journey and adventure society concept embodied in the restaurant itself. Management believes that continual guest feedback on the key attributes of food quality, menu variety, service and ambiance is crucial to Hotel Discovery's success. It is currently obtained by weekly tabulation of comment cards that are distributed with every guest check, an extensive mystery diner program and periodic marketing research and telephone interviews. This constant feedback enables Hotel Discovery management to monitor guest response to all areas of the operation and react accordingly. Great care is taken to ensure that only the finest and freshest meats, vegetables, spices and other ingredients are used in Hotel Discovery recipes. Hotel Discovery's freshly prepared menu items are designed to cater to the most discerning tastes consistent with the image of an upscale casual dining experience. RESTAURANT OPERATIONS Hotel Discovery strives to maintain quality through extensive training of its employees and careful supervision of personnel. The Company has developed, and expects to implement at each Hotel Discovery restaurant, operations in accordance with a detailed operating manual, which contains specifications relating to food and beverage preparation, maintenance of premises and employee conduct. Each restaurant is expected to have a director of operations, five to seven managers and a controller. The Company places emphasis on employee training and incentives. Problems of employee turnover, low morale and inconsistent performance have been worsening within the restaurant industry in recent years. The Company believes that many of these problems can be lessened through extensive training, both initially and on an ongoing basis. Hotel Discovery training begins with classroom sessions that immerse new employees in Company food, beverage and service standards and guest communication guidelines. Each prospective guest service employee actually tastes, and is tested on, every food and beverage item on the menu. Daily shift meetings are held prior to lunch and dinner to communicate daily specials and feedback from comment cards and to reinforce service standards. MANAGEMENT AND FINANCIAL CONTROLS Hotel Discovery has implemented specific management control features for employee follow-up, customer satisfaction, and financial results. These controls are described below. Employee Follow-up. Shift schedules are posted weekly for each position in the restaurant. Each shift is managed by a scheduled manager. Managers are responsible for executing job functions and following a thorough and complete checklist for each category of the restaurant. Checklists review the appearance of the outside of the restaurant, the dining room, kitchen and restrooms as well as dining room service and food preparation. Regular one-on-one meetings are held with employees and feedback as to their performance is given on a regular and consistent basis. This feedback includes positive reinforcement as well as redirection when a change in focus is needed. In addition, the restaurant's director of operations holds a weekly quality 19 21 circle luncheon for key employees from each position in the restaurant. The President of the Company also holds a quarterly "town meeting" with selected employees to ensure that a strong communications system between the corporate office and the field is in place. Customer Satisfaction. Similar checklists are used to ensure that guests receive a high level of service and food quality. In addition, floor management is conducted during all peak seating periods by management. Management's incentives include a bonus based upon a percentage of cash flow and/or profitability. These incentives enable the manager to act and work as a "partner." It is this type of pay-for-performance system that will allow the results of Hotel Discovery restaurants to mirror those of an entrepreneurially owned and operated business. Financial Controls. Financial controls are monitored through a computer software system that is state-of-the-art for tracking sales, food costs, labor, and guest lists. All of this data is reviewed on a daily, weekly and monthly basis, enabling management to react promptly to correct deviations and capitalize on trends. COMPETITION The food service industry is intensely competitive with respect to food quality, concept, location, service and price. In addition, there are many well-established food service competitors with substantially greater financial and other resources than the Company and with substantially longer operating histories. The Company believes that it competes with other full-service dine-in restaurants, take-out food service companies, fast-food restaurants, delicatessens, cafeteria-style buffets and prepared food stores, as well as with supermarkets and convenience stores. Competitors include national, regional and local restaurants, purveyors of carry-out food and convenience dining establishments. Competition in the food service business is often affected by changes in consumer tastes, national, regional, and local economic and real estate conditions, demographic trends, traffic patterns, the cost and availability of labor, purchasing power, availability of product and local competitive factors. The Company attempts to manage or adapt to these factors, but it should be recognized that some or all of these factors could cause the Company to be adversely affected. Management is of the opinion that quality food pleasingly presented is an absolute requirement within the upscale casual segment of the market. THE UPSCALE CASUAL DINING SEGMENT The Hotel Discovery concept is positioned squarely in the upscale casual segment of the dining-out industry. Virtually all the successful upscale casual chains in the full service restaurant industry locate in major metropolitan areas and most typically within or contiguous to a high-traffic, upscale regional mall or resort area. While mall traffic in general has been sporadic or declining in recent years as the "big box" concept in retailing drains potential customers away from malls, the regional mall still remains a viable concept for fulfilling customer needs. In actuality, the declining customer count within the regional mall has created an opportunity for the upscale casual segment of the restaurant industry. Landlords desiring to increase traffic within the upscale mall have shown a willingness to provide restaurants with generous "add backs" or "give ups" to locate within a specific mall in order to increase the traffic flow, thereby creating an advantageous situation for both the mall developer as well as the restaurant investor. Although price is not the most important determinant to customer count within this $15 per average check niche, value is. The Hotel Discovery menu is extensive, varied, innovative, original and constantly evolving, using only the freshest ingredients coupled with a pleasing presentation. The surroundings are high-energy and casual with efficient, attentive and friendly service. Rather than merely a place to consume food, the concept appeals to all the senses through video, audio and entertainment features. While the dining-out industry as a whole has shown relatively sluggish growth over the last few years, the segment of the industry targeted by Hotel Discovery has recently shown rapid growth. Since the mid-1980s the top 20% of households have been increasing their share of total income. While this trend has had a profound effect on retailing in general, the effect on various segments of the restaurant industry has also been 20 22 quite pronounced. An increase in the frequency of meals consumed away from home and a significantly larger average check have been observed. GOVERNMENT REGULATIONS Hotel Discovery restaurants are subject to federal, state and local laws affecting the operation of its restaurants, including zoning, health, sanitation and safety regulation and alcoholic beverage licensing requirements. Each restaurant is operated in accordance with standardized procedures designed to assure compliance with all applicable codes and regulations. The suspension of food service or liquor license would cause an interruption of operations at the affected restaurant. The Company believes that it is in compliance with all licensing and other regulations. The Company is also subject to the Fair Labor Standards Act, which governs minimum wages, overtime and working conditions. A significant portion of Hotel Discovery restaurant employees are paid at rates relating to federal minimum wage. Accordingly, an increase in the minimum wage would directly increase each restaurant's labor cost. Obtaining alcoholic beverage licenses from various jurisdictions will require disclosure of certain detailed information about directors, officers and greater than 10% shareholders of the Company's equity securities, and will necessitate that such persons be approved by the appropriate liquor licensing authority. The Kenwood Unit LOCATION The Kenwood Unit is located in the recently refurbished Sycamore Plaza at Kenwood Shopping Center, a premier location in Cincinnati, Ohio, and opened for business on December 19, 1996. The restaurant contains approximately 17,000 square feet on three levels and is located at the northeast corner of the Shopping Center Plaza. The Company leases the site upon which the restaurant is constructed. The Kenwood Unit was open for dinner on December 19, 1996 and for lunch on January 4, 1997. For the 26 weeks ended June 29, 1997, the Kenwood Unit had total sales of $1,864,564. DESCRIPTION OF LEASE The initial term of the lease is for 15 years. In addition, the Company has the right to extend the term of the lease for two additional terms of five years each, exercisable not earlier than 12 months nor later than six months prior to the expiration of the initial term or first option period, as applicable. The lease provides for the payment of both a monthly fixed minimum rent and a percentage rent based on gross sales in excess of an escalating base amount. The monthly fixed minimum rent is $12,833 for the first five years of the lease, $14,117 for the sixth through tenth years, $15,400 for the eleventh through fifteenth years, $16,683 during the first five-year lease renewal term and $17,967 during the second five-year lease renewal term. In addition to the fixed minimum rent, the lease provides for the payment of a percentage rent equal to 4% of the gross sales from the restaurant in excess of the following annual gross sales amounts: $3,850,000 for the first five years of the lease, $4,235,000 for the sixth through tenth years, $4,620,000 for the eleventh through fifteenth years, $5,004,999 for the first five-year lease renewal term and $5,390,000 for the second five-year lease renewal term. The lease is a "triple net" lease and, in addition to the fixed minimum rent and percentage rent, the Company is required to pay its proportionate share of taxes, insurance, and maintenance and operation costs. Initially, the estimated annual amount payable with respect to taxes, maintenance and operating costs, and insurance is $4.15 a square foot, or approximately $32,000 per year. The landlord agreed to reimburse the Company in an amount up to $200,000 as a construction allowance for the completion of building and leasehold improvements within 30 days of the opening of the Kenwood 21 23 Unit. The Company expects to complete the necessary documentation to obtain such reimbursement in the near future. In addition, the landlord agreed that it will not construct any permanent facility within a designated no-build area outlined in the lease. This "no-build" area allows unimpaired visibility of the restaurant from both Kenwood Road and Montgomery Road. FINANCING OF THE KENWOOD UNIT The total cost of the Kenwood Unit, including additional features, was approximately $4.7 million. Approximately $2,475,000 of the cost of the restaurant was funded by the proceeds of a private placement in October 1995. Another $1,025,000 was financed by a private placement which was concluded in June 1997, $850,000 of which was spent on new additional features. Leasehold improvements in the amount of $200,000 will be financed by the landlord. An additional $1,000,000 was funded by a leasehold mortgage term loan (the "Loan") which was incurred by the Kenwood Restaurant Limited Partnership and assumed by the Company. The Loan is secured with a leasehold mortgage and lien on the assets of the restaurant and is guaranteed by Mr. King individually. The Loan bears interest at a floating rate which is currently 9.06% and provides for monthly payments of principal in the amount of $5,785 plus interest through October 1999, at which time the remaining balance is due in full. The Mall of America Unit LOCATION The Mall of America Unit will consist of a 16,000-square-foot restaurant located on the third floor of the Mall of America in Bloomington, Minnesota. The site is leased pursuant to a lease dated August 4, 1997 between Mall of America Company, a Minnesota general partnership, and the Company. The Mall of America opened in August 1992 with 266 tenants and now holds approximately 520 stores, merchandise carts and attractions, including four large anchor tenants (Macy's, Bloomingdale's, Sears and Nordstrom). The mall encompasses 4.2 million square feet on four enclosed floors, of which 2.5 million square feet are leasable, and employs 11,000 to 13,000 people, depending on the season. More than 93% of the leasable space is under contract, up from 71% five years ago. The mall draws an estimated 40 million visitors per year. Tourists account for 35% to 39% of mall traffic, which percentage increases up to 50% in the summer months. According to a recent article in the Minneapolis Star Tribune, the industry benchmark for success in prime shopping malls is $325 in annual sales per square foot, while stores in the Mall of America with fewer than 15,000 square feet (which includes most of the mall's tenants) average $450 in annual sales per square foot. This figure is partially offset by higher-than-average expenses, including property taxes and charges for common areas such as the rotunda and broad hallways. Mall development will increasingly focus on entertainment in order to maintain a strong flow of visitors to the mall. Since it opened in 1992, the mall has emerged as a laboratory for new retail and development concepts, including: - Knott's Camp Snoopy, the country's first indoor amusement park combined with a shopping center, - The first Rainforest Cafe, a tropical-theme restaurant with related entertainment and merchandise which has undergone three expansions since its 1994 opening and has since opened six other locations in the United States and in London, England; - Postmark America, the U.S. Postal Service's only retail store, and - Chrysler's Great Cars Great Trucks, a prototype showcase where shoppers can inspect vehicles and use touchscreen computers to price customized vehicles. Having successfully pioneered the Hotel Discovery concept at the Kenwood Unit, the management of the Company is optimistic that the Mall of America, with its reputation for innovation in retailing and entertainment, will be an ideal location to showcase the Company's continuing development of its highly-themed, entertainment-oriented Hotel Discovery restaurant concept. 22 24 DESCRIPTION OF MALL OF AMERICA LEASE The term of the lease is for 12 years, commencing on the earlier of (i) the day following the last day allowed to the Company for completion of remodeling of the leased space or (ii) the date on which the restaurant opens for business. The lease does not provide for renewal terms. The lease provides for the payment of either a minimum annual rent or a percentage rent based on gross sales. The minimum annual rent is $25 per square foot, or $405,375 per year based on approximately 16,215 square feet of leased area. The percentage rent is the amount by which 6% of gross sales exceeds minimum rent. The lease provides for waiver of the minimum annual rent for the first year of the lease. The landlord will also reimburse the Company for up to $1.6 million in leasehold improvements. The lease is a triple net lease and, in addition to the fixed minimum rent and percentage rent, the Company is required to pay its proportionate share of taxes, insurance, and maintenance and operation costs. EMPLOYEES As of August 22, 1997, the Company employed 133 persons, of whom 82 worked in full-time positions and 51 were part-time. The Mall of America Unit is expected to employ approximately 250 full- and part-time personnel when operating at full capacity. No current employee is covered by a collective bargaining agreement, and the Company has never experienced an organized work stoppage, strike or labor dispute. The Company considers relations with its employees to be excellent. LEGAL PROCEEDINGS The Company is not a party to any material litigation and is not aware of any threatened litigation that would have a material adverse effect on its business. 23 25 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES The following table sets forth certain information with respect to each of the directors and executive officers of the Company.
NAME AGE POSITION(S) HELD ---- --- ---------------- Stephen D. King.............................. 41 Chairman and Chief Executive Officer Ronald K. Fuller............................. 51 President, Chief Operating Officer and Director Steven B. Carey.............................. 36 Vice President -- Menu Development Samuel J. Talucci, Jr. ...................... 45 Vice President -- Operations John J. Motschenbacher....................... 34 Controller Patricia J. Diamond.......................... 38 Director of Retail Michael L. Krienik........................... 44 Director Thomas W. Orr................................ 52 Director
Stephen D. King, the Chairman and Chief Executive Officer of the Company, is a managing partner of BaryCenter Capital Management, a Cincinnati-based financial advisor and investment firm. Mr. King will devote substantially all of his management time to the Company. From 1982 to 1990, Mr. King served in various capacities, including Chief Executive Officer, of Pizza Hut of Cincinnati, Inc., which operates 36 Pizza Hut restaurants in the Cincinnati, Ohio area. Mr. King has also served in various capacities with Long John Silver, Two Pesos and Skyline Chili franchise operations. Mr. King also has extensive real estate and financing expertise and, from 1991 to 1994, served as managing partner of a real estate development partnership with properties valued at approximately $60 million. Ronald K. Fuller joined the Company as President and Chief Operating Officer in January 1997. Mr. Fuller had served since 1993 as President and Chief Executive Officer for Leeann Chin, Inc., Minneapolis, Minnesota. From 1985 to 1993, Mr. Fuller held several executive positions with General Mills, Inc. and General Mills Restaurants, Inc. in Minneapolis and Orlando, Florida, including Vice President -- Operations, Executive Vice President -- New Concept Development, and President/General Manager. Steven B. Carey became Vice President -- Menu Development of the Company in January 1997. From 1994 until that time, Mr. Carey was Corporate Executive Chef for Leeann Chin, Inc. From 1985 to 1994 he acted as Executive Chef or Senior Executive Chef for a number of units of Restaurants Unlimited, based in Seattle, Washington, including Palomino (Minneapolis), Ryan's Grill (Honolulu), Cutter's Grand Cafe (Philadelphia), Kincaid's Bayhouse (Burlingame, California) and Skates on the Bay (Berkeley). Samuel J. Talucci, Jr. became Vice President -- Operations in September 1997. From 1985 until that time, Mr. Talucci served as founder, owner and general manager of Magnolia Cafe, an award-winning Cajun and Creole restaurant in Philadelphia. From 1983 to 1985 Mr. Talucci worked for Mike Kelly's/Joe Kelly's, a full-service fresh seafood, steak and prime rib restaurant enterprise. He was initially Regional Supervisor for Joe Kelly's in Oklahoma City, where he oversaw profitability, store openings and management training for four restaurants, and then Director of Operations for Mike Kelly's in Detroit where he opened two restaurants, set up systems and procedures and supervised management training. From 1978 to 1983, Mr. Talucci served in various management capacities for T.W. Lee's Inc. (Lexington, Kentucky), That's Entertainment Inc. (New Haven and Yalesville, Connecticut), and Clyde's Inc. (Columbia, Maryland and Sao Paulo, Brazil). John J. Motschenbacher became Corporate Controller of the Company in June 1997. From 1993 to immediately prior to joining the Company, Mr. Motschenbacher served in various capacities for Leeann Chin, Inc., including as Director of Accounting and MIS and as Corporate Controller. He was the Controller of Q-Steaks, Inc., a steakhouse chain based in St. Louis Park, Minnesota. From 1991 to 1992 he was a Regional Controller for Bon Appetit Management Company (San Francisco), a provider of contract and institutional food service. From 1988 to 1991, he served as Senior Regional Accountant and then Manager of Accounting 24 26 and Administration for Consul Restaurant Corporation (Bloomington, Minnesota), a Chi-Chi's Restaurant franchisee and provider of contract food services. Patricia J. Diamond became Director of Retail of the Company in August 1997. From April 1996 to immediately prior to joining the Company, Ms. Diamond served as General Manager of UnderWater World at the Mall of America, where she was responsible for developing and coordinating all aquarium operations, including financial, personnel, marketing and retail functions. From January 1992 to April 1996, Ms. Diamond acted as General Manager of the LEGO Imagination Center at the Mall of America, where she was responsible for setup, development, and management, including budgeting, hiring of personnel, retail, exhibition and special events promotion. Michael L. Krienik became a director of the Company in September 1997 and is President of Krienik Advertising Inc., Cincinnati, Ohio, a full-service advertising agency which he founded in 1981. Prior to founding his own advertising agency, Mr. Krienik served in various merchandising/management roles with Federated Department Stores from 1973 to 1977 and then served as the National Advertising Manager for U.S. Shoe Corporation from 1977 to 1981. Thomas W. Orr became a Director of the Company in September 1997 and has been a Senior Consultant since 1995 for the Delta Consulting Group, Trumbull, Connecticut, specializing in business strategy, new business development, marketing and sales. From 1994 to 1995, Mr. Orr was President of the retail chicken group of ConAgra Broiler Company, with responsibility for strategic direction, operations of five plants, sales, marketing, international and commodity businesses. Mr. Orr had previously been associated with ConAgra Broiler Company from 1991 to 1993 as Vice President of Sales and Vice President of Marketing. From 1993 to 1994, Mr. Orr served as Senior Vice President for Jennie-O Foods, Inc., a subsidiary of Hormel Foods, with responsibility for strategy development, marketing and sales for the retail, food service and commodity divisions. The Company is actively searching for a Chief Financial Officer and expects to hire such officer by the end of 1997. EXECUTIVE COMPENSATION The following table sets forth all cash compensation paid by the Company for the period from January 13, 1994 (Inception) through December 29, 1996 to the Company's Chairman and Chief Executive Officer:
LONG-TERM ANNUAL COMPENSATION COMPENSATION ------------------------ --------------- OTHER ANNUAL AWARD NAME OF INDIVIDUAL POSITION SALARY COMPENSATION OPTIONS GRANTED ------------------ -------- ------ ------------ --------------- Stephen D. King................... Chairman of the Board and $0(1) 0 -- Chief Executive Officer
