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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 15, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 0-1154
MAX & ERMA'S RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-1041397
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
4849 EVANSWOOD DRIVE, COLUMBUS, OHIO 43229
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (614) 431-5800
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 15, 2005, there were 2,554,183 shares of common stock outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
May 15,
2005 October 31,
(UNAUDITED) 2004
------------- --------------
ASSETS
Current Assets:
Cash $ 2,049,016 $ 2,187,529
Inventories 1,283,304 1,377,366
Other Current Assets 3,297,703 2,865,251
------------- --------------
Total Current Assets 6,630,023 6,430,146
Property - At Cost: 99,377,024 98,070,311
Less Accumulated Depreciation and Amortization 44,634,153 42,720,109
------------- --------------
Property - Net 54,742,871 55,350,202
Other Assets 9,888,805 9,326,737
------------- --------------
Total $ 71,261,699 $ 71,107,085
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities of Long-Term Obligations $ 4,161,715 $ 4,160,314
Accounts Payable 6,559,885 5,334,219
Accrued Payroll and Related Taxes 2,721,732 1,914,099
Accrued Liabilities 5,296,687 4,589,203
------------- --------------
Total Current Liabilities 18,740,019 15,997,835
Long-Term Obligations - Less Current Maturities 38,253,683 41,053,030
Stockholders' Equity:
Preferred Stock - $.10 Par Value;
Authorized 500,000 Shares - none outstanding
Common Stock - $.10 Par Value;
Authorized 5,000,000 Shares,
Issued and Outstanding 2,554,183 Shares
at 5/15/05 and 2,507,328 Shares at 10/31/04 254,727 250,732
Additional Paid In Capital 685,738 319,404
Accumulated Other Comprehensive (Loss) (72,566) (203,406)
Retained Earnings 13,400,098 13,689,490
------------- --------------
Total Stockholders' Equity 14,267,997 14,056,220
------------- --------------
Total $ 71,261,699 $ 71,107,085
============= ==============
(See notes to interim unaudited condensed consolidated financial statements)
1
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Twelve Weeks Ended Twenty-eight Weeks Ended
------------------- ------------------------
May 15, May 9, May 15, May 9,
2005 2004 2005 2004
------------ ------------ ------------- ------------
REVENUES: $ 43,024,863 $ 41,882,192 $ 100,295,691 $ 95,303,714
COSTS AND EXPENSES:
Costs of Goods Sold 11,098,173 10,832,967 25,610,149 24,071,425
Payroll and Benefits 13,844,390 13,633,259 31,850,514 30,837,128
Other Operating Expenses 14,362,187 13,022,428 33,055,194 29,803,418
Pre-Opening Expenses 116,989 101,746 124,038 249,034
Impairment of Assets 1,450,000 - 1,450,000
Administrative Expenses 3,413,598 3,130,350 7,921,698 7,380,834
------------ ------------ ------------- ------------
Total Operating Expenses 44,285,337 40,720,750 100,011,593 92,341,839
------------ ------------ ------------- ------------
Operating Income (Loss) (1,260,474) 1,161,442 284,098 2,961,875
Interest Expense 538,233 515,120 1,244,235 1,111,674
Minority Interest in Income
of Affiliated Partnerships - 19,252 19,252 19,252
------------ ------------ ------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES (1,798,707) 627,070 (979,389) 1,830,949
INCOME TAXES (CREDIT) (855,000) 130,000 (690,000) 443,000
------------ ------------ ------------- ------------
NET INCOME (LOSS) $ (943,707) $ 497,070 $ (289,389) $ 1,387,949
============ ============ ============= ============
NET INCOME (LOSS) PER SHARE:
Basic $ (0.37) $ 0.20 $ (0.11) $ 0.57
============ ============ ============= ============
Diluted $ (0.37) $ 0.19 $ (0.11) $ 0.54
============ ============ ============= ============
SHARES OUTSTANDING:
Basic 2,549,083 2,457,539 2,529,133 2,454,266
============ ============ ============= ============
Diluted 2,549,083 2,580,060 2,529,133 2,592,867
============ ============ ============= ============
(See notes to interim unaudited condensed consolidated financial statements)
2
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Twenty-eight Weeks Ended
----------------------------
May 15, May 9,
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (Loss) $ (289,389) $ 1,387,949
Depreciation and amortization 4,608,310 4,313,898
Loss on Disposition of Assets 112,122 106,419
Impairment of Assets 1,450,000 -
Minority interest in income of Affiliated Partnerships 19,252 19,252
Changes in other assets and liabilities (76,447) (232,566)
------------ ------------
Net cash provided by operating activities 5,823,848 5,594,952
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property Additions (4,258,270) (12,562,965)
Proceeds from sale of assets 2,805,704
Decrease (increase) in other assets 75,283 (282,855)
------------ ------------
Net cash used by investing activities (4,182,987) (10,040,116)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under long-term obligations (42,536,563) (41,851,228)
Proceeds from long-term obligations 40,557,697 45,512,814
Proceeds from sale of stock 259,694 42,430
Purchase of common stock (20,721)
Debt issue costs (40,950) (77,780)
Distributions to minority interests in Affiliated Partnerships (19,252) (19,252)
------------ ------------
Net cash provided by (used by) financing activities (1,779,374) 3,586,263
------------ ------------
NET DECREASE IN CASH AND EQUIVALENTS (138,513) (858,901)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 2,187,529 2,616,324
------------ ------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 2,049,016 $ 1,757,423
============ ============
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest (net of $41,000 and $100,000 capitalized in 2005 and 2004) $ 1,517,224 $ 1,487,453
Income taxes $ 342,539 $ 361,964
Non-cash activities:
Property additions financed by accounts payable $ 1,818,048 $ 817,439
(See notes to interim unaudited condensed consolidated financial statements)
3
MAX & ERMA'S RESTAURANTS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Presentation
The accompanying unaudited condensed financial statements have been
prepared in accordance with the instructions to Form 10-Q and include all
of the information and disclosures required by accounting principles
generally accepted in the United States of America for interim reporting,
which are less than those required for annual reporting. In the opinion of
management, all adjustments, consisting of only normal recurring accruals,
considered necessary for a fair presentation have been included.
The Company and its Affiliated Partnership each have a 52-53 week fiscal
year, which ends on the last Sunday in October. Fiscal 2005 consists of 52
weeks and includes one sixteen-week and three twelve-week quarters. Fiscal
2004 consists of 53 weeks and includes one sixteen-week, two twelve-week
and one thirteen-week quarters.
2. Recently Issued Financial Accounting Standards
In December 2004, the Financial Accounting Standard Board issued Statement
of Financial Accounting Standards ("SFAS") No. 123R, Share-Based Payment,
which supersedes Accounting Principle Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and SFAS No. 123, Accounting for
Stock-Based Compensation. This pronouncement eliminates the ability to
account for share-based compensation transactions using APB Opinion No. 25
and requires share-based compensation to employees, including employee
stock options and similar awards, to be measured at their fair value on
the awards' grant date using either the Black-Scholes or a binomial
option-pricing model. The value of the awards is recognized as
compensation expense in the statement of operations over the vesting
period of the awards. The Company currently does not expense its
share-based compensation, but discloses the effect of these items as
required by SFAS No. 123. See Note 4 - Stock Options. SFAS No. 123R is
effective for annual periods beginning after June 15, 2005. Management is
currently evaluating the impact the adoption of this accounting standard
will have on its consolidated financial statements.