- ------------------------- (1) Effective August 1, 1997, the Company began paying a salary to Mr. King of $200,000 per year. EMPLOYMENT AGREEMENTS Mr. Fuller has a two-year employment agreement with the Company, which provides for an annual base salary of $200,000 for his first year of employment, which may be adjusted annually as determined by the Board of Directors, plus a bonus based upon the Company's performance. Such agreement also provides that if Mr. Fuller is terminated by the Company for a reason other than "cause," as defined therein, he will receive up to two years' severance if such termination occurs prior to the Effective Date and one year's severance if such termination occurs thereafter. Mr. Fuller receives medical, dental and other customary benefits. The employment agreement provides that Mr. Fuller will not compete with the Company for one year following termination of his employment. Mr. Fuller received options to purchase 300,000 shares of Common Stock at an exercise price of $3.00 per share. Options to purchase 50,000 shares are currently vested. The remaining options vest over two years. 25 27 The Company intends to retain other executive management employees pursuant to employment agreements. The Company intends to offer stock options to such employees. STOCK OPTION AND COMPENSATION PLAN The Board of Directors adopted the 1997 Stock Option and Incentive Compensation Plan (the "Plan") in January 1997 and reserved 500,000 shares of Common Stock for issuance to employees and key consultants under the Plan. The Plan was amended in September 1997 to increase to 750,000 the number of shares available for issuance under the Plan. The Plan is administered by the Board of Directors, which has the discretion to determine the number and purchase price of shares subject to stock options, which may not be below 85% of the fair market value of the Common Stock on the date granted, the term of each option, and the time or times during its term when the option becomes exercisable. As of the date of this Prospectus, options aggregating 502,666 shares of Common Stock have been granted to certain employees of the Company. BOARD OF DIRECTORS AND DIRECTOR COMPENSATION Each of the Company's directors has been elected to serve until the next annual meeting of shareholders. The Company's executive officers are appointed annually by the Company's directors. Each of the Company's directors continues to serve until his or her successor has been designated and qualified. Directors receive no fees for serving as directors and the Company has no current plans to pay cash compensation to its directors. The Company's two non-employee directors, Messrs. Krienik and Orr, each received a ten-year option to purchase 25,000 shares of Common Stock when they joined the Board. One-third of the options vest on each of the first, second and third anniversaries of the date of grant. The options granted to Messrs. Krienik and Orr have an exercise price of $3.34 a share. Members of the Board who are also employees of the Company receive no options for their services as directors. REORGANIZATION The Company's predecessor, Hotel Mexico, Inc. ("HMI"), was originally incorporated in January 1994 as an Ohio corporation. The Kenwood Restaurant Limited Partnership, an Ohio limited partnership (the "Kenwood Partnership"), was formed in June 1995 for the purpose of owning and operating the Kenwood Unit. The general partner of the Kenwood Partnership is Kenwood Restaurant, Inc., an Ohio corporation (the "General Partner"), which is 12.9% owned by Stephen D. King and 87.1% owned by other shareholders. Mr. King owns 23.9% of the voting stock of the General Partner. The Kenwood Partnership has 22 limited partners (the "Limited Partners") as a result of a private placement in October 1995. HMI's operations and the net assets of the Kenwood Partnership were combined on November 14, 1996. On that date, the Kenwood Partnership contributed all of its net assets to a newly formed corporation in exchange for shares of such corporation. HMI then merged with and into the newly-formed corporation, the name of which was changed to Hotel Mexico, Inc. Upon consummation of the merger, outstanding shares of HMI were converted into an aggregate of 1,350,000 shares of Common Stock of the newly formed corporation. The shares of HMI Common Stock received by the Kenwood Partnership in the reorganization will be retained by the Kenwood Partnership until the Effective Date. At that time, it is anticipated that the shares of Common Stock and any other partnership assets will be distributed to the general and limited partners in accordance with the Partnership Agreement and the Kenwood Partnership will be dissolved. On June 24, 1997, the Board of Directors of HMI approved its reincorporation as a Minnesota corporation named Hotel Discovery, Inc. Following approval of the transaction and of the name change by HMI's shareholders at a special meeting held on August 11, 1997, HMI was merged with and into Hotel Discovery, Inc., a newly-formed Minnesota corporation, on August 22, 1997. Hotel Discovery, Inc. has an 26 28 authorized capital stock of 100,000,000 undesignated shares, and each share of Common Stock of HMI was converted into one share of Common Stock of Hotel Discovery, Inc. CERTAIN TRANSACTIONS The Company granted a five-year non-exclusive license to Eastgate Restaurants, Inc., an Ohio corporation wholly owned by Stephen D. King, to test the concept at a demonstration restaurant at 792 Eastgate South Drive, Cincinnati, Ohio, which opened in June 1994. The license granted includes the right to use the Hotel Mexico name, emblems, restaurant design, furnishings, menu and operating procedures. The license fee included an initial payment of $2,500 to the Company and a monthly fee of $200. A principal shareholder, director and executive officer provided essentially all of the Company's working capital in the development stage. This working capital was provided by direct advances to the Company and reimbursement for various business costs and expenses incurred by the principal shareholder on behalf of the Company. During the years ended December 29, 1996 and December 31, 1995, the maximum amount of such indebtedness outstanding at any time was $1,213,469 and $862,891, respectively. At year end December 29, 1996 and December 31, 1995, the amount of such outstanding indebtedness was $447,787 and $862,891, respectively. Included in these amounts were concept development costs reimbursed to a demonstration restaurant owned and operated by the principal shareholder in the amount of $278,101 for the year ended December 29, 1996 and $433,996 for the year ended December 31, 1995. The Company pays interest of 11.5% on all such advances. Subsequent to December 29, 1996, this principal shareholder has continued to provide the Company with additional working capital advances on a revolving basis, with $348,430 and $524,000 outstanding on June 29, 1997 and the date of this Prospectus, respectively. Under the Kenwood Unit lease, the landlord is required to reimburse the Company for leasehold improvements in the amount of $200,000 upon presentation of appropriate documentation, which money the Company intends to use to retire a portion of its debt to Mr. King. In December 1996, the Company borrowed $2.5 million under a term loan from PNC Bank, Ohio, National Association, fully secured by cash collateral. The loan accrued annual interest of 5.94% and payments of interest only were due through January 1998, at which time the entire principal was due. The loan was personally guaranteed by Mr. King. This loan was paid in full on January 31, 1997. In May 1997 the Company borrowed $2.0 million on a 13-month term note, with interest only payable monthly at the rate of 7.15%. This note was guaranteed by Mr. King and was fully secured by substantially all of the Company's assets. This note was repaid in full in July 1997. Mr. King has also personally guaranteed a $1,000,000 leasehold mortgage term loan from PNC Bank, Ohio to the Company. See "The Kenwood Unit--Financing of the Kenwood Unit." On June 23, 1997, the Company borrowed $800,000 from Provident Bank, which is fully secured by substantially all of the Company's assets. The loan bears interest at 2% over the bank's reference rate payable monthly. The loan was personally guaranteed by Mr. King. This loan was repaid in full in July 1997. It is the Company's belief that each transaction referred to in this section between the Company and an officer, director or 5% shareholder of the Company's Common Stock was on terms no less favorable to the Company than could have been obtained from non-affiliated parties. Any future transactions and loans between the Company and any of such persons will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties. All future material affiliated transactions and loans, and any forgiveness of loans, must be approved by a majority of the independent outside members of the Company's Board of Directors who do not have an interest in the transactions. 27 29 PRINCIPAL SHAREHOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of the date of this Prospectus, as adjusted to give effect to the issuance of the securities offered hereby, by (i) each person known by the Company to be the beneficial owner of more than 5% of the outstanding Common Stock, (ii) each director of the Company, (iii) each executive officer of the Company, and (iv) all executive officers and directors of the Company as a group. Unless otherwise indicated, each of the following persons has sole voting and investment power with respect to the shares of Common Stock set forth opposite their respective names.
PERCENT ---------------------- SHARES OF PRIOR TO AFTER NAME COMMON STOCK OFFERING OFFERING(1) ---- ------------ -------- ----------- Stephen D. King(2)......................................... 900,000(3) 16.7% 11.4% Ronald K. Fuller........................................... 60,000(4) 1.1 0.8 Michael L. Krienik......................................... 0 -- -- Thomas W. Orr.............................................. 0 -- -- Kenwood Restaurant Limited Partnership(2).................. 1,350,000(5) 25.0 17.1 All executive officers and directors as a group (4 persons)................................................. 960,000(3) 17.6 12.1
- ------------------------- (1) Figures do not include any shares that may be purchased in the offering by executive officers, directors and the principal shareholder of the Company. Assumes that the Underwriter's over-allotment option is not exercised. (2) Such person's address is 8260 NorthCreek Drive, Suite 140, Cincinnati, Ohio 45236. (3) Includes 248,884 shares owned by Mr. King that are subject to options to purchase held by various individuals. Does not include 395,276 shares as to which Mr. King has voting control pursuant to voting trust agreements. Such voting trust agreements will terminate on the Effective Date. Mr. King has an option exercisable through September 20, 2001 to purchase those shares. Also does not include shares held by the Kenwood Restaurant Limited Partnership, as to which shares Mr. King has voting control. See "Reorganization." Including all such shares (but excluding, subsequent to the offering, the shares subject to the voting trust agreements), Mr. King's percentage ownership would be 49.0% and 28.5%, respectively. (4) Includes 50,000 shares issuable upon exercise of stock options that are exercisable within 60 days. (5) Mr. King has voting control of these shares. See "Reorganization." 28 30 DESCRIPTION OF SECURITIES UNITS Each Unit offered hereby consists of one share of Common Stock and one redeemable Class A Warrant. Warrants are immediately exercisable and, commencing 10 trading days after the Effective Date, separately transferable from the Common Stock. Each Class A Warrant entitles the holder to purchase at any time, until the earlier of redemption by the Company or four years following the Effective Date, one share of common Stock at an exercise price of $6.50 per Warrant, subject to adjustment. CAPITAL STOCK The Company's authorized capital stock consists of 100,000,000 undesignated shares of Common Stock, $.01 par value per share in the case of Common Stock, and a par value as determined by the Board of directors in the case of Preferred Stock. After the closing of this Offering, there will be issued and outstanding 7,899,289 shares of Common Stock, or 8,274,289 shares if the Underwriter's over-allotment option is exercised in full. COMMON STOCK There are no preemptive, subscription, conversion or redemption rights pertaining to the Common Stock. The absence of preemptive rights could result in a dilution of the interest of existing shareholders should additional shares of Common Stock be issued. Holders of the Common Stock are entitled to receive such dividends as may be declared by the Board of Directors out of assets legally available therefor, and to share ratably in the assets of the Company available upon liquidation. Each share of Common Stock is entitled to one vote for all purposes and cumulative voting is not permitted in the election of directors. Significant corporate transactions, such as amendments to the articles of incorporation, mergers, sales of assets and dissolution or liquidation, require approval by the affirmative vote of the majority of the outstanding shares of Common Stock. Other matters to be voted upon by the holders of Common Stock normally require the affirmative vote of a majority of the shares present at the particular stockholders' meeting. The Company's directors and officers as a group beneficially own approximately 17.6% of the Outstanding Common Stock of the Company. Upon completion of this Offering, such persons will beneficially own approximately 12.1% of the outstanding shares (11.5% if the Underwriter's over-allotment option is exercised in full). See "Principal Shareholders." Accordingly, such persons will continue to be able to substantially control the Company's affairs including, without limitation, the sale of equity or debt securities of the Company, the appointment of officers, the determination of officers' compensation and the determination whether to cause a registration statement to be filed. There are approximately 265 beneficial holders of the Company's Common Stock as of the date of this Prospectus. The rights of holders of the shares of Common Stock may in the future become subject to prior and superior rights and preferences in the event that the Board of Directors establishes one or more additional classes of Common Stock or one or more series of Preferred Stock. The Board of Directors has no present plan to establish any such class or series. The limited partners of the Kenwood Partnership, who currently own an aggregate of 206,250 shares of Common Stock of the Company and will receive an aggregate of 922,500 additional shares of the Company's Common Stock upon dissolution of the Kenwood Partnership, have preemptive rights with respect to certain private placements of equity securities and certain debt securities of the Company pursuant to a Shareholder Agreement dated as of September 30, 1995. These preemptive rights will terminate immediately prior to the Effective Date. CLASS A WARRANTS The Class A Warrants included as part of the Units being offered hereby will be issued under and governed by the provisions of a Warrant Agreement (the "Warrant Agreement") between the Company and Norwest Bank Minnesota, N.A. as Warrant Agent (the "Warrant Agent"). The following summary of the 29 31 Warrant Agreement is not complete, and is qualified in its entirety by reference to the Warrant Agreement, a copy of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part. Commencing 10 trading days after the Effective Date, the shares of Common Stock and the Class A Warrants offered as part of the Units will be detachable and separately transferable. One Class A Warrant entitles the holder ("Warrantholder") thereof to purchase one share of Common Stock during the four years following the Effective Date, subject to earlier redemption, provided that at such time a current prospectus relating to the shares of Common Stock issuable upon exercise of the Class A Warrants is in effect and the issuance of such shares is qualified for sale or exempt from qualification under applicable state securities laws. Each Class A Warrant will be exercisable at an exercise price of $6.50 per Warrant, subject to adjustment in certain events. The Class A Warrants are subject to redemption by the Company beginning 90 days after the Effective Date, on not less than 30 days' written notice, at a price of $.01 per Warrant at any time following a period of 14 consecutive trading days where the per share average closing bid price of the Common Stock exceeds $7.00 (subject to adjustment), provided that a current prospectus covering the shares issuable upon the exercise of the Class A Warrants is then effective under federal securities laws. For these purposes, the closing bid price of the Common Stock shall be determined by the closing bid price as reported by Nasdaq so long as the Common Stock is quoted on Nasdaq and, if the Common Stock is listed on a national securities exchange, shall be determined by the last reported sale price on the primary exchange on which the Common Stock is traded. Holders of Class A Warrants will automatically forfeit all rights thereunder except the right to receive the $.01 redemption price per Warrant unless the Class A Warrants are exercised before they are redeemed. The Warrantholders are not entitled to vote, receive dividends or exercise any of the rights of holders of shares of Common Stock for any purpose. The Class A Warrants are in registered form and may be presented for transfer, exchange or exercise at the office of the Warrant Agent. Although the Company has applied for listing of the Class A Warrants on the Nasdaq SmallCap Market, there is currently no established market for the Class A Warrants, and there is no assurance that any such market will develop. The Warrant Agreement provides for adjustment of the exercise price and the number of shares of Common Stock purchasable upon exercise of the Class A Warrants to protect Warrantholders against dilution in certain events, including stock dividends, stock splits, reclassification, and any combination of Common Stock, or the merger, consolidation, or disposition of substantially all the assets of the Company. The Class A Warrants may be exercised upon surrender of the certificate therefor on or prior to the expiration date (or earlier redemption date) at the offices of the Warrant Agent, with the form of "Election to Purchase" on the reserve side of the certificate properly completed and executed as indicated, accompanied by payment of the full exercise price (by certified or cashier's check payable to the order of the Company) for the number of Class A Warrants being exercised. RECENT PRIVATE PLACEMENTS OF COMMON STOCK In July 1997, the Company concluded the private placement of 499,804 shares of Common Stock at $3.00 per share. The Company realized net proceeds of approximately $1,400,000. These proceeds were used for working capital purposes. In June 1997, the Company concluded the private placement of 1,663,085 shares of Common Stock at $3.00 per share. The Company realized net proceeds of approximately $4,350,000. Of these net proceeds, $1,200,000 was used to repay a $1.2 million working capital loan from PNC Bank, Ohio, National Association, which loan had been guaranteed by Mr. King personally. An additional $675,000 was used to complete construction and development of the Kenwood Unit, $850,000 has been or is being used for new features for the Kenwood Unit, approximately $200,000 has been used for development and execution of the lease at the Mall of America, and the balance was utilized for working capital, including operating losses. The Underwriter acted as the selling agent (the "Agent") with respect to these equity offerings. The Agent received sales commissions equal to 8% of the gross proceeds of the offering plus a non-accountable 30 32 expense allowance of 2% of gross proceeds. The Agent also received four-year warrants to purchase 199,205 shares of the Company's Common Stock at an exercise price of $3.75 per share. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this Offering, there will be 7,899,289 shares of Common Stock issued and outstanding (8,274,289 if the Underwriter's over-allotment option is exercised in full). The shares purchased in this Offering will be freely tradeable without registration or other restriction under the 1933 Act, except for any shares purchased by an "affiliate" of the Company (as defined in the Act). All the currently outstanding shares were issued in reliance upon the "private placement" exemptions provided by the Act and are deemed restricted securities within the meaning of Rule 144 ("Restricted Shares"). Restricted Shares may not be sold unless they are registered under the Act or are sold pursuant to an applicable exemption from registration, including an exemption under Rule 144. A total of 4,438,288 Restricted Shares will become eligible for sale, assuming all of the other requirements of Rule 144 have been satisfied, as follows: 1,857,001 shares upon the Effective Date (except that holders of 1,510,933 of such shares have agreed not to sell or otherwise dispose of such shares for 90 days after the Effective Date), 1,092,400 shares in the fourth quarter of 1997 (except that the holders of such 1,092,400 shares have agreed not to sell or otherwise dispose of such shares for 90 days after the Effective Date), 800,685 shares in the second quarter of 1998, and 739,203 shares in the third quarter of 1998. Rule 144 provides that if at least one year has elapsed since restricted shares of Common Stock were last acquired from the Company or an affiliate of the Company, the holder is generally entitled to sell, within any three-month period, a number of shares that does not exceed the greater of 1% of the shares of Common Stock then outstanding or the reported average weekly trading volume of the Common Stock during the four calendar weeks immediately preceding the date on which notice of the sale is sent to the SEC. Sales under Rule 144 are subject to certain manner of sale restrictions, notice requirements and availability of current public information concerning the Company. A person who is not an affiliate of the Company during the three months preceding the sale generally may sell shares without regard to the volume limitations, manner of sale provision, notice requirements or the availability of public information concerning the Company, provided that at least two years have elapsed since the shares were last acquired from the Company or an affiliate. In general, under Rule 701 as currently in effect, any employee, consultant or advisor of the Company who purchases shares from the Company by exercising a stock option outstanding on the date of the Offering is eligible to resell such shares 90 days after the date of the Prospectus in reliance on Rule 144, but need not comply with certain restrictions contained in Rule 144, including the holding period requirement. After the Offering, the Company intends to register, through a Form S-8 registration statement, 750,000 shares of Common Stock that are reserved for issuance under the Stock Option Plan. See "Management." After the effective date of such registration statement, shares issued upon exercise of outstanding options would generally be eligible for immediate resale in the public market, subject to vesting under the applicable option agreements. Following this Offering, the Company cannot predict the effect, if any, that sales of the Common Stock or the availability of such Common Stock for sale will have on the market price prevailing from time to time. Nevertheless, sales by existing shareholders of substantial amounts of Common Stock could adversely affect prevailing market prices for the Common Stock if and when a public market exists. The Company's executive officers, directors and 5% shareholders have agreed that they will not sell, grant any option for the sale of, or otherwise dispose of any equity securities of the Company (or any securities convertible into or exercisable or exchangeable for equity securities of the Company) for a period of 180 days after the Effective Date without the prior written consent of the Underwriter. Holders of an aggregate of 2,162,889 shares of the Company's Common Stock purchased in two private placements in which the Underwriter