3. Net Income Per Share
Basic income per share amounts are based on the weighted average number of
shares of common stock outstanding during the years presented. Diluted
income per share amounts are based on the weighted average number of
shares of common stock and dilutive stock options outstanding during the
periods presented. Options to purchase 231,950 shares of common stock were
outstanding at May 15, 2005 but were not
4
included in the computation of diluted earnings per share because the
Company reported a net loss for the quarter and year-to-date periods and,
therefore, the effect would be antidilutive. The difference between basic
shares outstanding and diluted shares outstanding as follows:
Twelve Twelve Twenty-Eight Twenty-Eight
Weeks Ended Weeks Ended Weeks Ended Weeks Ended
May 15, 2005 May 9, 2004 May 15, 2005 May 9, 2004
------------ ----------- ------------ ------------
Basic Shares
Outstanding 2,549,083 2,457,539 2,529,133 2,454,266
Dilutive Effect of
Stock Options 122,521 138,601
--------- --------- --------- ---------
Diluted Shares
Outstanding 2,549,083 2,580,060 2,529,133 2,592,867
========= ========= ========= =========
4. Stock Options
During the twenty-eight weeks ended May 15, 2005, the Company's stock
options activity and weighted average exercise prices were as follows:
Shares Exercise Price
------ --------------
Outstanding, October 31, 2004 313,651 $ 12.69
Exercised (63,301) (9.51)
Forfeited (18,400) (13.83)
------- ---------
Outstanding, May 15, 2005 231,950 $ 13.47
======= =========
The Company accounts for employee and director stock options using the
intrinsic value method. Under this method, no compensation expense was
recorded in all years presented because all stock options were granted at
an exercise price equal to the fair market value of the Company's stock on
the date of the grant. If compensation expense for the Company's stock
option grants had been determined based on their estimated fair value at
the grant dates, the Company's net income and earnings per share for the
twelve-weeks and twenty-eight weeks 28-weeks ending May 15, 2005 and May
9, 2004 would have been as follows:
5
Twelve Twelve Twenty -Eight Twenty-Eight
Weeks Ended Weeks Ended Weeks Ended Weeks Ended
May 15, 2005 May 9, 2004 May 15 2005 May 9, 2004
------------ ----------- ------------- ------------
Net income (loss) as reported $ (943,707) $ 497,070 $ (289,389) $ 1,387,949
Deduct: total stock-based
compensation expense
determined under the fair value
method for all awards, net of
related tax benefits (1,277) (120,517) (6,384) (429,350)
------------ ----------- ------------- ------------
Pro forma net income (loss) $ (944,984) $ 376,553 $ (295,773) $ 958,599
============ =========== ============= ============
Earnings (loss) per common share, basic:
As reported $ (0.37) $ 0.20 $ (0.11) $ 0.57
============ =========== ============= ============
Pro forma $ (0.37) $ 0.15 $ (0.12) $ 0.39
============ =========== ============= ============
Earnings (loss) per common share, diluted:
As reported $ (0.37) $ 0.19 $ (0.11) $ 0.54
============ =========== ============= ============
Pro forma $ (0.37) $ 0.15 $ (0.12) $ 0.37
============ =========== ============= ============
The fair value of options granted was estimated on the date of the grant using
the Black-Scholes option-pricing model.
5. Withdrawal Of Proposed Deregistration
The Company's Board of Directors on March 29, 2005, withdrew the
1-for-200 reverse stock split proposal which was publicly announced
on January 19, 2005, subject to approval of a vote of its
stockholders, after which stockholders who owned less than one whole
share would be cashed out at $16 per share. On March 2, 2005, the
Securities and Exchange Commission (SEC) extended the compliance
date for non-accelerated filers, which included the Company, to
comply with Section 404 of the Sarbanes-Oxley Act (Section 404).
With the extension, the Company will not be required to include in
its annual reports a report by management on the Company's internal
controls over financial reporting and an accompanying report of
independent registered public accounting firm until the filing of
its annual report for fiscal 2006, which fiscal year ends October
29, 2006. There are also two recent initiatives underway concerning
future application of Section 404 to non-accelerated filers. First,
the SEC has established the SEC Advisory Committee on Smaller Public
Companies to assist the Commission in evaluating the current
securities regulatory system relating to smaller public companies,
including the internal control requirements. Second, the Committee
of Sponsoring Organizations
6
(COSO) has established a task force to develop new guidance for smaller
companies regarding internal controls that it intends to publish this
summer. One of the primary reasons for the Company's 1-for-200 reverse
stock split proposal was to enable the Company to save substantial annual
compliance costs that it would have begun to incur in fiscal 2005, by
deregistering as an SEC reporting company and thereby making Section 404
inapplicable to it. Because of the SEC's recent extension in the date of
compliance, COSO's initiatives to study the application of the new
internal controls requirements to smaller public companies, and a material
increase in the estimated number of shares held by stockholders with fewer
than 200 shares that would have been cashed out in the proposed reverse
stock split, the Company's Board of Directors determined to withdraw the
reverse stock split proposal.
6. Asset Impairment
During the second quarter of 2005, the Company recorded a $1,450,000 asset
impairment charge related to six restaurant properties, two of which are
at or close to the end of their lease terms and the write off of costs
associated with the proposed deregistration transaction. The Company
expensed $1,260,000 for the write downs of restaurant assets and for
payment to a landlord to obtain a release from one of the leases, where
the related restaurant will be closed. The Company currently expects to
operate the other four restaurants through the remainder of their lease
terms, but has written down the restaurant assets to a fair value based
upon future discounted cash flows. The Company also recorded a charge of
$190,000 for expenses, primarily legal, accounting and professional fees,
associated with the proposed deregistration transaction, which was
terminated during the second quarter of 2005.
7. Bank Covenants
As a result of the Asset Impairment charge discussed above, the Company
was in default under the fixed charge coverage ratio and the senior debt
to EBITDA ratio covenants of its bank loan agreement. The Company has
obtained a waiver of the defaults for the period ended May 15, 2005 and
believes that it will be in compliance with such covenants in the coming
year. Accordingly it has classified amounts due under its loan agreement
as long-term obligations less amounts appropriately classified as current
maturities.
8. Comprehensive Income
Comprehensive income (loss) consists of net income (loss) and the change
in the fair value (net of tax) of the Company's interest rate swap
agreement. Comprehensive income (loss) was approximately ($895,000) and
$635,000 for the twelve weeks ended and ($159,000) and $1,692,000 for the
twenty-eight weeks ended May 15, 2005 and May 9, 2004 respectively.
7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We derive revenues and income from the operation and franchising of
restaurants. Our Company-owned and franchised restaurants sell both food and
alcoholic beverages (with the exception of two franchised locations that only
sell food). Our restaurants are primarily located in the mid-west, within a 400
mile radius surrounding Columbus, Ohio, our Company's headquarters, and to a
lesser extent in the southeast. Our franchised restaurants tend to be located on
the outer edge of the mid-west, e.g., Philadelphia, Green Bay and St. Louis,
with selective markets or locations within the mid-west also operated by
franchisees.
We generally lease the real estate for our restaurants and invest
approximately $1.0 million dollars in furniture, fixtures and equipment and
building costs not totally funded by landlords. We anticipate that new
restaurants will generate annual sales of approximately $2.5 million each and an
average restaurant level profit of at least $300,000. Franchisees generally pay
an initial franchise fee of $40,000 per location, plus an annual royalty of 4%
of sales. We anticipate that each additional franchised location will pay annual
royalties of approximately $100,000.
The restaurant industry is very competitive. We typically compete very
favorably with several larger, national restaurant chains in most of our
locations. Nonetheless the amount of competition is one of the most significant
factors affecting the success of a restaurant location. While we seek out less
competitive sites, highly successful locations quickly attract competition,
which may affect sales.
During late 2003 and through most of 2004, our restaurants experienced
margin pressure due to rising beef, chicken, produce and dairy prices. In late
2004 and into 2005, we began to implement a series of menu specification changes
and systematically re-bid a large number of inventory items. These moves, along
with consolidating our chicken purchasing with one vendor at a then below market
fixed price and a return to more normal pricing for produce and dairy, resulted
in a significant decline in cost of sales, as a percentage of revenues for the
first twenty-eight weeks of 2005 as compared to a mid - 2004 high point. Our
approach to rising commodity prices has always been to cautiously raise prices
every six months at a rate consistent with inflation and not over react to
shorter-term price spikes. As a result of this policy, we have generally
maintained a gradually declining cost of sales percentage. We expect some
further reduction in the costs of sales percentage as additional cost savings
measures are implemented in 2005.