acted as selling agent agreed not to sell or otherwise dispose of any shares of Common Stock for a period of 90 days after the Effective Date. 31 33 MINNESOTA ANTI-TAKEOVER LAW The Company is governed by the provisions of Sections 302A.671 and 302A.673 of the Minnesota Business Corporation Act. In general, Section 302A.671 provides that the shares of a corporation acquired in a "control share acquisition" have no voting rights unless voting rights are approved in a prescribed manner. A "control share acquisition" is an acquisition, directly or indirectly, of beneficial ownership of shares that would, when added to all other shares beneficially owned by the acquiring person, entitle the acquiring person to have voting power of 20% or more in the election of directors. In general, Section 302A.673 prohibits a publicly-held Minnesota corporation from engaging in a "business combination" with an "interested shareholder" for a period of four years after the date of the transaction in which the person became an interested shareholder, unless the business combination is approved in a prescribed manner. "Business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested shareholder. An "interested shareholder" is a person who is the beneficial owner, directly or indirectly, of 10% or more of the corporation's voting stock or who is an affiliate or associate of the corporation and at any time within four years prior to the date in question was the beneficial owner, directly or indirectly, of 10% or more of the corporation's voting stock. TRANSFER AGENT AND REGISTRAR Norwest Bank Minnesota, N.A. is the transfer agent and registrar for the Common Stock. UNDERWRITING Under the terms and subject to the conditions contained in the Underwriting Agreement, dated the effective date of this offering, R.J. Steichen & Company (the "Underwriter") has agreed to purchase from the Company, and the Company has agreed to sell to the Underwriter, an aggregate of 2,500,000 Units. The Underwriting Agreement provides that the Underwriter will be obligated to purchase, subject to the terms and conditions set forth therein, all of the Units being sold pursuant to the Underwriting Agreement (other than the Units covered by the over-allotment option) if any of the Units being sold pursuant to the Underwriting Agreement are purchased. The Company has been advised by the Underwriter that the Underwriter proposes to offer the 2,500,000 Units at a Price to Public of $5.00 per Unit and to certain selected dealers at such price less a concession not in excess of $.24 per Unit to certain other dealers who are members of the National Association of Securities Dealers, Inc. After the initial public offering, the Price to Public and other selling terms may be changed by the Underwriter. The Underwriter does not intend to confirm sales to any account over which it has discretionary authority. In the Underwriting Agreement, the Company and the Underwriter have agreed to indemnify each other (including officers, directors and control persons of each other) against certain liabilities under the 1933 Act, or to contribute to payments which the Underwriter may be required to make in respect thereof. Insofar as indemnification for liabilities arising under the 1933 Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company 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. The Company has granted to the Underwriter an option, exercisable within 45 days after the date of this Prospectus, to purchase up to an additional 375,000 Units at the Price to Public, less the Underwriting Discount shown on the cover page of this Prospectus. This option may only be exercised in whole or in part, but only for the purpose of covering any over-allotments in the sale of the Units offered hereby. The Company's executive officers, directors and 5% shareholders have agreed that they will not sell, grant any option for the sale of, or otherwise dispose of any equity securities of the Company (or any securities convertible into or exercisable or exchangeable for equity securities of the Company) for a period of 180 days after the Effective Date without the prior written consent of the Underwriter. Holders of an aggregate of 32 34 2,162,889 shares of the Company's Common Stock purchased in two private placements in which the Underwriter acted as selling agent agreed not to sell or otherwise dispose of any shares of Common Stock for a period of 90 days after the Effective Date. The Company has agreed to pay the Underwriter a nonaccountable expense allowance of 2% of the aggregate Total Price to Public of the Units or $250,000 ($287,500 if the Underwriter's over-allotment option is exercised in full). The Company has agreed to sell to the Underwriter, for $50.00, five-year warrants to purchase 250,000 shares of Common Stock of the Company at a price per share equal to 120% of the Price to Public (the "Underwriter's Warrant"). The Underwriter's Warrant is exercisable commencing one year from the Effective Date and for a period of four years thereafter. The Underwriter's Warrant contains anti-dilution provisions providing for appropriate adjustments to the exercise price and the number of shares on the occurrence of certain events. The shares of Common Stock received upon exercise of the Underwriter's Warrant may participate in any securities registration by the Company, at the Company's expense, during the term of the Warrant and for two years thereafter unless and to the extent that, in the judgment of the underwriter of such offering, the market for the securities to be sold by the Company would be adversely affected thereby. In addition, the holders of such shares have a one-time right to demand registration of the shares during the term of the Warrant, at the Company's expense, if and when registration of the Company's securities on Form S-3 becomes available under the 1933 Act. The Underwriter's Warrant also has a cashless exercise option. Any profits realized by the Underwriter upon the sale of the Underwriter's Warrant or the securities issuable upon exercise thereof may be deemed to constitute additional underwriting compensation. In November 1996 through July 1997, the Company sold an aggregate of 2,162,889 shares of Common Stock in two private placements in which the Underwriter acted as selling agent. The Underwriter received agent's commissions of approximately $597,616 and warrants to purchase an aggregate of 199,205 shares of Common Stock exercisable at $3.75 per share. At the request of the Company, up to 10% of the Units offered hereby may be reserved for sale to persons designated by the Company. The price of such Units will be the Price to Public set forth on the cover of this Prospectus. Prior to this Offering, there has been no public market for the shares. Consequently, the Price to Public of the Units and the exercise price of the Class A Warrants were arbitrarily determined through negotiation between the Company and the Underwriter and bears no relation to the Company's current earnings, book value, net worth, financial statement criteria of value, the history of and prospects for the industry in which the Company principally competes or the capability of the Company's management. There can be no assurance that the price at which the Units, the Class A Warrants or the Common Stock will sell in the public market after this Offering will not be lower than the price at which they are sold by the Underwriter. The foregoing is a summary of the material provisions of the Underwriting Agreement and the Underwriter's Warrant. Copies of such documents have been filed as exhibits to the Registration Statement of which this Prospectus is a part. LEGAL MATTERS The validity of the Units offered hereby will be passed upon for the Company by Maslon Edelman Borman & Brand, LLP, Minneapolis, Minnesota. Certain legal matters relating to the sale of the Units of Common Stock will be passed upon for the Underwriter by Doherty Rumble & Butler, P.A., Minneapolis, Minnesota. EXPERTS The financial statements of Hotel Discovery, Inc. at December 29, 1996 and for each of the two years in the period ended December 29, 1996 appearing in this Prospectus and Registration Statement have been audited by Ernst & Young, LLP, independent auditors, as set forth in their report appearing elsewhere herein 33 35 and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company is not a reporting company under the Securities Exchange Act of 1934, as amended. The Company has filed with the Washington, D.C. Office of the Securities and Exchange Commission (the "Commission") a Registration Statement on Form SB-2 under the Act with respect to the Common Stock offered hereby. This Prospectus filed as a part of the Registration Statement does not contain all of the information contained in the Registration Statement and the exhibits thereto, certain portions of which have been omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the securities offered hereby, reference is made to such Registration Statement including the exhibits and schedules thereto. Statements contained in this Prospectus as to the contents of any contract, agreement or other documents are not necessarily complete, and in each instance, reference is made to such contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. The Registration Statement and exhibits may be inspected without charge and copied at the Washington office of the Commission, 450 Fifth Street, N.W., Washington, DC 20549, and copies of such material may be obtained at prescribed rates from the Commission's Public Reference Section at the same address. 34 36 INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Independent Auditors.............................. F-1 Audited Financial Statements: Balance Sheet............................................. F-2 Statements of Operations.................................. F-3 Statements of Shareholders' Equity........................ F-4 Statements of Cash Flows.................................. F-5 Notes to Financial Statements............................... F-6
37 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of Hotel Discovery, Inc., We have audited the accompanying balance sheet of Hotel Discovery, Inc. as of December 29, 1996 and the related statements of operations, shareholders' equity, and cash flows for the years ended December 31, 1995 and December 29, 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 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 Hotel Discovery, Inc. at December 29, 1996 and the results of its operations and its cash flows for the years ended December 31, 1995 and December 29, 1996 in conformity with generally accepted accounting principles. ERNST & YOUNG, LLP Cincinnati, Ohio August 20, 1997 F-1 38 HOTEL DISCOVERY, INC. BALANCE SHEET
DECEMBER 29, JUNE 29, 1996 1997 ------------ -------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents................................. $2,707,561 $ 1,998,056 Inventory................................................. 138,757 131,987 Other current assets...................................... 91,575 205,936 ---------- ----------- Total current assets................................... 2,937,893 2,335,979 ---------- ----------- PROPERTY AND EQUIPMENT Building.................................................. 1,900,547 1,900,547 Leasehold improvements.................................... 1,452,635 1,584,677 Equipment and fixtures.................................... 902,334 1,218,538 ---------- ----------- 4,255,516 4,703,762 Less: accumulated depreciation............................ (25,000) (300,000) ---------- ----------- Total property and equipment, net...................... 4,230,516 4,403,762 ---------- ----------- OTHER ASSETS................................................ 51,841 233,024 ---------- ----------- Total assets........................................... $7,220,250 $ 6,972,765 ========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Short-term notes payable.................................. $2,500,000 $ 2,800,000 Accounts payable.......................................... 803,885 751,197 Accrued expenses.......................................... 538,637 14,466 Salaries and wages payable................................ 174,882 36,583 Advances payable to principal shareholder................. 447,787 348,430 Current portion of long-term debt......................... 69,420 69,420 ---------- ----------- Total current liabilities.............................. 4,534,611 4,020,096 LONG-TERM DEBT, LESS CURRENT PORTION........................ 924,795 895,870 CONVERTIBLE PROMISSORY NOTES PAYABLE........................ 150,000 150,000 ---------- ----------- Total liabilities...................................... 5,609,406 5,065,966 ---------- ----------- COMMITMENTS AND CONTINGENCIES (NOTE 7) SHAREHOLDERS' EQUITY: Common stock (.01 par value, 100,000,000 shares authorized and 3,945,400 and 4,899,485 shares issued and outstanding)........................................... 39,454 48,995 Additional paid-in capital................................ 5,013,126 7,581,231 Less: common stock subscribed............................. 0 (600,000) Accumulated deficit....................................... (3,441,736) (5,123,427) ---------- ----------- Total shareholders' equity............................. 1,610,844 1,906,799 ---------- ----------- Total liabilities and shareholders' equity............. $7,220,250 $ 6,972,765 ========== ===========
See accompanying notes F-2 39 HOTEL DISCOVERY, INC. STATEMENTS OF OPERATIONS
YEAR ENDED TWENTY-SIX WEEKS ENDED --------------------------- ------------------------ DECEMBER 31, DECEMBER 29, JUNE 30, JUNE 29, 1995 1996 1996 1997 ------------ ------------ -------- -------- (UNAUDITED) NET SALES................................... $ 0 $ 104,129 $ 0 $ 1,864,564 ---------- ----------- ---------- ----------- COSTS AND EXPENSES: Food and beverage costs................... 0 43,324 0 612,115 Labor and benefits........................ 0 85,407 0 1,036,302 Restaurant operating expenses............. 0 155,832 0 602,055 Depreciation and amortization............. 0 25,000 0 275,000 Selling, general and administrative expenses............................... 14,775 138,209 44,122 765,573 Pre-opening and development costs......... 923,482 1,970,452 413,889 189,423 ---------- ----------- ---------- ----------- Total costs and expenses............. 938,257 2,418,224 458,011 3,480,468 ---------- ----------- ---------- ----------- LOSS FROM OPERATIONS........................ (938,257) (2,314,095) (458,011) (1,615,904) OTHER INCOME (EXPENSE): Interest (expense)........................ (2,209) (13,507) 0 (92,503) Interest income........................... 0 0 10,950 26,716 ---------- ----------- ---------- ----------- Total other income (expense)......... (2,209) (13,507) 10,950 (65,787) ---------- ----------- ---------- ----------- Net loss............................. $ (940,466) $(2,327,602) $ (447,061) $(1,681,691) ========== =========== ========== =========== Shares used in per share calculations....... 3,362,611 4,355,187 4,286,100 5,058,240 ========== =========== ========== =========== Net loss per share.......................... $ (.28) $ (.53) $ (.10) $ (.33) ========== =========== ========== ===========
See accompanying notes F-3 40 HOTEL DISCOVERY, INC. STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL ------------------- PAID-IN COMMON STOCK ACCUMULATED SHARES AMOUNT CAPITAL SUBSCRIBED DEFICIT TOTAL ------ ------ ---------- ------------ ----------- ----- BALANCE -- JANUARY 1, 1995..... 1,650,000 $16,500 $ 9,000 $ (25,500) $ (173,668) $ (173,668) Issuance of shares........... 1,350,000 13,500 2,461,000 (1,750,000) -- 724,500 Cash received on stock subscribed................. -- -- -- 830,000 -- 830,000 Net loss..................... -- -- -- -- (940,466) (940,466) --------- ------- ---------- ----------- ----------- ----------- BALANCE -- DECEMBER 31, 1995... 3,000,000 30,000 2,470,000 (945,500) (1,114,134) 440,366 Issuance of shares........... 945,400 9,454 2,543,126 -- -- 2,552,580 Cash received on stock subscribed................. -- -- -- 945,500 -- 945,500 Net loss..................... -- -- -- -- (2,327,602) (2,327,602) --------- ------- ---------- ----------- ----------- ----------- BALANCE -- DECEMBER 29, 1996... 3,945,400 39,454 5,013,126 -- (3,441,736) 1,610,844 Issuance of shares (unaudited)................ 947,685 9,477 2,548,969 (690,000) -- 1,868,446 Shares issued for services (unaudited)................ 6,400 64 19,136 -- -- 19,200 Cash received on stock subscribed (unaudited)..... -- -- -- 90,000 -- 90,000 Net loss (unaudited)......... -- -- -- -- (1,681,691) (1,681,691) --------- ------- ---------- ----------- ----------- ----------- BALANCE -- JUNE 29, 1997 (UNAUDITED)........ 4,899,485 $48,995 $7,581,231 $ (600,000) $(5,123,427) $ 1,906,799 ========= ======= ========== =========== =========== ===========
See accompanying notes F-4 41 HOTEL DISCOVERY, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED TWENTY-SIX WEEKS ENDED --------------------------- ----------------------- DECEMBER 31, DECEMBER 29, JUNE 30, JUNE 29, 1995 1996 1996 1997 ------------ ------------ -------- -------- (UNAUDITED) OPERATING ACTIVITIES: Net loss.................................. $ (940,466) $(2,327,602) $(447,061) $(1,681,691) Depreciation and amortization.......... 0 25,000 0 275,000 Shares issued for services............. 0 0 0 19,200 Changes in operating assets and liabilities -- Inventory............................ 0 (138,757) 0 6,770 Other current assets................. 20,000 (71,575) 20,000 (114,361) Other assets......................... 0 0 34,527 (177,183) Accounts payable..................... (12,083) 775,228 148,731 (52,689) Accrued expenses and salaries and wages payable..................... 0 713,519 0 (662,470) ---------- ----------- --------- ----------- Net cash used for operating activities...................... (932,549) (1,024,187) (243,803) (2,387,424) ---------- ----------- --------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment....... (811,969) (3,443,544) (996,684) (448,245) Payment of organization costs............. 0 0 (165) (4,000) ---------- ----------- --------- ----------- Net cash used for investing activities...................... (811,969) (3,443,544) (996,849) (452,245) ---------- ----------- --------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Advances (payments) from shareholder...... 637,221 (415,103) (67,185) (99,357) Net increase in short-term notes payable................................ 0 2,500,000 0 300,000 Proceeds from issuance of bank note....... 0 1,000,000 0 0 Issuance of convertible notes payable..... 0 150,000 100,000 0 Proceeds from issuance of equity.......... 724,980 2,552,580 0 1,868,446 Principal repayments on bank note......... 0 (5,785) 0 (28,925) Payments received on stock subscriptions.......................... 830,000 945,500 915,000 90,000 ---------- ----------- --------- ----------- Net cash provided by financing activities...................... 2,192,201 6,727,192 947,815 2,130,164 ---------- ----------- --------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................... 447,683 2,259,461 (292,837) (709,505) CASH AND CASH EQUIVALENTS, BEGINNING........ 417 448,100 448,100 2,707,561 ---------- ----------- --------- ----------- CASH AND CASH EQUIVALENTS, ENDING........... $ 448,100 $ 2,707,561 $ 155,263 $ 1,998,056 ========== =========== ========= =========== SUPPLEMENTAL CASH FLOWS INFORMATION: Cash paid for interest.................... $ 60,000 $ 45,000 $ 0 $ 65,787 Cash paid for income taxes................ $ 0 $ 0 $ 0 $ 0
See accompanying notes F-5 42 HOTEL DISCOVERY, INC. NOTES TO THE FINANCIAL STATEMENTS DECEMBER 29, 1996 AND DECEMBER 31, 1995 1. DESCRIPTION OF THE BUSINESS AND FORMATION OF THE COMPANY Hotel Discovery, Inc. (the "Company") owns and operates one restaurant in Cincinnati Ohio (the "Kenwood Unit"). Prior to the opening of this restaurant on December 19, 1996, the Company was in the development stage. In August 1997, the Company reincorporated in the State of Minnesota and changed its name from Hotel Mexico, Inc. to Hotel Discovery, Inc. and increased the number of authorized shares to 100,000,000. On November 13, 1996, the Company was reorganized after Hotel Mexico, Inc. was incorporated in the state of Ohio and became the owner of Hotel Mexico, Inc.-predecessor and all the net assets of Kenwood Restaurant Limited Partnership. The result of the reorganization is that the owners of Hotel Mexico, Inc.-predecessor and the Partnership became the owners of all the outstanding stock of Hotel Mexico, Inc.-successor. The reincorporation and reorganization have been reflected retroactively and all share and per share amounts have been adjusted. A demonstration and test restaurant, owned by the principal shareholder of the Company, which opened in June 1994, was used in the development of the Hotel Discovery concept. This restaurant operates using the Hotel Mexico name under a license agreement with the Company. 2. SIGNIFICANT ACCOUNTING POLICIES INTERIM FINANCIAL DATA The unaudited balance sheet as of June 29, 1997 and the related statements of operations, cash flows and shareholders' equity for the twenty-six week period ended June 29, 1997 have been prepared in accordance with the accounting policies in effect as of December 29, 1996 and for the two years ended December 29, 1996. In the opinion of management such interim financial statements contain all adjustments (all of which are normal and recurring in nature) necessary to present fairly the Company's financial position and results of operations and cash flows. The results of operations for the twenty-six week period ended June 29, 1997 is not necessarily indicative of the results to be expected for the full year. FISCAL YEAR The Company has adopted a 52/53 week accounting period ending on the Sunday nearest December 31 of each year. CASH AND CASH EQUIVALENTS Cash and cash equivalents includes cash on hand, bank deposits and liquid money market investments with maturities of 90 days or less. INVENTORY Restaurant food and supplies inventories are stated at the lower of cost (determined using the first-in first-out method) or market. ADVERTISING COSTS The Company expenses advertising costs as incurred. Advertising expense was $0 and $98,673 for 1995 and 1996. F-6 43 HOTEL DISCOVERY, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PRE-OPENING AND DEVELOPMENT COSTS Pre-opening costs such as staff training, advertising, rent, and concept development, menu design, consultant and similar costs of a development nature are expensed as incurred. PROPERTY AND EQUIPMENT Property and equipment acquired are recorded at cost and includes interest on funds borrowed to finance construction. Capitalized interest in 1996 was $45,000. Improvements are capitalized, while repair and maintenance expenses are charged to operations as incurred. Leasehold improvements are being amortized using the straight line method over the shorter of the estimated useful life or the lease term. Furniture and equipment are being depreciated on a straight-line method over 5 to 15 years. INCOME TAXES The Company accounts for income taxes using the liability method to recognize deferred income tax assets and liabilities. Deferred income taxes are determined based upon the temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. STOCK OPTIONS As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, the Company has chosen to account for stock option grants using the intrinsic value method prescribed in APB opinion No. 25, Accounting for Stock Issued to Employees. No options were granted during the two years ended December 29, 1996. RECENTLY ISSUED ACCOUNTING STANDARDS During 1996 the Company adopted Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (Statement 121). Statement 121 establishes accounting standards for the recognition and measurement of impairment of long-lived assets, certain identifiable intangibles, and goodwill either to be held or disposed of. The adoption of Statement 121 did not have an impact on the Company's financial position or results of operations. 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 amounts reported in the financial statements and the accompanying notes. Actual results could differ from the estimates. NET LOSS PER COMMON SHARE Net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding and dilutive common equivalent shares assumed to be outstanding during each period. Common equivalent shares consist of dilutive options to purchase common stock. However, pursuant to certain rules of the Securities and Exchange Commission, the calculation also includes equity securities, including options and warrants, issued within one year of an initial public offering with an issue price less than the initial public offering price, even if the effect is anti-dilutive. The treasury stock method was used in determining the dilutive effect of such issuances. F-7 44 HOTEL DISCOVERY, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company will adopt in the fiscal year ending December 28, 1997, Statement of Financial Accounting Standards No. 128 "Earnings per Share" (SFAS No. 128), which was issued in February 1997. SFAS No. 128 requires disclosures of basic earnings per share (EPS) and diluted EPS, which replaces the existing primary EPS and fully diluted EPS, as defined by APB No. 15. Basic EPS is computed by dividing net income by the weighted average number of shares of Common Stock, outstanding during the year. Dilutive EPS is computed similar to EPS as previously reported provided that, when applying the treasury stock method to common equivalent shares, the Company must use its average share price for the period rather than the more dilutive greater of the average share price or end-of-period share price required by APB No. 15. 3. DEBT The Company borrowed $1,000,000 in August 1996 under a leasehold mortgage term loan from a bank. The loan bears interest at 9.06%, payments of principal and interest are due monthly in the amount of $5,785 through October 1999 at which time the remaining balance is due in full. In December 1996, the Company borrowed an additional $2,500,000 under a mortgage term loan from a bank. The loan bears interest at 5.94%, payments of interest only are due through January 1998 at which time the entire principal is due. The loan has been classified as short-term as it was repaid in full in January 1997. The loans are secured by the leasehold mortgage and substantially all assets of the Kenwood Unit. Additionally the principal shareholder has personally guaranteed the loans. Related loan agreements require minimum working capital, tangible net worth and debt coverage ratios and restrict additional indebtedness or asset sales. The fair value of the Company's debt approximates market. Aggregate maturities of long-term debt are as follows: 1997........................................................ $ 69,420 1998........................................................ 69,420 1999........................................................ 855,375 -------- $994,215 ========