We also have experienced sharply rising healthcare and workers'
compensation insurance costs over the past several years. At the start of 2004,
we implemented a new health insurance program and increased our employee
contribution rates in an effort to reduce our health insurance costs.
Contribution levels were increased again at the start of 2005. As a result of
these
8
efforts, health insurance expense declined in both 2004 and for the first
twenty-eight weeks of 2005. Late in 2004, we began self-funding our Ohio
workers' compensation insurance. We believe this program will lower our worker's
compensation expense by $300,000 or more in 2005.
During the second quarter of 2005, the Company recorded an asset
impairment charge of $1.45 million primarily related to six restaurant
properties, two of which are at or close to the end of their related lease terms
and will be closed. The two restaurants expected to close had operating losses
of $300,000 during the first twenty-eight weeks of 2005. As a result of the
write down of restaurant assets at the other four restaurants depreciation
expense will be reduced by approximately $120,000 annually. Included in the
charge was the write-off of $190,000 of cost associated with the proposed
deregistration transaction, which was terminated during the second quarter of
2005.
We have bank borrowings of approximately of $29.1 million. The related
notes carry variable interest rates. As a result, our Company is exposed to a
risk associated with rising interest rates. To mitigate this risk, we have
purchased an interest rate swap, which essentially fixes the rate on
approximately 30% of the outstanding balance. However, rising interest rates in
the first quarter of 2005 resulted in higher interest expense and reduced
profitability. The interest rate swap expires October 31, 2005 and depending
upon further increases in interest rates could subject us to higher interest
expense.
Approximately two thirds of the outstanding balance under our loan
agreement arose from the repurchase of our common stock. In late 1998, we began
a repurchase program, which has resulted in the repurchase of approximately 2.2
million shares of our common stock.
At our current growth rate of three to four restaurants per year, we
believe internally generated cash flow, landlord construction allowances and the
sale-lease back of real estate should be sufficient to fund growth, replacement
capital expenditures and current debt service, all of which represent our major
cash needs. A significant repurchase of our common stock, an accelerated growth
rate or extended periods of reduced profitability would require additional
borrowings. We believe we have adequate borrowing capacity to meet our needs.
However, the longer-term goal is to reduce debt levels.
YEAR-TO-YEAR COMPARISONS AND ANALYSIS
9
RESULTS OF OPERATIONS
The following table sets forth our operating results as a percentage of
revenues:
Sixteen Sixteen Twenty-Eight Twenty-Eight
Weeks Ended Weeks Ended Weeks Ended Weeks Ended
May 15, 2005 May 9, 2004 May 15, 2005 May 9, 2004
------------ ----------- ------------ ------------
Revenues 100.0 100.0 100.0 100.0
Cost of Goods Sold (25.8) (25.9) (25.5) (25.3)
Payroll & Benefits (32.2) (32.6) (31.8) (32.3)
Other Operating Expenses (33.4) (31.1) (33.0) (31.3)
Pre-Opening Expenses (0.3) (0.2) (0.1) (0.3)
Impairment of Assets (3.4) - (1.4) -
Administrative Expenses (7.9) (7.5) (7.9) (7.7)
Interest Expense (1.2) (1.2) (1.2) (1.2)
Minority Interest - - - -
Income (Taxes) Credit 2.0 (0.3) 0.7 (0.5)
----- ----- ----- -----
Net Income (Loss) (2.2) 1.2 (0.2) 1.4
===== ===== ===== =====
REVENUES
Revenues for the second quarter of 2005 increased $1,143,000 or 2.7% from
the second quarter of 2004. The increase was a result of i) the opening of three
restaurants during the second half of 2004 and ii) increased franchise fees and
royalties from the opening of three franchised locations during 2004. No new
Company-owned or franchised restaurants opened during the first half of 2005.
Same store sales at restaurants opened at least eighteen months declined
$546,000 or 1.5%.
Year-to-date revenues increased $4,992,000 or 5.2% from 2004 to 2005. The
increase was a result of i) the opening of five restaurants during 2004 and ii)
the opening of three franchised restaurants during 2004. Year-to-date same-store
sales declined $972,000 or 1.2%. Franchise fees and royalties increased 16%
year-to-date.
The decline in same-store sales for the quarterly period was primarily a
result of increased competition, a sluggish mid-western economy and the opening
of two new Max & Erma's restaurants late last year near existing Max & Erma's
restaurants. On a year-to-date basis same store sales were also negatively
impacted $487,000 by Christmas falling on Saturday in the current year as
compared to mid-week last year and a major winter storm during the fourth week
of January 2005, which impacted most of our markets and resulted in a $383,000
sales decline for the three day week-end. Total revenue growth for the quarter
and year-to-date periods was also negative affected by a shift in restaurant
openings to the second half of the 2005.
During the first half of 2005 a television and radio advertising campaign
was tested in Cleveland, Columbus and Toledo, Ohio, Detroit, Michigan and
Pittsburgh, Pennsylvania. Through the second quarter of 2005, television and
radio advertising increased $600,000. Same-
10
store-sales increases in Cleveland, where the advertising ran during the first
quarter of 2005, were sufficient to pay for the increased advertising costs.
Same-store-sales in the other markets were positive and in each case resulted in
improved sales trends relative to our markets with out television and radio and
to sales trends prior to the advertising. However, through the end of the second
quarter of 2005, sales gains in the other markets did not appear to be
sufficient to justify the advertising costs.
We expect to open three restaurants during the second half of 2005 and
three to four restaurants in 2006. Two restaurants were under construction at
the end of the second quarter of 2005, and are expected to open during the third
quarter. We were under contract to lease one additional site, which should open
during the fourth quarter of 2005. We were in some stage of renegotiating for
the purchase or lease of seven additional locations, which we believe would open
in either 2006 or 2007.
We also expect continued increases in franchise fees and royalties. The
number of franchised restaurants increased from eighteen at the end of the
second quarter of 2004 to twenty at the end of the second quarter of 2005. Two
franchised restaurants were under construction in Richmond, Virginia and South
Bend, Indiana at the end of the second quarter of 2005 and are also expected to
open during the third quarter. Early in the third quarter 2005 construction
commenced on a franchised restaurant in Huntington, West Virginia. We anticipate
the opening of three to four additional franchised restaurants in 2006.
COSTS AND EXPENSES
Cost of goods sold, as a percentage of revenues, decreased from 25.9% for
the second quarter of 2004 to 25.8% for the second quarter of 2005. Year-to-date
cost of goods sold, as a percentage of revenues, increased from 25.3% for 2004
to 25.5% for 2005. The increase was due primarily to continued high beef prices
in 2005 and to a lesser extent higher produce prices during the second quarter
of 2005. Various cost savings measures, declining market prices for chicken and
dairy products, and a 1 to 2 percent menu price increase over last year have
allowed us to reduce cost of goods sold, as a percentage of revenues, from a
mid-2004 high point.
Payroll and benefits, as a percentage of revenues, decreased from 32.6%
for the second quarter of 2004 to 32.2% for the second quarter of 2005.
Year-to-date payroll and benefits decreased from 32.3% for 2004 to 31.8% for
2005. The decreases were a result of reduced health insurance and workers'
compensation expenses. The decline in health insurance expense was due to a
change in our health plan early in 2004 and increased employee contribution
levels. Two large claims mitigated the savings during the second quarter of
2005, but health insurance expense still remains 20 basis points below last
year. The decrease in workers' compensation expense was due to a change to self
funding of Ohio workers' compensation claims, where forty percent of our
restaurants are located.
Other operating expenses, as a percentage of revenues, increased from
31.1% for the second quarter of 2004 to 33.4% for the second quarter of 2005.
Year-to-date other operating expenses experienced a similar increase from 31.3%
for 2004 to 33.0% for 2005. The increases
11
for both the quarter and year-to-date periods were a result of increased
marketing expenses, carryout supplies, credit and gift card fees, higher natural
gas prices and increased real estate taxes. The increase in other operating
expenses, as percentage of revenues, was exacerbated by the decline in
same-store sales from last year, as many of the expenses in this category are of
a somewhat fixed nature.