In May and June 1997, the Company borrowed $2,800,000 under loan agreements with banks. The loans have been classified as short-term as they were repaid in full in July 1997. 4. CONVERTIBLE PROMISSORY NOTES PAYABLE In June and July 1996, the Company executed three convertible promissory notes in the total amount of $150,000. The notes mature on July 1, 1999, bearing interest at 8.01% per annum. The notes are convertible into 39,600 shares of the Company's common stock at maturity, at the payee's option. 5. INCOME TAXES Deferred tax assets and liabilities are recognized based on the difference between financial statement amounts and tax carrying values of assets and liabilities. Due to the limited history of the Company's operations, a valuation allowance was established for the net deferred tax assets. For the two years ending F-8 45 HOTEL DISCOVERY, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) December 29, 1996, the Company did not record a benefit from income taxes. Significant components of the Company's deferred tax assets and liabilities are as follows at December 29, 1996: Deferred tax assets: Net operating loss carryforward........................... $ 685,700 Deferral of pre-opening expenses.......................... 336,200 Other tax deferred items.................................. 67,200 ---------- Total deferred tax assets................................... 1,089,100 Less: valuation allowance................................... 1,089,100 ---------- Net deferred tax assets..................................... -0- Deferred tax liabilities.................................... -0- ---------- Net deferred tax assets..................................... $ -0- ==========
The Company's net operating loss carryforward expires in 2011. The following is a reconciliation of the tax expense recorded in these financial statements to the expected tax rate based on statutory rates.
FOR THE YEARS ENDED --------------------------------- DECEMBER 29, DECEMBER 31, 1996 1995 ------------ ------------ Net loss.......................................... $(2,327,602) $(940,466) Expected rate..................................... 40% 40% ----------- --------- Expected tax benefit.............................. (931,000) (376,200) Tax loss attributable to predecessor entities..... -- 218,100 Valuation allowance............................... 931,000 158,100 ----------- --------- Tax benefit recognized............................ $ -0- $ -0- =========== =========
6. SHAREHOLDERS' EQUITY STOCK OPTION PLAN In January 1997, the Board of Directors adopted the 1997 Stock Option and Incentive Compensation Plan (the "Plan") and reserved 500,000 common shares for issuance under the Plan. The Plan is administered by a stock option committee of the Board of Directors which has the discretion to determine the number of shares granted, the price of the option, the term of the option and the time period over which the option may be exercised. As of August 20, 1997 the Company had granted 452,666 options to purchase the Company's stock for $3.00 per share under the Plan. Additionally, 25,000 options have been granted to a Director outside of the Plan at $3.34 per share. As of August 20, 1997, 50,000 options are exercisable, the remaining options become exercisable over the next three years. The total options that will be exercisable at each year end are: 1997--50,000, 1998--315,999, 1999--459,332 and 2000--477,666. WARRANTS In 1997, the Company granted 214,995 warrants. The warrants are immediately exercisable at a price of $3.75 per share and expire in five years. F-9 46 HOTEL DISCOVERY, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) 6. SHAREHOLDERS' EQUITY (CONTINUED) CAPITAL STOCK In June 1997, in connection with the Company's reincorporation in Minnesota, the authorized capital of the Company increased to 100,000,000 shares. As allowed under Minnesota law the Board of Directors is authorized to designate and issue shares in such classes or series (including classes or series of preferred stock) as it deems appropriate and to establish the rights, preferences, and privileges of such shares. 7. COMMITMENTS AND CONTINGENCIES The Company has entered into a long-term operating ground lease, which expires in 2012, for the Kenwood Unit. The agreement requires the Company to pay all maintenance, taxes, operating expenses and a percentage (4%) of sales over stated thresholds. The future minimum base rent payments are: 1997........................................................ $ 153,996 1998........................................................ 153,996 1999........................................................ 153,996 2000........................................................ 153,996 2001........................................................ 153,996 Thereafter.................................................. 1,770,960 ---------- $2,540,940 ==========
On August 14, 1997, the Company entered into a twelve year lease with Mall of America Company for a 16,000 square-foot restaurant space in Mall of America. The minimum annual rent is $405,375 plus a percentage rent for a total annual rent of up to 6% of gross sales. The minimum rent has been waived for the first year. 8. RELATED PARTY TRANSACTIONS The principal shareholder, director and executive officer provided essentially all of the Company's working capital in the development stage. The working capital was provided by direct advances to the Company and reimbursement for various business costs and expenses incurred by the shareholder on behalf of the Company. During the years ended December 29,1996 and December 31, 1995 the maximum amount of such indebtedness outstanding at any time was $1,213,469, and $862,891, respectively. At December 29,1996 and December 31, 1995, the amount outstanding of such indebtedness was $447,787 and $862,891. Included in these amounts were concept development costs reimbursed to a demonstration restaurant owned and operated by the principal shareholder in the amount of $278,101 for the year ended December 29, 1996 and $433,996 for the year ended December 31, 1995. The Company pays interest at 11.5% on these advances. There are no fixed repayment terms on the advances. 9. SALE OF SHARES AND PROPOSED TRANSACTION In July 1997, the Company sold an additional 499,804 common shares at $3.00 per share. The Board of Directors has initiated the completion of a public offering. F-10 47 [PHOTOGRAPHS] 48 ====================================================== NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITER. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. --------------------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary...................... 3 Risk Factors............................ 6 Use of Proceeds......................... 11 Dilution................................ 12 Dividend Policy......................... 13 Capitalization.......................... 13 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 14 Business................................ 17 Management.............................. 24 Reorganization.......................... 26 Certain Transactions.................... 27 Principal Shareholders.................. 28 Description of Securities............... 29 Underwriting............................ 32 Legal Matters........................... 33 Experts................................. 33 Additional Information.................. 34 Index to Financial Statements........... F-1
---------------------------- UNTIL , 1997 (25 DAYS AFTER THE DATE OF THE PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ====================================================== ====================================================== HOTEL DISCOVERY, INC. LOGO 2,500,000 UNITS CONSISTING OF 2,500,000 SHARES OF COMMON STOCK AND 2,500,000 REDEEMABLE CLASS A WARRANTS ------------------------------ PROSPECTUS ------------------------------ RJ STEICHEN & COMPANY LOGO , 1997 ====================================================== 49 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Company is governed by Minnesota Statutes Chapter 302A. Minnesota Statutes Section 302A.521 provides that a corporation shall indemnify any person made or threatened to be made a party to any proceeding by reason of the former or present official capacity of such person against judgments, penalties, fines, including, without limitation, excise taxes assessed against such person with respect to an employee benefit plan, settlements, and reasonable expenses, including attorney's fees and disbursements, incurred by such person in connection with the proceeding, if, with respect to the acts or omissions of such person complained of in the proceeding, such person has not been indemnified by another organization or employee benefit plan for the same expenses with respect to the same acts or omissions; acted in good faith; received no improper personal benefit and Section 302A.255, if applicable, has been satisfied; in the case of a criminal proceeding, had no reasonable cause to believe the conduct was unlawful; and in the case of acts or omissions by persons in their official capacity for the corporation, reasonably believed that the conduct was in the best interests of the corporation, or in the case of acts or omissions by persons in their capacity for other organizations, reasonably believed that the conduct was not opposed to the best interests of the corporation. As permitted by Section 302A.251 of the Minnesota Statutes, the Articles of Incorporation of the Company provide that a director shall have no personal liability to the Company and its shareholders for breach of his fiduciary duty as a director, to the fullest extent permitted by law. The Underwriting Agreement contains provisions under which the small business issuer on the one hand, and the Underwriter, on the other hand, have agreed to indemnify each other (including officers and directors of the small business issuer and the Underwriter and any person who may be deemed to control the small business issuer or the Underwriter) against certain liabilities, including liabilities under the Securities Act of 1933, as amended. ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The estimated expenses in connection with the issuance and distribution of the securities registered hereby, other than underwriting discounts and fees, are set forth in the following table: SEC registration fee........................................ $ 10,007 NASD filing fee............................................. 3,875 Nasdaq listing fee.......................................... 10,000 Legal fees and expenses..................................... 75,000 Accounting fees and expenses................................ 40,000 Blue Sky fees and expenses.................................. 20,000 Transfer agent fees and expenses............................ 1,000 Printing and engraving expenses............................. 45,000 Miscellaneous............................................... 15,118 -------- Total..................................................... $220,000 ========
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES. In connection with the initial capitalization of the Company in January 1994, the Company sold an aggregate of 1,750 shares of Common Stock to two "accredited investors" as defined in Regulation D of the Securities Act of 1933, as amended (the "Securities Act") for nominal consideration. Such shares were split 825-to-1 in November 1996, and now represent 1,443,750 shares of the Company. The Company believes that such sale of such Common Stock was exempt from registration pursuant to Section 4(2) of the Securities Act and Rules 505 and/or 506 under Regulation D of the Securities Act. II-1 50 In October 1995, the Company and Kenwood Restaurant Limited Partnership, an Ohio limited partnership formed in June 1995, raised gross proceeds of $2.5 million in a private placement of 250 shares of Common Stock of the Company (which shares were split 825-to-1 in November 1996, and now represent 206,250 shares of the Company) and limited partnership interests in the Kenwood Restaurant Limited Partnership to 19 "accredited investors." In a reorganization of the Company which occurred in November 1996, the Kenwood Restaurant Limited Partnership contributed all of its assets to the Company, including the Kenwood Unit, in exchange for 1,350,000 shares of Common Stock of the Company. The Company believes that such sale of such securities was exempt from registration pursuant to Section 4(2) of the Securities Act and Rules 505 and/or 506 under Regulation D of the Securities Act. From November 1996 through July 1997, the Company completed private placements to "accredited investors" of an aggregate of 2,392,889 shares of Common Stock at $3.00 per share. The net proceeds to the Company were approximately $5.9 million. The Company believes that such sales of Common Stock were exempt from registration pursuant to Section 4(2) of the Securities Act and Rule 506 under Regulation D of the Securities Act. II-2 51 ITEM 27. EXHIBITS. EXHIBIT INDEX 1.1 Form of Underwriting Agreement (with form of Underwriter's Warrant) 3.1 Articles of Incorporation* 3.2 By-laws* 4 Form of Warrant Agreement* 5 Opinion of Maslon Edelman Borman & Brand, LLP* 10.1 Indenture of Lease dated November 9, 1994 between Phillip E. Stephens, Trustee and Kenwood Restaurant, Inc.; First Amendment to Lease dated May 3, 1995 by and between Phillip E. Stephens, Trustee and Kenwood Restaurant, Inc.; by Second Amendment to Lease dated 1996 between Phillip E. Stephens, Trustee and Kenwood Restaurant Limited Partnership; Second Amendment to Agreement dated October 18, 1996 between Phillip E. Stephens, Trustee and Kenwood Restaurant Limited Partnership; and Addendum to Second Amendment to Lease dated October 18, 1996 between Phillip E. Stephens, Trustee and Kenwood Restaurant Limited Partnership (Kenwood Unit)* 10.2 Lease dated August 4, 1997 between Mall of America Company and Hotel Mexico, Inc. (Mall of America Unit)* 10.3 Loan Agreement by and among Kenwood Restaurant Limited Partnership and PNC Bank, Ohio, National Association* 10.4 Company's 1997 Stock Option and Compensation Plan* 10.5 Employment Agreement between the Company and Ronald K. Fuller dated March 17, 1997* 10.6 Amendment to Company's 1997 Stock Option and Compensation Plan 24.1 Consent of Maslon Edelman Borman & Brand, LLP (included in Exhibit 5)* 24.2 Consent of Ernst & Young LLP* 25 Powers of Attorney (included on page II-5) 27.1 Financial Data Schedule*
- --------------- * Previously filed. II-3 52 ITEM 28. UNDERTAKINGS. Insofar as indemnification for liabilities arising under the Act may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions or otherwise, the small business issuer 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 the small business issuer of expenses incurred or paid by a director, officer or controlling person of the small business issuer 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, the small business issuer 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 is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned small business issuer hereby undertakes that it will: (1) File, during any period in which it offers or sells securities, a post-effective amendment to this registration statement to (i) include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement; and (iii) include any additional or changed material information on the plan of distribution. (2) For determining any liability under the Securities Act, treat the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the small business issuer under Rule 424(b)(1) or (4) or Rule 497(h) under the Securities Act as part of this registration statement as of the time the Commission declared it effective. (3) For determining any liability under the Securities Act, treat each post-effective amendment that contains a form of prospectus as a new registration statement for the securities offered in the registration statement, and that offering of the securities at that time as the initial bona fide offering of those securities. The small business issuer hereby undertakes to provide to the Underwriter at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriter to permit prompt delivery to each purchaser. II-4 53 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and has authorized this Amendment No. 1 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Minneapolis, State of Minnesota, on September 17, 1997. HOTEL DISCOVERY, INC. By /s/ STEPHEN D. KING -------------------------------------- Stephen D. King Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Stephen D. King, Ronald K. Fuller or William M. Mower, each or any of them, such person's true and lawful attorney-in-fact and agent with full power of substitution and resubstitution for such person and in such person's name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing necessary or desirable to be done in and about the premises, as fully to all intents and purposes as such person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. In accordance with the requirements of the Securities Act of 1933, this Amendment No. 1 to the Registration Statement has been signed by the following persons in the capacities and on the dates stated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ STEPHEN D. KING Chairman of the Board and Chief September 17, 1997 - ----------------------------------- Executive Officer Stephen D. King /s/ RONALD K. FULLER President, Chief Operating Officer September 17, 1997 - ----------------------------------- and Director (Chief Financial and Ronald K. Fuller Chief Accounting Officer) /s/ THOMAS W. ORR Director September 17, 1997 - ----------------------------------- Thomas W. Orr /s/ MICHAEL L. KRIENIK Director September 17, 1997 - ----------------------------------- Michael L. Krienik
II-5 EX-1.1 2 FORM OF UNDERWRITING AGREEMENT 1 EXHIBIT 1.1 2,500,000 UNITS CONSISTING OF 2,500,000 SHARES OF COMMON STOCK AND 2,500,000 REDEEMABLE CLASS A COMMON STOCK PURCHASE WARRANTS HOTEL DISCOVERY, INC. UNDERWRITING AGREEMENT ____________, 1997 R. J. Steichen & Company One Financial Plaza 120 South Sixth Street Minneapolis, MN 55402 Ladies and Gentlemen: Hotel Discovery, Inc., an Minnesota corporation (the "COMPANY"), proposes to issue and sell to you (the "UNDERWRITER"), an aggregate of 2,500,000 Units ("UNITS"), each Unit consisting of one share of Common Stock ("COMMON STOCK") and one Redeemable Class A Common Stock Purchase Warrant (the "WARRANT") exercisable for a period of four (4) years commencing on the effective date of the Registration Statement to purchase one share of Common Stock of the Company at a price of $6.50 per share. The Warrants shall be immediately exercisable and are detachable and transferable commencing ten (10) trading days after the effective date of the Registration Statement under the Act or at any earlier time agreed to by the Underwriter and the Company. The Warrants shall be redeemable at the option of the Company at $.01 per Warrant at any time ninety (90) days after the effective date and upon thirty (30) days' prior notice in writing of the Company's intention to redeem, provided that the average closing bid price for the Common Stock exceeds $7.00 per share (subject to adjustment) for any 14 consecutive trading days prior to such notice, on such other terms set forth in the Preliminary Prospectus (defined herein). The 2,500,000 Units to be purchased from the Company are referred to herein as the "FIRM UNITS." In addition, solely for the purpose of covering overallotments with respect to the Firm Units, the Company proposes to grant to the Underwriter, for its account, the option to purchase up to an additional 375,000 Units (the "OPTION UNITS"). The Firm Units and any Option Units purchased pursuant to this Underwriting Agreement are herein referred to as the "UNITS." 2 The Company hereby confirms its agreement with respect to the purchase of the Units by the Underwriter. 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company represents and warrants to, and agrees with, the Underwriter as follows: (a) The Company has prepared in conformity in all material respects with the requirements of the Securities Act of 1933, as amended (the "ACT"), and the applicable rules and regulations of the Securities and Exchange Commission (the "COMMISSION") thereunder, and has filed with the National Office of the Commission in Washington, D.C., a registration statement on Form SB-2, File No. 333-_________, including a Prospectus relating to the Units, and will file with the Commission before the effective date of the registration statement one or more amendments thereto. Copies of such registration statement and amendments (including all forms of the preliminary prospectus) have been delivered to you. Any such preliminary prospectus (as described in Rule 430 under the Act) included at any time as part of such registration statement is herein called a "PRELIMINARY PROSPECTUS." As used herein, the term "REGISTRATION STATEMENT" shall, except where the context otherwise requires, mean said registration statement (and all exhibits thereto) as amended by all amendments filed prior to its effective date; and the term "PROSPECTUS" shall, except where the context otherwise requires, mean said final prospectus on file with the Commission when the Registration Statement becomes effective (except that, if the prospectus filed by the Company pursuant to Rule 424(b) under Act shall differ from the prospectus included in the Registration Statement, the term "PROSPECTUS" shall, except where the context otherwise requires, mean the prospectus so filed pursuant to Rule 424(b) from and after the date on which it shall have been first used.) Reference herein to the Registration Statement, to any Preliminary Prospectus, to the Prospectus or to any amendment of or supplement to the Prospectus includes all documents and information incorporated therein by reference. (b) The Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus, and each Preliminary Prospectus, at the time of filing thereof with the Commission, did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; PROVIDED, HOWEVER, that none of the representations and warranties in this subparagraph shall apply to statements in, or omissions from, any Preliminary Prospectus which are based upon and conform to written information furnished to the Company by or on behalf of you specifically for use in the preparation thereof. (c) When the Registration Statement becomes effective and at all times subsequent thereto up to each Closing Date (defined hereinafter) and upon the effective date of any post-effective amendment to the Registration Statement, the Registration Statement and the Prospectus, and any amendments thereof or supplements thereto, will in all material respects conform to the requirements of the Act and of the applicable rules 2 3 and regulations of the Commission thereunder (the "RULES AND REGULATIONS"). When the Registration Statement becomes effective and at all times subsequent thereto, up to each Closing Date and the effective date of any post-effective amendment to the Registration Statement, neither the Registration Statement (as amended, if the Company shall have filed with the Commission any post-effective amendment thereto), nor the Prospectus, will include an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; PROVIDED, HOWEVER, that the Company makes no representations or warranties as to information contained in or omitted from the Registration Statement or the Prospectus, or any such amendment or supplement, in reliance upon and in conformity with written information furnished to the Company by you specifically for use in the preparation thereof. There is no contract or document required to be described in the Registration Statement or Prospectus, or to be filed as an exhibit to the Registration Statement, which was not described or filed as required. (d) [Deleted] (e) Ernst & Young, LLP, the accountants who have examined certain financial statements and schedules of the Company, filed and to be filed with the Commission as part of the Registration Statement and the Prospectus, are independent public accountants within the meaning of the Act and the Rules and Regulations. The financial statements of the Company, together with related notes and summaries thereof, set forth in the Registration Statement and Prospectus, in all material respects present fairly the financial position and results of operations and changes in financial position of the Company as of the dates and for the periods indicated. All such financial statements (including the related notes) have been prepared in accordance with generally accepted accounting principles consistently applied throughout the periods concerned except as may be otherwise stated therein. (f) Subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus, and other than as described in the Registration Statement and Prospectus, (i) the Company has not incurred any material liabilities or obligations, contingent or otherwise, or entered into any material transaction, except obligations incurred in the ordinary course of business that in the aggregate are not material; (ii) the Company has not paid or declared any dividend or other distribution on its Common Stock; (iii) there has not been any change in the Common Stock or increase in the long-term debt of the Company (including any capitalized lease obligation), or any issuance of options, warrants, or rights to purchase Common Stock of the Company, or any material adverse change in the business, financial position, results of operations, key personnel, capitalization, properties, or net worth of the Company, considered as a whole; and (iv) no material loss or damage (whether or not insured) to the property of the Company has been sustained. 3 4 (g) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation, with full power and authority to own its properties and conduct its business as it is currently being carried on and as described in the Prospectus and is duly qualified to do business as a foreign corporation and is in good standing in all states or jurisdictions in which the ownership or lease of property or the conduct of its business requires such qualification and in which the failure to so qualify would have a material adverse effect on its business condition (financial or other), or properties. The Company has all necessary and material authorizations, approvals and orders of and from all governmental regulatory officials and bodies to own its properties and conduct its business as described in the Prospectus and is conducting its business in substantial compliance with all applicable laws, rules and regulations of the jurisdictions in which it is conducting business. (h) The Company is not in violation of its articles of incorporation, bylaws, or other governing documents and is not in default in the performance of any obligation, agreement or condition contained in any lease agreement or in any bond, debenture, note or any other evidence of indebtedness or in any material contract, indenture, loan agreement or license where such default would have a material adverse effect on the business condition (financial or other) or properties of the Company, considered as a whole which violation or default has not been waived. The consummation of the transactions herein contemplated and the fulfillment of the terms hereof will not conflict with or result in a material breach of any of the terms or provisions of, or constitute a material default under, the articles of incorporation or bylaws, or other governing documents of the Company, or any indenture, mortgage, agreement or other instrument to which the Company is a party or by which it is bound, or to which any property of the Company is subject, or conflict with or violate any law or any order, rule or regulation, applicable to the Company of any court, or of any federal or state regulatory body or administrative agency, having jurisdiction over the Company or any of its properties which conflict, breach or default has not been waived. (i) The Company will, as of each Closing Date, have the duly authorized and outstanding capitalization set forth in the Prospectus. The outstanding Common Stock of the Company is duly authorized and validly issued, fully paid and nonassessable. The Common Stock of the Company conform in all material respects in substance to all statements in relation thereto contained in the Registration Statement and the Prospectus. The Company has all requisite power and authority (corporate and other) to issue, sell, and deliver the Units, including the Common Stock issuable upon exercise of the Warrants in accordance with and upon the terms and conditions set forth in this Agreement and in the Registration Statement and Prospectus; and all corporate action required to be taken by the Company for the due and proper authorization, issuance, sale, and delivery of the Units, including the Common Stock issuable upon exercise of the Warrants, has been validly and sufficiently taken. 4 5 (j) The Company has full legal power, right and authority (corporate and other) to enter into this Underwriting Agreement and to perform and discharge its obligations hereunder, and this Underwriting Agreement has been duly authorized, executed and delivered on behalf of the Company and is the valid and binding obligation of the Company, subject, as to the enforcement of remedies, to applicable bankruptcy, insolvency, moratorium and other laws affecting the rights of creditors generally, and except as enforceability of the indemnification or contribution provisions may be limited by federal or state securities laws or principles of public policy. (k) The Company will apply the proceeds of the sale of the Units by it substantially to the purposes set forth in the Prospectus. (l) To the best of the Company's knowledge, no approval, authorization, consent or order of any public board or body (other than in connection with or in compliance with the provisions of the Act and the securities or Blue Sky laws of various jurisdictions) is legally required for the sale of the Units by the Company. (m) The Company has no subsidiaries. (n) The Company has good and marketable title, free and clear of all liens, encumbrances, equities, charges or claims, to all of the property, real and personal, described in the Registration Statement and Prospectus as being owned by it, except as otherwise set forth in the Registration Statement and Prospectus and except for such as are not in the aggregate material in relation to the property of the Company considered as a whole and do not materially affect the value of such property, and, except as otherwise stated in the Registration Statement and Prospectus, has valid and binding leases to the real and/or personal property described in the Registration Statement and Prospectus as under lease to it with such exceptions as could not materially interfere with the conduct of the business. (o) There are no actions, suits or proceedings or investigations pending before any court or governmental agency, authority or body to which the Company is a party or of which the business or property of the Company is the subject which, if decided adversely, would have a material adverse effect on the general affairs, condition (financial or other), business, properties, net worth, or results of operations of the Company, and, to the best of the Company's knowledge, no such actions, suits or proceedings are threatened. (p) The Company has not taken or will not take, directly or indirectly, any action designed to or which has constituted or which might reasonably be expected to cause or result in stabilization or manipulation as defined in the Securities Exchange Act of 1934, as amended, of the price of the Company's securities to facilitate the sale or resale of the Units. 5 6 (q) The Company has not, directly or indirectly, at any time during the past five years (i) made any contributions to any candidate for political office, or failed to disclose fully any contribution in violation of law, or (ii) made any payment to any state, Federal or foreign governmental officer or official, or other person charged with similar public or quasi-public duties, other than payments required or permitted by applicable law. (r) Except as described in the Prospectus and to the best knowledge of the Company, the Company owns or possesses the right to utilize all the patents, patent applications, trademarks, service marks, trade names, trademark registrations, service mark registrations, copyrights, licenses, inventions, trade secrets, and similar rights necessary for the present conduct of its business as described in the Prospectus, without any known conflict with the asserted rights of others in respect of such matters. Except as may be stated in the Prospectus, the Company has not received any notice of any infringement of, or license or similar fees for, any patents, patent applications, trademarks, service marks, trade names, trademark registrations, service mark registrations, copyrights, licenses, inventions, trade secrets, or other similar rights of others, or any claim with respect thereto, which would have a material adverse effect on the business of the Company. (s) The Company has filed all necessary federal, state and foreign income and franchise tax returns or if not filed, has obtained all necessary extensions and has paid all taxes as shown as due on any such returns; and the Company has no knowledge of any material tax deficiency which has been asserted against the Company, and, to the best of the Company's knowledge, the Company has no material obligation to pay any taxes except as may be stated in the Prospectus. (t) All prior offers or sales of the securities of the Company were exempt from registration under the Act and all applicable state blue sky laws. (u) No securities of the Company have been sold within three years prior to the date hereof, except as set out in Item 26 of Part II of the Registration Statement. (v) The Company knows of no outstanding claims for services in the nature of a finder's fee or origination fee with respect to the sale of the Units or Underwriter's Warrants (defined hereinafter) hereunder resulting from its acts for which the Underwriter may be responsible. The Company will indemnify the Underwriter for and hold the Underwriter harmless against any claim for such finder's fees or origination fees. (w) All material contracts or agreements are properly filed as an exhibit to the Registration Statement. Each contract to which the Company is a party and which is filed as a part of or incorporated by reference into the Registration Statement has been duly and validly executed, is in full force and effect in all material respects in accordance with its terms, and none of such contracts have been assigned by the Company, and the Company knows of no present situation or condition or fact which would prevent compliance by the Company with the terms of such contracts, as amended to date. Except for amendments 6 7 or modifications of such contracts in the ordinary course of business, the Company has no intention of exercising any right which it may have to cancel any of its obligations under any of such contracts, and has no knowledge that any other party to any of such contracts has any intention not to render full performance under such contracts. (x) The Company maintains insurance which is in full force and effect, of the types and in an amount, in the judgment of the Company and except as otherwise disclosed in the Prospectus, which is reasonable for its present business taking into account its operations and assets, including, but not limited to, insurance covering all personal property owned or leased by the Company against theft, damage, destruction, acts of vandalism and all other risks customarily insured against. (y) The Company maintains a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, (iii) access to assets is permitted only in accordance with management's general or specific authorization, and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (z) All material transactions between the Company and its officers, directors, promoters, and its shareholders who beneficially own 5% or more of any class of the Company's voting securities required to be disclosed in the Prospectus have been accurately disclosed in the Prospectus, and the terms of each such transaction are fair to the Company and no less favorable to the Company than the terms that could have been obtained from unrelated parties. 2. PURCHASE OF THE UNITS BY THE UNDERWRITER. (a) On the basis of the representations and warranties herein contained, but subject to the terms and conditions herein set forth, the Company agrees to sell to the Underwriter, and the Underwriter agrees to purchase from the Company, the Firm Units. The purchase price for each Firm Unit shall be $4.60 per Unit. (b) The Company hereby grants to the Underwriter, for its account, an option to purchase from the Company, solely for the purpose of covering overallotments in the sale of Firm Units, all or any portion of an aggregate of 375,000 Option Units for a period of 45 days from the date hereof at the same purchase price per Option Unit as the purchase price per Firm Unit set forth in Section 2(a) above. 3. DELIVERY OF AND PAYMENT FOR UNITS. Delivery of certificates for the Firm Units and payment therefor shall be made at the offices of Maslon Edelman Borman & Brand, PLLP (or such other place as mutually may be agreed upon), at 10:00 a.m., Minneapolis, Minnesota 7 8 time, on or before the third full business day following the effective date of the Registration Statement (the "FIRST CLOSING DATE"). The option to purchase Option Units granted in Section 2(b) hereof may be exercised at any time (but not more than once) during the 45-day term thereof by written notice to the Company from you. Such notice shall set forth the aggregate number of Option Units as to which the option is being exercised, and the time and date, not earlier than either the First Closing Date or the second business day after the day on which the option shall have been exercised but not later than the third full business day after the date of such exercise, as determined by you, when the Option Units are to be delivered (the "SECOND CLOSING DATE"). Delivery and payment for such Option Units to be purchased by you are to be at the offices set forth above for delivery and payment of the Firm Units. The First Closing Date and the Second Closing Date are sometimes herein individually called the "CLOSING DATE" and collectively called the "CLOSING DATES." Delivery of facsimile certificates for the Units shall be made by or on behalf of the Company to you against payment by you of the purchase price therefor by wire transfer or certified or official bank check in clearing house funds to the order of the Company. The certificates for such Units shall be registered in such names and denominations as you shall have requested at least two full business days prior to the applicable Closing Date. Time shall be of the essence and delivery at the time and place specified in this Agreement is a further condition to your obligations hereunder. 4. COVENANTS OF THE COMPANY. The Company covenants and agrees with each Underwriter that: (a) The Company will use its best efforts to cause the Registration Statement to become and remain effective, up to each Closing Date. The Company will notify you promptly of any request by the Commission for any amendment of or supplement to the Registration Statement or the Prospectus or for additional information, will prepare and file with the Commission, promptly upon your request, any amendments of or supplements to the Registration Statement or Prospectus which, in your reasonable opinion, may be necessary or advisable in connection with the distribution of the Units; and will not file any amendments and supplements to the Registration Statement as originally filed with the Commission unless it shall first have delivered copies of such amendments or supplements to you, or file any such amendment or supplement to which you shall have reasonably objected in writing to the Company. The Company will immediately advise you by telephone, confirming such advice in writing (i) when notice is received from the Commission that the Registration Statement has become effective, (ii) of any order suspending the effectiveness of the Registration Statement or of any proceedings or examination under the Act, as soon as the Company is advised thereof, and (iii) of any order or communication of any public authority addressed to the Company suspending or threatening to suspend qualification of the Units for sale in any state. The Company will use its best efforts to prevent the issuance of any stop order or other such order, and, 8 9 should a stop order or other such order be issued, to obtain as soon as possible the lifting thereof. (b) If, at any time when a prospectus relating to the Units is required to be delivered under the Act, any event shall have occurred as a result of which, in the opinion of counsel for the Company or in the reasonable opinion of counsel for you, the Prospectus, as then amended or supplemented, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or if it is necessary at any time to amend or supplement the Prospectus to comply with the Act, the Company will notify you promptly and prepare and file with the Commission an appropriate amendment or supplement. (c) The Company will use its best efforts to take or cause to be taken all necessary action and furnish to whomever you may reasonably direct such information as may be required in qualifying the Units for offering and sale under the Blue Sky or securities laws of such states as you and the Company shall designate. The Company shall not, however, be required to register or qualify as a foreign corporation or as a dealer in securities or, except as to matters and transactions related to the offering or sale of the Units, consent to service of process in any state. (d) The Company will furnish to the Underwriter, from time to time and without charge, copies of the Registration Statement, each Preliminary Prospectus, the Prospectus (including all documents from which information is incorporated by reference), and all amendments of and supplements to any of such documents, in each case as soon as available and in such quantities as you may from time to time reasonably request for the purposes contemplated by the Act. The Company authorizes the Underwriter and all dealers to whom any of the Units may be sold by the Underwriter to use the Preliminary Prospectuses and Prospectuses supplied, as from time to time amended or supplemented, in connection with the sale of the Units as and to the extent permitted by federal and applicable state and local securities laws. (e) The Company will furnish to you two copies of the Registration Statement and all amendments thereof which are signed and include all exhibits and schedules. (f) The Company will, for a period of two (2) years after the Effective Date, furnish directly to you as soon as the same shall be sent to shareholders generally, copies of all annual or interim shareholder reports of the Company, and will, for the same period, also furnish you with the following: (i) two copies of any report, application, or document (other than exhibits, which, however, will be furnished on request) which the Company shall file with the Commission or any securities exchange; 9 10 (ii) as soon as the same shall be sent to shareholders generally, copies of each communication which shall be sent to shareholders; and (iii) from time to time such other information concerning the Company as you may reasonably request, provided that the Company shall not be required to furnish any information pursuant hereto that is not furnished to its shareholders or not otherwise made publicly available. (g) The Company will, for a period of two (2) years after the Effective Date, furnish directly to you, quarterly profit and loss statements, reports of the Company's cash flow filed by the Company with the Commission. (h) The Company will make generally available to its security holders as soon as practicable, but in any event not later than eighteen months after the effective date of the Registration Statement, a statement of earnings of the Company (which need not be audited) complying with Section 11(a) of the Act and the rules and regulations of the Commission thereunder (including, at the option of the Company, Rule 158). (i) Whether or not this Agreement becomes effective or is terminated or cancelled or the sale of the Units to you is consummated, and regardless of the reason for or cause of any such termination, cancellation, or failure to consummate, the Company will pay or cause to be paid (A) all expenses (including any transfer taxes) incurred in connection with the delivery to you of the Units, (B) all expenses and fees (including, without limitation, fees and expenses of the Company's accountants and counsel, excluding, however, fees of the Underwriter' counsel) in connection with the preparation, printing, filing, delivery, and shipping of the Registration Statement (including the financial statements therein and all amendments, schedules, and exhibits thereto), each Preliminary Prospectus, the Prospectus, and any amendment thereof or supplement thereto, (C) all fees and expenses, including all Company counsel fees, (D) fees and expenses of the Underwriter's counsel, incurred in connection with the qualification of the Units for offering