Pre-opening expenses, as a percentage of revenues, increased from 0.2% for
the second quarter of 2004 to 0.3% for the second quarter of 2005. Year-to-date
pre-opening expenses decreased from 0.3% for 2004 to 0.1% for 2005. The
differences were a result of the timing of restaurant openings and that all 2005
openings will be during the second half of the year.
ASSET IMPAIRMENT
During the second quarter of 2005 we recorded a $1.45 million asset
impairment charge related to six under performing restaurants and to write off
costs associated with the proposed deregistration of our common stock. We
expensed $1.26 million for the write down of restaurant assets at the six
restaurants and for payment to a landlord to obtain a release from one of the
leases. We expect to close two of the restaurants over the next three months.
The restaurants to be closed are both within three years of the end of their
current lease terms. Three of the restaurants are in shopping centers where
factors associated with the center have negatively impacted our business.
Through the first twenty-eight weeks of 2005, the two restaurants scheduled for
closing had operating losses of $300,000. We currently expect to operate the
other four restaurants through the remainder of their lease terms, but may
consider a sale or sub-lease of any of the locations. The restaurant assets at
these restaurants were written down to a fair value based upon future discounted
cash flows. The write down of restaurant assets at these three restaurants will
reduce annual depreciation expense by approximately $120,000. We believe that
the closing or write down of the impaired locations, along with related overhead
savings, should result in annual savings of approximately $800,000.
We also expensed $190,000 of costs associated with the proposed
deregistration of our common stock. Because the Securities and Exchange
Commission extended the date for compliance with the Sarbanes-Oxley Act for
non-accelerated filers and because of two initiatives which may reduce the
compliance costs, we elected to terminate the proposed deregistration
transaction during the second quarter of 2005. Accordingly, we wrote off
approximately $190,000 of costs, primarily legal, accounting and professional
fees, associated with the transaction.
ADMINISTRATIVE EXPENSES
Administrative expenses, as a percentage of revenues, increased from 7.5%
for the second quarter of 2004 to 7.9% for the second quarter of 2005.
Year-to-date administrative expenses, as a percentage of revenues, increased
from 7.7% for 2004 to 7.9% for 2005. In dollar terms, administrative expenses
increased 9% and 7% for the quarter and year-to-date periods, respectively. The
increases in dollars were a result of raises for corporate personnel, higher
professional fees and costs associated with converting from paper gift
certificate to an electronic gift card program.
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INTEREST EXPENSE
Interest expense increased 4% from the second quarter of 2004 to the
second quarter of 2005 and year-to-date 12% from 2004 to 2005 due to an increase
in the interest rate charged under our revolving credit agreement.
Our interest rate is based upon the ratio of bank indebtedness to earnings
before interest, taxes, depreciation and amortization. Based upon results for
fiscal 2004, the interest rate under our credit agreement increased to LIBOR
plus 3.5% or prime plus 3/4 percent. As a result, the interest rate under the
revolving credit line was 6.75% at May 15, 2005, as compared to 4.75% at May 9,
2004. Through the use of an interest rate swap, the interest rate on
approximately 30% of our two term loans is essentially fixed at 9.9% at May 15,
2005 and at May 9, 2004. The interest rate on the balance of the two term loans
increased from 4.75% at May 9, 2004 to 6.75% at May 15, 2005.
Total interest bearing debt decreased from $30.0 million at May 9, 2004 to
$29.1 million at May 15, 2005. The decrease was due to scheduled principal
amortization which was partially offset by construction related borrowings under
our revolving credit line. We capitalized $41,000 of construction period
interest during the first 28 weeks of 2005 versus $100,000 during the first half
of 2004.
INCOME TAXES
Our effective tax for the first 28 weeks of 2004 was 24.0%. In 2005 we
recorded a tax credit which reflects the tax benefit of the reported loss before
income taxes and the FICA tax on tips credit, estimated at $1.3 million for
2005. We believe we have appropriately estimated the effect of this credit on
our tax provision for 2005. However, unusual fluctuation in pre-tax income make
this a difficult calculation and may cause our effective tax rate to vary from
quarter to quarter.