and sale by the Underwriter or by dealers under the securities or Blue Sky laws of the states and other jurisdictions which you and the Company mutually shall designate in accordance with Section 4(c) hereof, (E) subject to the further provisions of this Section 4(i), all fees and expenses, including all counsel fees, excluding, however, fees of the Underwriter's counsel, incurred in connection with the review of the offering by the National Association of Securities Dealers, Inc. and listing fees, if any, (F) all costs and expenses incident to qualification with The Nasdaq SmallCap Market, (G) postage and express charges and other expenses in connection with delivery of the Preliminary and Final Prospectus to the Underwriter, and (H) all other costs and expenses incident to the performance of the Company's obligations hereunder that are not otherwise specifically provided for herein. In addition to and not in lieu of the foregoing, the Company shall pay to the Underwriter on each Closing Date, for out-of-pocket expenses (including fees of Underwriter's counsel), a nonaccountable expense allowance equal to two percent (2%) of the aggregate purchase price for the Units sold to the Underwriter on each Closing 10 11 Date. If the Underwriter withdraws from the sale of the Units as herein proposed for any reason other than its inability to sell the Units and through no other fault of its own, or if the sale of the Units as herein proposed is abandoned by the Company, the Company will reimburse the Underwriter in the amount of all accountable expenses (including fees and disbursements of counsel) incurred by the Underwriter in connection with the contemplated purchase, offer, and sale of the Units, including without limitation, expenses incurred in their investigation, preparation to market, and marketing of the Units, and in contemplation of performing and in performance of its obligations hereunder, up to an aggregate of $30,000, such expenses and fees to be evidenced by appropriate receipts, invoices, or other documentation. (j) The Company will cause each officer and director of the Company to furnish to the Underwriter, on or prior to the date of this Agreement, a letter or letters, in form and substance satisfactory to counsel for the Underwriter, pursuant to which each such person shall agree not to offer for sale, sell, distribute or otherwise dispose of any securities of the Company for a period of 180 days from the date hereof. The Company will use its best efforts to cause each significant Shareholder of the Company (as reasonably determined by the Underwriter) to furnish to the Underwriter, on or prior to the date of this Agreement, a letter or letters, in form and substance satisfactory to counsel for the Underwriter, pursuant to which each such Shareholder shall agree not to offer for sale, sell, distribute or otherwise dispose of any securities of the Company for a period of 90 days from the date hereof. (k) The Company will not, during the 180 days following the effective date of the Registration Statement, except with your prior written consent, offer for sale, sell, distribute, or otherwise dispose of any Common Stock or sell or grant options, rights, or warrants with respect to any Common Stock (except for the grants, options, rights, warrants or convertible securities pursuant to the Company's 1997 Stock Option and Incentive Compensation Plan), otherwise than in accordance with this Agreement or as contemplated by the Prospectus. (l) The Company authorizes the Underwriter and all dealers to whom any of the Units may be sold by the Underwriter in connection with the distribution of the Units, to use the Prospectus as from time to time amended or supplemented in connection with the offering and sale of the Units and in accordance with the applicable provisions of the Act and the applicable Rules and Regulations and applicable state Blue Sky or securities laws. (m) The Company shall not request an effective date nor allow the Registration Statement to be declared effective without the prior approval of the Underwriter. (n) Within the time during which the Prospectus is required to be delivered under the Act, the Company will comply, at its own expense, with all requirements imposed upon it by the Act, by the Rules and Regulations, by the Exchange Act, and by any order of the Commission, so far as necessary to permit the continuance of sales or dealings in the Units. (o) The Company shall file an application and take all other steps necessary to have the Units actually listed on The Nasdaq SmallCap Market on or prior to the effective date of the Registration Statement under the Act. 11 12 (p) The Company will reserve and keep available that maximum number of its authorized but unissued shares of Common Stock which are issuable upon exercise of Warrants and the Underwriter's Warrant during the term of the Warrants and the Underwriter's Warrant. (q) Prior to the Closing Date, no discussions will be held by officers, directors or any other affiliate or associate of the Company with any member of the news media and no news release or other publicity about the Company will be permitted without prior approval of the Company's and the Underwriter's respective legal counsel. (r) The Company shall have obtained a CUSIP number for the Units (and its components) prior to the effective date of the Registration Statement under the Act. (s) The Company shall supply to the Underwriter, and its legal counsel, at the Company's cost, one complete bound volume of all of the documents relating to the public offering, within a reasonable time after the Closing Date, not to exceed four (4) months. The volume shall be hard cover bound in book format. (t) The Company will apply the proceeds from the sale of the Units by it to the purposes and in the manner set forth in the Registration Statement and, pending such application, shall invest such net proceeds only in one or more of the following, except as otherwise provided by prior written consent of the Underwriter: (i) interest-bearing obligations issued by the United States Government or issued by an agency or instrumentality of the United States Government and guaranteed by the United States Government and having a maturity not in excess of one year, (ii) interest-bearing domestic commercial paper having a maturity of not more than 365 days and, at the time of purchase by the Company, rated investment grade by Moody's Investors Service, Inc. or Standard & Poor's Corporation, (iii) interest-bearing certificates of deposit issued by a commercial bank chartered by the United States Government or by any state of the United States having shareholders' equity of at least $500,000,000 except that the foregoing notwithstanding, the Company may invest no more than $100,000 of such net proceeds in certificates of deposit issued by any such commercial bank regardless of shareholders' equity, and (iv) shares or other units of interest in a registered open-ended investment company the assets of which aggregate at least $200,000,000 and are invested solely in so-called "money market" obligations. 5. CONDITIONS OF UNDERWRITER'S OBLIGATIONS. The obligations of the Underwriter herein shall be subject to the accuracy of the representations and warranties on the part of the Company herein as of the date hereof, and as of each Closing Date, to the accuracy of the written statements of Company officers made pursuant to the provisions hereof, to the performance by the Company of its obligations hereunder and to the following additional conditions: 12 13 (a) The Registration Statement shall have become effective not later than 5:00 P.M., Minneapolis, Minnesota time, on the date of this Agreement or on such later time and date as shall be satisfactory to the Underwriter, no stop order suspending the effectiveness of the Registration Statement or any amendment thereof or supplement or the qualification of the Units for offering or sale shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or shall be threatened by the Commission or by any state securities authority, and any request of the Commission for additional information (to be included in the Registration Statement or the Prospectus or otherwise) shall have been complied with to the Underwriter's satisfaction. (b) The Underwriter shall not have advised the Company that the Registration Statement or Prospectus, or any amendment thereof or supplement thereto, contains an untrue statement of fact that, in the Underwriter's reasonable opinion, is material, or omits to state a fact that, in your reasonable opinion, is material and is required to be stated therein or is necessary to make the statements therein not misleading provided that this Section 5(b) shall not apply to statements in, or omissions from, the Registration Statement or Prospectus, or any amendment thereof or supplement thereto that are based upon and conform to written information provided by the Underwriter specifically for use in the Registration Statement or Prospectus. (c) On or prior to each Closing Date, the form and validity of the Units, the legality and sufficiency of the corporate proceedings and matters relating to the incorporation of the Company and other matters incident to the issuance of the Units, the form of the Registration Statement and the Prospectus and of any amendments thereof or supplements thereto filed prior to such Closing Date (other than financial statements and schedules and other financial or statistical data included therein), the authorization, execution, and delivery of this Agreement and the description of the Units contained in the Prospectus shall have been reasonably approved by the Underwriter. In connection with such determination, the Company shall have furnished to the Underwriter such documents as you may have requested for the purpose of enabling the Underwriter to pass upon such matters. (d) On each Closing Date there shall have been furnished to the Underwriter, the favorable opinion (addressed to the Underwriter) of Maslon Edelman Borman & Brand, a Professional Limited Liability Partnership, counsel for the Company, dated such Closing Date, and in form reasonably satisfactory to counsel for the Underwriter, to the effect that: (i) The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Minnesota, with corporate power and authority to own or lease its properties and conduct its business as described in the Prospectus. The Company has no subsidiaries other than as described in the Prospectus. 13 14 (ii) The authorized capital stock of the Company as of the date of this Agreement is as set forth in the Prospectus. The outstanding shares of the Common Stock of the Company have been duly authorized and validly issued and are fully paid and nonassessable. The Units (and their components) have been duly authorized and, upon issuance, delivery and payment therefor as described in this Agreement, will be validly issued, fully paid and nonassessable. The shares of Common Stock underlying the Warrants have been duly authorized and reserved for issuance and when issued, sold and delivered in accordance with the terms of the Warrant, will be validly issued, fully paid and nonassessable. The issuance, sale and delivery of the Underwriter's Warrant has been duly authorized and the shares (the "WARRANT SHARES") of Common Stock issuable upon the exercise thereof have been reserved for issuance upon such exercise. The Warrant Shares, when issued, sold and delivered in accordance with the terms of the Underwriter's Warrant, will be validly issued, fully paid and nonassessable. No preemptive rights of, or rights of refusal in favor of, stockholders of the Company exist with respect to the Units (or any component thereof), the Underwriter's Warrant or the Warrant Shares, or the issue and sale thereof, pursuant to the Company's Articles of Incorporation or Bylaws. (iii) The authorized securities of the Company conform as to legal matters in all material respects to the description thereof set forth in the Prospectus under the caption "Description of Securities." The certificates representing the Warrants and the Common Stock are in proper form under the Minnesota Business Corporation Act. (iv) The Registration Statement has become effective under the Securities Act and, to such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement or suspending or preventing the use of the Prospectus is in effect and, to our knowledge, no proceedings for that purpose have been instituted or are pending by the Commission. (v) The Registration Statement and the Prospectus comply as to form in all material respects with the requirements of the Securities Act and with the Rules and Regulations, except the financial statements, the notes thereto and the related schedules and other financial and statistical data contained therein, as to which we express no opinion. (vi) Counsel knows of no contracts, leases, documents or pending legal proceedings that are required to be described in the Prospectus or to be filed as exhibits to the Registration Statement that are not so described or filed. (vii) The Underwriting Agreement, the Warrant Agreement and the Underwriter's Warrant have been duly authorized by all requisite corporate action, 14 15 executed and delivered by the Company and constitute the valid and binding obligations of the Company enforceable in accordance with their respective terms. (viii) The execution and delivery of the Underwriting Agreement and the issue and sale of the Underwriter's Warrant, the Units (and their components) and the shares underlying the Warrant will not violate or conflict with the Articles of Incorporation or the Bylaws of the Company or any material provision of any material contract or instrument filed as an exhibit to the Registration Statement to which the Company is a party or by which the Company is bound (other than any violation of or conflict with any financial tests or covenants contained therein, as to which counsel need express no opinion) or any law of the United States or the State of Minnesota, any rule or regulation of any governmental authority or regulatory body of the United States or the State of Minnesota, or any judgment, order or decree known to us and applicable to the Company of any court or governmental authority. (ix) No holders of capital stock of the Company, or securities convertible into capital stock of the Company, have the right to cause the Company to include such holder's capital stock in the Registration Statement pursuant to the Company's Articles of Incorporation or Bylaws or any contract or agreement. (x) No consent, approval, authorization or order of, and no notice to or filing with, any governmental agency or body or any court is required to be obtained or made by the Company for the issue and sale of the Units pursuant to the Underwriting Agreement, except such as have been obtained or made and such as may be required under applicable state securities or blue sky laws or by the National Association of Securities Dealers, Inc., as to which we express no opinion. Although counsel to the Company cannot guarantee the accuracy and completeness of the statements contained in the Registration Statement or in the Prospectus, on the basis of discussions and meetings with officers of the Company, representatives of the Company's independent auditors, the Underwriter and counsel to the Underwriter, our participation in the preparation of the Registration Statement and the Prospectus, our examination of the documents referred to in the Registration Statement and in the Prospectus, and our procedures forming the basis of the opinions expressed above, nothing came to our attention that led us to believe that the Registration Statement, as of the date it was declared effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that the Prospectus, as of its date or on the date hereof, contained or contains an untrue statement of a material fact or omitted or omits to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (provided that we express no view with respect to the content of financial statements, the 15 16 notes thereto and the related schedules and other financial or statistical data included in the Registration Statement or the Prospectus or as to statements in the Registration Statement or Prospectus which are based on and conform to written information furnished to the Company by or on your behalf specifically for use in the preparation thereof). In rendering such opinion, such counsel may rely (A) as to questions of the law of jurisdictions other than the State of Minnesota or the United States upon an opinion or opinions (dated the Closing Date, addressed to the Underwriter and in form satisfactory to the Underwriter) of counsel acceptable to the Underwriter and (B) as to matters of fact, to the extent they deem proper, on certificates of appropriate officers of the Company, of the transfer agent and registrar for the Units and of public officials; PROVIDED, such opinions and certificates must be attached to the opinion of counsel. (e) At the time of execution of this Agreement, the Underwriter shall have received from Ernst & Young, LLP, a letter dated the date of such execution, in form and substance satisfactory to the Underwriter, to the effect that they are independent accountants with respect to the Company within the meaning of the Act and the applicable published instructions, and Regulations thereunder, and further stating in effect that: (i) In their opinion, the audited financial statements included in the Registration Statement and Prospectus covered by their report included therein, comply as to form in all material respects with the applicable requirements of the Act and the published instructions, and Regulations, thereunder. (ii) On the basis of (A) a reading of the minutes of the shareholders' and directors' meetings of the Company since inception, (B) inquiries of certain officials of the Company responsible for financial and accounting matters, (C) a reading of the Company's monthly operating statements subsequent to December 31, 1996, and (D) other specified procedures and inquiries (but not an audit in accordance with generally accepted auditing standards), nothing came to their attention causing them to believe that: (1) that the unaudited financial statements of the Company, contained in the Prospectus and any amendment thereof or supplement thereto, do not comply as to form, in all material respects, with the applicable accounting requirements of the Act and the published Rules and Regulations or were not prepared in conformity with generally-accepted accounting principles and practices applied on a basis consistent in all material respects with those followed in the preparation of, the audited financial statements of the Company included therein; or (2) that the unaudited amounts of revenues, income before provision for income taxes, net income and ratio of earnings to fixed charges of the Company contained in the Prospectus, or any amendment 16 17 thereof or supplement thereto, were not derived from financial statements prepared in conformity with generally-accepted accounting principles and practices applied on a basis consistent in all material respects with those followed in the preparation of the audited financial statements of the Company included therein; or (3) that the unaudited pro forma financial statements of the Company and recently-acquired companies, if any, contained in the Prospectus or any amendment thereof or supplement thereto, were not properly compiled in accordance with generally-accepted accounting principles or did not provide for all adjustments necessary for a fair presentation of the information purported to be shown thereby; or (4) with respect to the period subsequent to December 31, 1996, there were, at a specified date, not more than five (5) business days prior to the date of the letter, any changes or any material increases or decreases in capital stock, long-term or short-term debt or shareholders' equity, decreases in net assets, net current assets, or net worth or any material decrease, as compared with the corresponding period of the prior year, in revenues or net income of the Company as compared with the amounts shown in the December 31, 1996 balance sheet included in the Registration Statement, except as disclosed or referred to in the Prospectus and Registration Statement. (iii) Certain information set forth on the cover of the Prospectus, and in the Prospectus under the headings "Prospectus Summary," "Summary Financial Information," "Risk Factors," "Use of Proceeds," "Dilution," "Capitalization," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business," "Management," "Reorganization," "Certain Transactions," "Principal Shareholders" and "Description of Securities" and that are expressed in dollars (or percentages derived from dollar amounts) or numbers have been compared to accounting records of the Company which were subject to the internal accounting controls of the Company and are in agreement with such records or computations made therefrom, excluding any questions of legal interpretation. (f) The Underwriter shall have received from Ernst & Young, LLP, a letter dated as of each Closing Date, to the effect that such accountants reaffirm, as of such Closing Date, and as though made on such Closing Date, the statements made in the letter furnished by such accountants pursuant to subparagraph (e) of this Section 5, except that the specified date referred to in such letter will be a date not more than five (5) business days prior to such Closing Date. 17 18 (g) At each Closing Date, the Company shall have performed all material obligations and satisfied all material conditions on its part to be performed or satisfied on or prior thereto (except any condition satisfaction of which shall have been waived as herein provided) and compliance with the provisions of this subparagraph (g) shall be evidenced by a certificate of an executive officer of the Company. (h) On each Closing Date there shall have been furnished to you a certificate, dated as of such Closing Date and addressed to the Underwriter, signed by the principal executive officer and principal financial officer of the Company to the effect that: (i) the representations and warranties and covenants of the Company in this Agreement are true and correct in all material respects as if made at and as of such Closing Date and the Company has complied in all material respects with all the agreements and satisfied all the material conditions on its part to be performed or satisfied hereunder at or prior to such Closing Date; (ii) no stop order or other order suspending the effectiveness of the Registration Statement or any amendment or supplement thereto or the qualification of the Units for offering or sale has been issued and, to the Company's knowledge, no proceedings for that purpose have been instituted or are pending or, to the knowledge of the respective signers thereof, are threatened by the Commission or any state or regulatory body; (iii) neither the Registration Statement, as of the date it was declared effective, nor the Prospectus, as of its date and the Closing Date, included any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; (B) since the effective date of the Registration Statement, no event has occurred which should have been set forth in an amendment or supplement to the Prospectus which has not been set forth in such an amendment or supplement; (C) subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus and except as set forth in or contemplated by the Prospectus, the Company has not incurred any material liability or obligation, direct or contingent, whether or not in the ordinary course of business, or entered into any material transaction, outside of the ordinary course of business, and there has not been any material change in the Common Stock, or any increase in the short-term or long-term debt, including any capitalized lease obligation (other than in the ordinary course of its business and in an amount which is not material) or any issuance of options, warrants, convertible securities or other rights to purchase the Common Stock of the Company or any material adverse change in the general affairs, business, key personnel, capitalization or financial position of the Company considered as a whole (other than the issuance of Common Stock pursuant to existing options); and subsequent to the date of the Underwriting Agreement, the Company has not 18 19 sustained any material loss or damage to its property or interference with its business by strike, fire, flood, accident or other calamity, whether or not any of the foregoing is insured, that would have a material adverse effect upon the Company considered as a whole, (D) the projection of the Company previously presented to the Underwriter showing that the Company will be able to meet the maintenance requirements for listing on The Nasdaq SmallCap Market for a period of 24 months from the date hereof, were prepared in good faith and continue to represent the signers' best present estimate of the Company's financial condition following the Closing of the sale of the Units. (i) The Underwriter shall receive a Blue Sky Memorandum reasonably satisfactory to the Underwriter from Doherty, Rumble & Butler, P.A., confirming that all requisite action for the offer and sale of the Units in all jurisdictions requested has been taken. (j) The Underwriter shall have received "lock up" agreements, in form and substance acceptable to the Underwriter, from (i) all directors, officers and five percent or greater shareholders of the Company restricting the sale, assignment or other conveyance of any securities of the Company without the prior written consent of the Underwriter for a period of 180 days from the effective date of the Registration Statement under the Act, and (ii) from all significant shareholders of the Company (as reasonably determined by the Underwriter) restricting the sale, assignment or other conveyance of any securities of the Company without the prior written consent of the Underwriter for a period of 90 days from the effective date of the Registration Statement under the Act. (k) The Company's Units (and the securities comprising the Units) shall be listed on The Nasdaq SmallCap Market on or prior to the effective date of the Registration Statement under the Act. (l) Prior to the First Closing, the number of issued and outstanding shares of common stock of the Company shall not exceed 5,399,289 shares, and there shall be no change in the capitalization of the Company without the prior written consent of the Underwriter. (m) The Company's Units (and the securities comprising the Units) shall be registered under the Securities Exchange Act of 1934, as amended, pursuant to Form 8-A, on or prior to the effective date of the Registration Statement under the Act. (n) The Company shall have furnished to the Underwriter and Doherty, Rumble & Butler, P.A., counsel for the Underwriter, such further certificates and documents as the Underwriter's counsel may reasonably request, relating to the fulfillment of the conditions set forth in this Section 5. All such opinions, certificates, letters and documents will be in compliance with the provisions hereof only if they are reasonably satisfactory to the Underwriter and to counsel for the Underwriter. The Company will furnish you with such conformed copies of such opinions, certificates, letters, and other documents as you shall reasonably request. The Underwriter may 19 20 waive in writing the performance of any one or more of the conditions specified in this Section 5 or extend the time for their performance. If any of the conditions specified in this Section 5 shall not have been fulfilled when and as required by this Agreement to be fulfilled, this Agreement and all obligations of the Underwriter hereunder may be cancelled by the Underwriter at, or at any time prior to, each Closing Date. Any such cancellation shall be without liability of the Underwriter to the Company or any liability of the Company to the Underwriter, except pursuant to Section 4(i) hereof. Notice of such cancellation shall be given to the Company in writing, or by telefax or telephone confirmed in writing. The Underwriter may waive in writing the performance of any one or more of the foregoing conditions or extend the time for their performance. 6. EFFECTIVE DATE AND TERMINATION. (a) This Agreement shall become effective at immediately after the time at which the Registration Statement shall have become effective under the Act. (b) Until the First Closing Date, this Agreement may be terminated by you by giving notice to the Company, if (i) the Company shall have sustained a loss or damage by fire, flood, accident, or other calamity which is material to the property, business, or condition (financial or other) of the Company considered as a whole, any properties of the Company shall have become a party or subject to litigation material to the Company considered as a whole, or there shall have been, since the respective dates as of which information is given in the Registration Statement or the Prospectus, any material adverse change or development in the general affairs, condition (financial or other), business, key personnel, capitalization, properties, results of operations or net worth, of the Company considered as a whole, whether or not arising in the ordinary course of business, which loss, damage, or change, in your judgment, shall render it inadvisable to proceed with the delivery of the Units, whether or not such loss shall have been insured, (ii) trading in securities generally on the New York Stock Exchange, the American Stock Exchange, The Nasdaq National Market, The Nasdaq SmallCap Market or the over-the-counter market shall have been suspended or minimum prices shall have been established on such exchange or market by the Commission or by such exchange, (iii) a general banking moratorium shall have been declared by federal or state authorities, or (iv) there shall have been such a serious, unusual and material adverse change in general economic, political, or financial conditions or the effect of international conditions on the financial markets in the United States shall be such as, in your reasonable judgment, makes it inadvisable to proceed with the delivery of the Units. Any termination of this Agreement pursuant to this Section 6 shall be without liability of the Company to the Underwriter, except as otherwise provided in Sections 4(i), 7 and 8 hereof, and without liability of the Underwriter to the Company, except as provided in Sections 7 and 8 hereof. 20 21 (c) Any notice referred to in this Section 6 may be given at the address specified in Section 11 hereof in writing or by telegraph or telephone, and if by telegraph or telephone, shall be immediately confirmed in writing. 7. INDEMNIFICATION. (a) The Company agrees to indemnify and hold harmless the Underwriter and each person, if any, who controls the Underwriter within the meaning of the Act against any losses, claims, damages or liabilities, joint or several, to which such Underwriter or such controlling person may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of a material fact made by the Company in Section l hereof or contained (A) in the Registration Statement, any Preliminary Prospectus, or the Prospectus, or any amendment thereof or supplement thereto, or (B) in any Blue Sky application or other document executed by the Company specifically for that purpose or based upon and conforming to written information furnished by the Company filed in any state or other jurisdiction in order to qualify any or all of the Units under the securities laws thereof (any such application, document or information being hereinafter called a "BLUE SKY APPLICATION"), or (ii) the omission or alleged omission to state in the Registration Statement, any Preliminary Prospectus, or the Prospectus, or any amendment thereof or supplement thereto, or in any Blue Sky Application a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and will reimburse the Underwriter, its officers and directors and each such controlling person for any legal or other expenses reasonably incurred by the Underwriter, its officers and directors or such controlling person in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any such case to the extent, but only to the extent, that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with written information furnished to the Company through you or on your behalf specifically for use in the preparation of the Registration Statement or any amendment thereof or supplement thereto, or any such Blue Sky Application or any such Preliminary Prospectus or the Prospectus or any such amendment thereof or supplement thereto; and provided, further, that the foregoing indemnity agreement is subject to the condition that, insofar as it relates to any untrue statement, alleged untrue statement, omission or alleged omission made in any Preliminary Prospectus but eliminated or remedied in the Prospectus (as amended or supplemented), such indemnity agreement shall not inure to the benefit of the Underwriter (or to the benefit of any person who controls the Underwriter), if the person asserting any loss, liability, claim or damage purchased the Units which are the subject thereof and a copy of the Prospectus (as then supplemented or amended) was not sent or given to such person with or prior to the written confirmation of the sale of such Units to such person. 21 22 (b) The Underwriter will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the Registration Statement, and each person, if any, who controls the Company within the meaning of the Act, against any losses, claims, damages or liabilities, joint or several, to which the Company or any such director or officer, or controlling person, may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of a material fact contained (A) in the Registration Statement, any Preliminary Prospectus, or the Prospectus, or any amendment thereof or supplement thereto, or (B) in any Blue Sky Application, or (ii) the omission or alleged omission to state in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment thereof or supplement thereto or in any Blue Sky Application a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company through you specifically for use with reference to the Underwriter in the preparation of the Registration Statement or any amendment thereof or supplement thereto or any such Blue Sky Application or any such Preliminary Prospectus or the Prospectus or any such amendment thereof or supplement thereto; and will reimburse the Company, any such director or officer, or controlling person, for any legal or other expenses reasonably incurred by the Company or any such director or officer, or controlling person, in connection with investigating or defending any such loss, claim, damage, liability or action. This indemnity agreement will be in addition to any liability which the Underwriter may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 7 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 7, notify in writing the indemnifying party of the commencement thereof; no indemnification shall be available to any party who shall fail to give notice as provided in this Section 7(c) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was prejudiced by the failure to give such notice, but the omission so to notify such indemnifying party of any such action, suit or proceeding shall not relieve it from any liability that it may have to any indemnified party for contribution or otherwise than under this section. In case any such action is brought against any indemnified party, and the indemnified party notifies an indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein, and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel who shall be to the reasonable satisfaction of such indemnified party, and (notwithstanding subparagraphs (a) and (b) of this Section 7) after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section 7 for any legal or other expenses subsequently incurred by such indemnified party 22 23 in connection with the defense thereof other than reasonable costs of investigation except as provided below. The indemnified party shall have the right to employ its counsel in any such action, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of counsel by such indemnified party has been authorized in writing by the indemnifying parties, (ii) the indemnified party shall have reasonably concluded that there may be a conflict of interest between the indemnifying parties, or any of them, and the indemnified party in the conduct of the defense of such action (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying parties shall not have employed counsel to assume the defense of such action within a reasonable time after notice of the commencement thereof, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying parties; provided, however, that the indemnifying parties shall not be liable for the fees and expenses of more than one counsel for the indemnified parties. Any such indemnifying party shall not be liable to any such indemnified party on account of any settlement of any claim or action effected by the indemnified party without the consent of such indemnifying party. 8. CONTRIBUTION. In order to provide for just and equitable contribution in circumstances in which indemnification provided for in Section 7 is unavailable, each indemnifying party shall contribute to the aggregate losses, claims, damages, expenses and liabilities to which the indemnified parties may be subject in such proportion so that the Underwriter is responsible for that portion (the "UNDERWRITING PORTION") represented by the percentage that the underwriting commissions appearing on the cover page of the Prospectus bear to the public offering price (net of Underwriting Commissions) appearing thereon and the Company is responsible for the remaining portion (the "RESIDUAL PORTION"); provided, however, (i) that no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) will be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation; and (ii) if such allocation is not permitted by applicable law, then the relative fault of the Company, its directors, officers and controlling persons, on the one hand, and the Underwriter, its officers, directors and its controlling persons, on the other, in connection with the statements or omissions which resulted in such damages and other relevant equitable considerations shall also be considered. The relative fault shall be determined by reference to, among other things, whether in the case of an untrue statement of a material fact or the omission to state a material fact, such statement or omission relates to information supplied by the Company or by the Underwriter and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such untrue statement or omission. The Company and the Underwriter agree that it would not be just and equitable if the respective obligations of the Company on the one hand, and the Underwriter, on the other, to contribute pursuant to this Section 8 were to be determined by pro rata or per capita allocation of the aggregate damages (even if the Underwriter, its officers, directors and its controlling persons in the aggregate were treated as one entity for such purpose) or by any other method of allocation that does not take account of the equitable considerations referred to in this Section 8. For purposes of this Section 8, the term "DAMAGES" shall include any legal or other expense reasonably incurred by the indemnified party in connection with investigating or defending any action or claim that is the 23 24 subject of the contribution provisions of this Section 8. Notwithstanding the provisions of this Section 8, the Underwriter, its officers, directors and its controlling persons in the aggregate shall not be required to contribute any amount in excess of the amount by which the total purchase price of the Units purchased by it, directly or indirectly, from the Company pursuant to this Agreement exceeds the amount of any damages that the Underwriter, its officers, directors and its controlling persons in the aggregate have otherwise been required to pay by reason of such untrue statement or omission. For purposes of this Section 8, each person, if any, who controls the Underwriter within the meaning of the Act shall have the same rights to contribution as the Underwriter, and each person, if any, who controls the Company within the meaning of the Act, each officer who shall have signed the Registration Statement and each director of the Company shall have the same rights to contribution as the Company. Each party entitled to contribution agrees that, upon the service of a summons or other initial legal process upon it in any action instituted against it in respect of which contribution may be sought, it will promptly give written notice of such service to the party or parties from whom contribution may be sought, but the omission so to notify such party or parties of any such service shall not relieve the party from whom contribution may be sought from any obligation it may have hereunder or otherwise. In case any such action, suit, or proceeding is brought against any party, and such person so notifies a contributing party of the commencement thereof, the contributing party will be entitled to participate therein with the notifying party and any other contributing party similarly notified. 9. SURVIVAL OF INDEMNITIES, CONTRIBUTION, WARRANTIES AND REPRESENTATIONS. The respective indemnity and contribution agreements of the Company and the Underwriter contained in Sections 7 and 8 hereof, the representations, warranties, and covenants of the Company contained in Sections 1 and 4 hereof and the representations and warranties of the Underwriter contained in Section 14 hereof shall remain operative and in full force and effect, regardless of any termination or cancellation of this Agreement or any investigation made by or on behalf of the Underwriter or the Company or any of their respective directors or officers, or any controlling person referred to in said Sections 7 and 8, and shall survive the delivery of, and payment for, the Units. 10. NOTICES. Except as otherwise expressly provided in this Agreement, all notices and other communications hereunder shall be in writing and, if given to the Underwriter, shall be mailed, delivered or telefaxed to R. J. Steichen & Company, One Financial Plaza, 120 South Sixth Street, Minneapolis, MN 55402, Attention: President, with a copy to Girard P. Miller, Doherty, Rumble & Butler, P.A., 150 South Fifth Street, Suite 3500, Minneapolis, MN 55402, or if given to the Company, shall be mailed, delivered or telefaxed to it at Hotel Discovery, Inc., 7701 France Avenue South, Suite 217, Edina, MN 55435, Attention: President, with a copy to William M. Mower, Maslon Edelman Borman & Brand, a Professional Limited Liability Partnership, 90 South Seventh Street, Suite 3300, Minneapolis, MN 55402. 11. UNDERWRITER'S WARRANTS. Upon payment of a purchase price of $50 by the Underwriter, the Company will issue and deliver to R. J. Steichen & Company, for its account, Warrants to purchase Common Stock in an amount equal to 250,000 shares of Common Stock. Such Warrants shall be issued on the Closing Date and shall be dated as of the Closing Date. 24 25 Such Warrants shall be exercisable commencing one (1) year after the Effective Date for a period of four years thereafter at a price per share of $6.00. Such Warrant shall contain such terms and conditions as contained in the form of Underwriter's Warrant attached hereto and labeled Appendix A. 12. INFORMATION FURNISHED BY UNDERWRITER. The statements relating to stabilization activities of the Underwriter on the inside front cover of the Preliminary Prospectus and the Prospectus, and under the caption "UNDERWRITING" in any Preliminary Prospectus and in the Prospectus, and, to the extent the same relate to you, in any Blue Sky application, constitute the written information furnished by or on behalf of you referred to in Section 1 hereof and in paragraphs (a) and (b) of Section 7 hereof. 13. PARTIES. This Agreement is made solely for the benefit of the Underwriter, the Company, any director, officer, or controlling person referred to in Sections 7 and 8 hereof, and their respective personal representatives, successors and assigns, and no other person shall acquire or have any right by virtue of this Agreement. The term "personal representatives, successors and assigns," as used in this Agreement, shall not include any purchaser of Units (as such purchaser) from the Underwriter. 14. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE UNDERWRITER. The Underwriter represents, warrants to and agrees with the Company that: (a) The Underwriter is a corporation duly incorporated and validly existing in good standing under the laws of the jurisdiction in which it is incorporated. (b) The Underwriter is duly registered as a broker-dealer under the Securities Exchange Act of 1934, as amended, and under the securities laws of Minnesota and of such other states in which it intends to offer or sell the Units, if such registration is required in any such other state, and is a member in good standing of the National Association of Securities Dealers, Inc., and no proceedings have been initiated or threatened to suspend any such registration or membership. (c) The execution, delivery and performance of this Agreement by the Underwriter, and the consummation of the transactions contemplated hereby, have been duly authorized by the Underwriter, and at the time of its execution, performance, or consummation, will not constitute or result in any breach or violation of any of the terms, provisions or conditions of, or constitute a default under, any federal statute or regulation (including, without limitation, the net capital requirements under Rule 15c-1 of the Securities Exchange Act of 1934) or any statute or regulation of any state in which it intends to offer or sell the Units, or any order, judgment, decree, rule or regulation of any court or governmental agency or body having jurisdiction over the Underwriter or any of its activities or property; and other than registration of the Units under the Act and applicable states securities laws and subject to the favorable review by the National Association of Securities Dealers, Inc., no consent, approval, authorization or order of any 25 26 court or governmental agency or body is required for the consummation of the transactions contemplated hereby. (d) There is not now pending or threatened against the Underwriter or any control person of the Underwriter any action or proceeding either in any court of competent jurisdiction or before the Commission, National Association of Securities Dealers, Inc. or the securities authorities of any state, based upon any action or failure to act on the part of the Underwriter or any controlling person of an Underwriter that would restrict the Underwriter's ability to perform its obligations hereunder. (e) The Units will be offered by the Underwriter only to persons resident in Minnesota and such other states as are mutually designated by the Underwriter and the Company pursuant to Section 4(c) hereof. All of such persons shall be persons and entities for whom the purchase of the Units is a suitable investment and the Underwriter shall employ or engage no Selected Dealer, sales person, agent or representative in the offer or sale of the Units, which Selected Dealer, sales person, agent or representative is not properly registered and licensed for the purpose of such offer or sale. All such registrations and licenses shall remain in full force and effect until after the Closing Dates. (f) The Underwriter agrees that neither the Underwriter nor any officer or other person employed by the Underwriter or any Selected Dealer will provide any information or make any representations to offerees of the Units, other than such information and representations as are either contained in the Prospectus or the Registration Statement or are not inconsistent with information set forth in the Prospectus or the Registration Statement. (g) The Underwriter agrees that in the event the Underwriter learns of any circumstances or fact which it believes would make any Preliminary Prospectus, the Prospectus, or the Registration Statement inaccurate or misleading in any material respect, it will immediately bring such circumstances or facts to the attention of the Company. 15. GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Minnesota. HOTEL DISCOVERY, INC. By _____________________________ Its ______________________ "COMPANY" 26 27 The foregoing Agreement is hereby confirmed and accepted as of the date first above written: R. J. STEICHEN & COMPANY By _________________________________ Authorized Officer ____________________________________ Print Name "UNDERWRITER" 27 28 APPENDIX A UNDERWRITER'S WARRANT 29 HOTEL DISCOVERY, INC. COMMON STOCK PURCHASE WARRANT Hotel Discovery, Inc., an Minnesota corporation (the "COMPANY"), hereby agrees that, for value received, R. J. STEICHEN & COMPANY, or its assigns, is entitled, subject to the terms set forth below, to purchase from the Company at any time or from time to time after ____________, 1998, and before 4:30 p.m., Minneapolis, Minnesota time, on __________, 2002 Two Hundred Fifty Thousand (250,000) shares of the $.01 par value Common Stock of the Company, at an exercise price of $6.00 per Share, subject to adjustment as provided herein. 1. EXERCISE OF WARRANT. The purchase rights granted by this Warrant shall be exercised (in minimum quantities of 100 shares) by the holder surrendering this Warrant with the form of exercise attached hereto duly executed by such holder, to the Company at its principal office, accompanied by payment, in cash or by cashier's check payable to the order of the Company, of the purchase price payable in respect of the Shares being purchased. If less than all of the Shares purchasable hereunder is purchased, the Company will, upon such exercise, execute and deliver to the holder hereof a new Warrant (dated the date hereof) evidencing the number of Shares not so purchased. As soon as practicable after the exercise of this Warrant and payment of the purchase price, the Company will cause to be issued in the name of and delivered to the holder hereof, or as such holder may direct, a certificate or certificates representing the Shares purchased upon such exercise. The Company may require that such certificate or certificates contain on the face thereof a legend substantially as follows: "The transfer of the shares represented by this certificate is restricted pursuant to the terms of a Common Stock Purchase Warrant dated____________, 1997, issued by Hotel Discovery, Inc., a copy of which is available for inspection at the offices of Hotel Discovery, Inc. Transfer may not be made except in accordance with the terms of the Common Stock Purchase Warrant. In addition, no sale, offer to sell or transfer of the shares represented by this certificate shall be made unless a Registration Statement under the Securities Act of 1933, as amended (the "ACT"), with respect to such shares is then in effect or an exemption from the registration requirements of the Act is then in fact applicable to such shares." ___________________________ THIS WARRANT IS SUBJECT TO THE RESTRICTIONS ON TRANSFER SET FORTH AT THE BOTTOM OF PAGE 8 HEREOF. 30 2. NEGOTIABILITY AND TRANSFER. This Warrant is issued upon the following terms, to which each holder hereof consents and agrees: (a) Except where directed by a court of competent jurisdiction pursuant to the dissolution or liquidation of a corporate holder hereof, for the period ending one year from _______________, 1997, title to this Warrant may not be sold, transferred, assigned or hypothecated, except that within such one-year period title to this Warrant may be transferred only to R. J. Steichen & Company (the "UNDERWRITER"), or to a person who is both an officer and shareholder, or both an officer and employee, of the Underwriter, or to a successor (or both an officer and shareholder, or both an officer and employee) in interest to the business of the Underwriter, by endorsement (by the holder hereof executing the form of assignment attached hereto) and delivery in the same manner as in the case of a negotiable instrument transferable by endorsement and delivery subject to the requirements of Section 4 hereof. (b) Until this Warrant is duly transferred on the books of the Company, the Company may treat the registered holder of this Warrant as absolute owner hereof for all purposes without being affected by any notice to the contrary. (c) Each successive holder of this Warrant, or of any portion of the rights represented thereby, shall be bound by the terms and conditions set forth herein. 3. ANTIDILUTION ADJUSTMENTS. If the Company shall at any time hereafter subdivide or combine its outstanding shares of Common Stock, or declare a dividend payable in Common Stock, the exercise price in effect immediately prior to the subdivision, combination or record date for such dividend payable in Common Stock shall forthwith be proportionately increased, in the case of combination, or proportionately decreased, in the case of subdivision or declaration of a dividend payable in Common Stock, and the number of Shares purchasable upon exercise of this Warrant, immediately preceding such event, shall be changed to the number determined by dividing the then current exercise price by the exercise price as adjusted after such subdivision, combination or dividend payable in Common Stock and against the number of Shares purchasable upon the exercise of this Warrant immediately preceding such event, so as to achieve an exercise price and number of Shares purchasable after such event proportional to such exercise price and number of Shares purchasable immediately preceding such event. No adjustment in exercise price shall be required unless such adjustment would require an increase or decrease of at least five cents ($0.05) in such price; PROVIDED, HOWEVER, that any adjustments which are not require to be so made shall be carried forward and taken into account in any subsequent adjustment. All calculations hereunder shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. 2 31 No fractional Shares are to be issued upon the exercise of the Warrant, but the Company shall pay a cash adjustment in respect of any fraction of a Share which would otherwise be issuable in an amount equal to the same fraction of the market price per share of Common Stock on the day of exercise as determined in good faith by the Company. In case of any capital reorganization or any reclassification of the Common Stock of the Company, or in the case of any consolidation with or merger of the Company into or with another corporation, or the sale of all or substantially all of its assets to another corporation, which is effected in such a manner that the holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a part of such reorganization, reclassification, consolidation, merger or sale, as the case may be, lawful provision shall be made so that the holder of the Warrant shall have the right thereafter to receive, upon the exercise hereof, the kind and amount of shares of stock or other securities or property which the holder would have been entitled to receive if, immediately prior to such reorganization, reclassification, consolidation, merger or sale, the holder had held the number of Shares which were then purchasable upon the exercise of the Warrant. In any such case, appropriate adjustment (as determined in good faith by the Board of Directors of the Company) shall be made in the application of the provisions set forth herein with respect to the rights and interest thereafter of the holder of the Warrant, to the end that the provisions set forth herein (including provisions with respect to adjustments of the exercise price) shall thereafter be applicable, as nearly as reasonably may be, in relation to any shares of stock or other property thereafter deliverable upon the exercise of the Warrant. When any adjustment is required to be made in the exercise price, initial or adjusted, the Company shall forthwith determine the new exercise price, and (a) prepare and retain on file a statement describing in reasonable detail the method used in arriving at the new exercise price; and (b) cause a copy of such statement to be mailed to the holder of the Warrant as of a date within ten (10) days after the date when the circumstances giving rise to the adjustment occurred. 4. REGISTRATION RIGHTS. Prior to making any disposition of the Warrant or of any Shares purchased upon exercise of the Warrant, the holder will give written notice to the Company describing briefly the manner of any such proposed disposition. The holder will not make any such disposition until (i) the Company has notified him that, in the opinion of its counsel, registration under the Act is not required with respect to such disposition, or (ii) a Registration Statement covering the proposed distribution has been filed by the Company and has become effective. The Company agrees that, upon receipt of written notice from the holder hereof with respect to such proposed distribution, it will use its best efforts, in the consultation with the holder's counsel, to ascertain as promptly as possible whether or not registration is required, and will advise the holder promptly with respect thereto, and the holder will cooperate in providing the Company with information necessary to make such determination. 3 32 If, at any time prior to the expiration of seven (7) years from the date hereof, the Company shall propose to file any Registration Statement (other than any registration on Forms S-4, S-8 or any other similarly inappropriate form or Registration Statement with respect to an initial public offering in which there are no selling shareholders) under the Securities Act of 1933, as amended, covering a public offering of the Company's Units or shares, it will notify the holder hereof at least thirty (30) days prior to each such filing and will include in the Registration Statement (to the extent permitted by applicable regulation), the shares purchased by the holder or purchasable by the holder upon the exercise of the Warrant to the extent requested by the holder hereof. Notwithstanding the foregoing, the number of shares of the holders of the Warrants proposed to be registered thereby shall be reduced pro rata with any other selling shareholder (other than the Company) upon the reasonable request of the managing underwriter of such offering. If the Registration Statement or Offering Statement filed pursuant to such thirty (30) day notice has not become effective within six months following the date such notice is given to the holder hereof, the Company must again notify such holder in the manner provided above. At any time prior to the expiration of five (5) years from the date hereof, and provided that a registration statement on Form S-3 (or its equivalent) is then available to the Company, and on a one-time basis only, if the holders of 50% or more of the Warrants and/or the Shares acquired upon exercise of the Warrants request the registration of the Shares on Form S-3 (or its equivalent), the Company shall promptly thereafter use its best efforts to effect the registration under the Securities Act of 1933, as amended, of all such shares which such holders request in writing to be so registered, and in a manner corresponding to the methods of distribution described in such holders' request. All expenses of any such registrations referred to in this Section 4, except the fees of counsel to such holders and underwriting commissions or discounts, filing fees, and any transfer or other taxes applicable to such shares, shall be borne by the Company. Upon effectiveness of a Registration Statement which includes Common Stock purchased or purchasable upon the exercise of this Warrant in accordance with a valid demand under this Section 4, the rights under this Warrant of all holders to make another such demand shall terminate. Each purchaser or transferee of a portion of this Warrant is responsible to determine whether his or her demand rights under this paragraph have been terminated by such an exercise. Any Warrants issued upon transfers subsequent to such an exercise shall have all of the demand registration provisions under this Section 4 deleted. The Company will mail to each record holder, at the last known post office address, written notice of any exercise of the rights granted under this paragraph 4, by certified or registered mail, return receipt requested, and each holder shall have twenty (20) days from the date of deposit of such notice in the U.S. Mail to notify the Company in writing whether such holder wishes to join in such exercise. The Company will furnish the holder hereof with a reasonable number of copies of any prospectus included in such filings and will amend or supplement the same as required during the 4 33 period of required use thereof. The Company will maintain, at its expense, the effectiveness of any Registration Statement or the Offering Statement filed by the Company, whether or not at the request of the holder hereof, for at least six (6) months following the effective date thereof. In the case of the filing of any Registration Statement, and to the extent permissible under the Securities Act of 1933, as amended, and controlling precedent thereunder, the Company and the holder hereof shall provide cross indemnification agreements to each other in customary scope covering the accuracy and completeness of the information furnished by each. The holder of the Warrant agrees to cooperate with the Company in the preparation and filing of any such Registration Statement or Offering Statement, and in the furnishing of information concerning the holder for inclusion therein, or in any efforts by the Company to establish that the proposed sale is exempt under the Act as to any proposed distribution. 5. RIGHT TO CONVERT. (a) The holder of this Warrant shall have the right to require the Company to convert this Warrant (the "CONVERSION RIGHT"), at any time after ________________, 1998 and prior to its expiration, into Common Stock as provided for in this Section 5. Upon exercise of the Conversion Right, the Company shall deliver to the holder (without payment by the holder of any exercise price) that number of shares of Common Stock equal to the quotient obtained by dividing (x) the value of the Warrant at the time the Conversion Right is exercised (determined by subtracting the exercise price for one Warrant Share in effect immediately prior to the exercise of the Conversion Right from the Fair Market Value (as determined below) for one Warrant Share immediately prior to the exercise of the Conversion Right) by (y) the Fair Market Value of one share of Common Stock immediately prior to the exercise of the Conversion Right. (b) The Conversion Right may be exercised by the holder, at any time or from time to time, prior to its expiration, on any business day, by delivering a written notice (the "CONVERSION NOTICE") to the Company at the offices of the Company exercising the Conversion Right and specifying (i) the total number of shares of Common Stock the Warrantholder will purchase pursuant to such conversion, and (ii) a place, and a date not less than five (5) nor more than twenty (20) business days from the date of the Conversion Notice, for the closing of such purchase. (c) At any closing under Section 5(b) hereof, (i) the holder will surrender the Warrant, (ii) the Company will deliver to the holder a certificate or certificates for the number of shares of Common Stock issuable upon such conversion, together with cash, in lieu of any fraction of a share, and (iii) the Company will deliver to the holder a new Warrant representing the 5 34 number of shares, if any, with respect to which the Warrant shall not have been converted. (d) "FAIR MARKET VALUE" of a share of Common Stock as of a particular date (the "DETERMINATION DATE") shall mean: (i) If the Company's Common Stock is traded on an exchange or is quoted on The Nasdaq National Market or The Nasdaq SmallCap Market, then the average closing or last sale prices, respectively, reported for the ten (10) business days immediately preceding the Determination Date. (ii) If the Company's Common Stock is not traded on an exchange or on The Nasdaq National Market or The Nasdaq SmallCap Market, but is traded in the over-the-counter market, then the average of the closing bid and asked prices reported for the ten (10) business days immediately preceding the Determination Date. (iii) If the Company's Common Stock is not publicly traded and there has been a bona fide sale for cash on an arm's-length basis within 45 days prior to the Determination Date of such Common Stock by the Company privately to one or more investors unaffiliated with the Company (a "Qualifying Sale"), then the most recent such sales price; and (iv) If the Company's Common Stock is not publicly traded and there has been no Qualifying Sale, then the appraised fair market value of such stock, as determined by mutual agreement of the Company and the holder of the Warrant; or if the parties cannot agree to such valuation, then each of the Company and the holder shall select an arbitrator and such arbitrators shall select a third, and such three arbitrators shall determine (in accordance with the Commercial Arbitration Rules of the American Arbitration Association, such expenses to be borne equally by the parties) the fair market value (without any discount for lack of marketability or minority interest) of a share of Common Stock of the Company. 6. NOTICES. The Company shall mail to the registered holder of the Warrant, at his or her last known post office address appearing on the books of the Company, not less than fifteen (15) days prior to the date on which (a) a record will be taken for the purpose of determining the holders of Common Stock entitled to dividends (other than cash dividends) or subscription rights, or (b) a record will be taken (or in lieu thereof, the transfer books will be closed) for the purpose of determining the holders of common stock entitled to notice of and to vote at a meeting of shareholders at which any capital reorganization, reclassification of common stock, consolidation, 6 35 merger, dissolution, liquidation, winding up or sale of substantially all of the Company's assets shall be considered and acted upon. 7. RESERVATION OF COMMON STOCK. A number of shares of Common Stock sufficient to provide for the exercise of the Warrant and the shares of Common Stock included therein upon the basis herein set forth shall at all times be reserved for the exercise thereof. 8. MISCELLANEOUS. Whenever reference is made herein to the issue or sale of shares of Common Stock, the terms "COMMON STOCK" or "SHARES" shall include any stock of any class of the Company other than preferred stock that has a fixed limit on dividends and a fixed amount payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company. The Company will not, by amendment of its Articles of Incorporation or through reorganization, consolidation, merger, dissolution or sale of assets, or by any other voluntary act or deed, avoid or seek to avoid the observance or performance of any of the covenants, stipulations or conditions to be observed or performed hereunder by the Company, but will, at all times in good faith, assist, insofar as it is able, in the carrying out of all provisions hereof and in the taking of all other action which may be necessary in order to protect the rights of the holder hereof against dilution. Upon written request of the holder of this Warrant, the Company will promptly provide such holder with a then current written list of the names and addresses of all holders of warrants originally issued under the terms of, and concurrent with, this Warrant. The representations, warranties and agreements herein contained shall survive the exercise of this Warrant. References to the "holder of" include the immediate holder of shares purchased on the exercise of this Warrant, and the word "holder" shall include the plural thereof. This Common Stock Purchase Warrant shall be interpreted under the laws of the State of Minnesota. All Shares or other securities issued upon the exercise of the Warrant shall be validly issued, fully paid and non-assessable, and the Company will pay all taxes in respect of the issuer thereof. Notwithstanding anything contained herein to the contrary, the holder of this Warrant shall not be deemed a stockholder of the Company for any purpose whatsoever until and unless this Warrant is duly exercised. 7 36 IN WITNESS WHEREOF, this Warrant has been duly executed by Hotel Discovery, Inc., this_____day of_________, 1997. HOTEL DISCOVERY, INC. By _____________________________ Its ____________________ THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, OR APPLICABLE STATE SECURITIES LAW. THESE SECURITIES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE OFFERED FOR SALE, SOLD, ASSIGNED, TRANSFERRED, PLEDGED, ASSIGNED OR OTHERWISE DISPOSED OF, AND NO TRANSFER OF THE SECURITIES WILL BE MADE BY THE COMPANY OR ITS TRANSFER AGENT, IN THE ABSENCE OF SUCH REGISTRATION OR AN OPINION OF COUNSEL ACCEPTABLE TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED. 8 37 WARRANT EXERCISE FORM To be signed only upon exercise of Warrant. The undersigned, the holder of the within Warrant, hereby irrevocably elects to exercise the purchase right represented by such Warrant for, and to purchase thereunder,_________________ shares of Common Stock of Hotel Discovery, Inc. to which such Warrant relates and herewith makes payment of $_________ therefor in cash or by certified check, and requests that such shares be issued and be delivered to,_______________, the address for which is set forth below the signature of the undersigned. Dated:____________ __________________________ _____________________________________ (Taxpayer's I.D. Number) Signature) _____________________________________ (Address) _____________________________________ _________________ ASSIGNMENT FORM To be signed only upon authorized transfer of Warrant. FOR VALUE RECEIVED, the undersigned hereby sells, assigns, and transfers unto ________ the right to purchase shares of Common Stock of Hotel Discovery, Inc. to which the within Warrant relates and appoints ____________, attorney, to transfer said right on the books of Hotel Discovery, Inc. with full power of substitution in the premises. Dated: ________________________ _____________________________________ (Signature) _____________________________________ (Address) _____________________________________ 38 CASHLESS EXERCISE FORM (To be executed upon exercise of Warrant pursuant to Section 5) The undersigned hereby irrevocably elects a cashless exercise of the right of purchase represented by the within Common Stock Purchase Warrant for, and to purchase thereunder, ______________________ shares of Common Stock, as provided for in Section 5 therein. If said number of shares shall not be all the shares purchasable under the within Common Stock Purchase Warrant, a new Warrant is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder rounded up to the next higher number of shares. Please issue a certificate or certificates for such Common Stock in the name of, and pay any cash for any fractional shares to: NAME ________________________________________________________ (Please Print Name) ADDRESS ________________________________________________________ ________________________________________________________ SOCIAL SECURITY NO. ______________________________________________________ SIGNATURE ____________________________________________________________ NOTE: The above signature should correspond exactly with the name on the first page of this Common Stock Purchase Warrant or with the name of the assignee appearing in the assignment form on the preceding page. EX-10.6 3 AMENDMENT - 1997 STOCK OPTION & COMPENSATION PLAN 1 EXHIBIT 10.6 HOTEL DISCOVERY, INC. AMENDMENT TO 1997 STOCK OPTION AND COMPENSATION PLAN 1. INCREASE IN NUMBER OF SHARES SUBJECT TO THE PLAN. Section 5.1 of the 1997 Stock Option and Compensation Plan is hereby amended to read in its entirety as follows: 5.1 NUMBER OF SHARES. Subject to adjustment as provided in Section 11.6, the number of shares of Common Stock which may be issued under the Plan shall not exceed 750,000 shares of Common Stock. 2. EFFECTIVE DATE. This Amendment became effective as of September 12, 1997. -----END PRIVACY-ENHANCED MESSAGE-----