Pending changes in state income tax laws for the state of Ohio could
reduce the value of our deferred state tax asset by $300,000 or more. Should the
change in taxes for Ohio occur we would immediately write down the value of that
asset.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital ratio remained at 0.4 to 1 at October 31, 2004 and May
15, 2005. Historically, we have been able to operate with a working capital
deficiency because 1) restaurant operations are primarily conducted on a cash
basis, 2) high turnover (about once every 10 days) permits a limited investment
in inventory, and 3) trade payables for food purchases usually become due after
receipt of cash from the related sales.
During the first 28 weeks of 2005, we expended approximately $4,258,000
for property additions and $42,537,000 to reduce long-term obligations. Funds
for such expenditures were provided primarily by $40,558,000 from proceeds of
long-term obligations, $5,824,000 from
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operations and $139,000 from cash on hand. We routinely draw down and repay
balances under our revolving credit agreement, the gross amounts of which are
included in the above numbers.
We intend to open two to three Max & Erma's restaurants during the
remainder of 2005 and three to four Max & Erma's restaurants during fiscal 2006.
At May 15, 2005 we were contractually committed to the lease of three sites, two
of which were under construction. Seven additional sites had been approved and
were in some stage of negotiations.
The estimated cost to complete the three restaurants that we are
contractually committed to is approximately $3.0 million as of May 15, 2005.
Funding for new restaurants is expected to be provided by cash flow from
operations, the sale-leaseback of real estate, landlord construction allowances
and our revolving credit line. At May 15, 2005, we had approximately $5.0
million available under our $15.0 million revolving credit line and $1.0 million
in landlord construction allowances. Typically, these have been the sources of
funding for capital expenditures and we expect that they will remain so.
In addition to expenditures for new restaurants, our other significant
uses of cash are for fixed asset replacements, debt repayment and the repurchase
of our common stock. We expect to expend approximately $3.0 million and $3.9
million annually on fixed asset replacement and debt service, respectively.
Expenditures for new restaurants, prior to signing the related contract to
purchase or lease, and the repurchase of common stock are of a more
discretionary nature and may be curtailed if cash flow from operations and other
financing sources were diminished. We have not experienced any such problems in
obtaining funding or maintaining recent levels of cash flow from operations.
However, if profitability of our restaurants were to decline significantly, for
an extended period of time, cash flow from operations would be reduced and we
might be forced to reduce expansion plans and forego any repurchase of common
stock. Based upon the first 28 weeks of 2005, net income represented
approximately 7% of net after tax cash flow (exclusive of the $1.45 million
asset impairment charge). Depreciation represented the other 93% or
approximately $4.6 million. Therefore, our Company could operate at a break even
for an extended period of time and still generate adequate cash flow from
operations to meet required debt service and fund fixed asset replacements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Operations and Financial Condition
discusses our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these consolidated financial statements requires our
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. On an ongoing basis, our
management evaluates its estimates and judgments. We believe that of our
significant accounting policies, the following may involve a higher degree of
judgment and complexity.
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Derivative Instruments
Our Company utilizes interest rate swap agreements to manage interest rate
exposure on floating-rate obligations. We do not use derivative instruments
unless there is an underlying exposure and, therefore, do not use derivative
instruments for trading or speculative purposes. We assess hedge effectiveness
at each financial reporting date. All derivative instruments are recognized in
the Consolidated Balance Sheet at estimated fair value.
Same-Store Sales
Our Company discloses certain information regarding the performance of certain
restaurants in operation at least 18 consecutive months in our management's
discussion and analysis. We exclude restaurants from this calculation that do
not meet this definition. In addition, restaurants are excluded when unusual
events or circumstances outside our control significantly change the business of
the restaurant.
Asset Impairment
We review each restaurant to ascertain whether property and equipment and
intangibles have been impaired based on the sum of expected future undiscounted
cash flows from operating activities. If the estimated net cash flows are less
than the carrying amount of such assets, we will recognize an impairment loss in
an amount necessary to write down the assets to a fair value as determined from
expected future discounted cash flow. In performing our review, we consider the
age of the restaurant and any significant economic events, recognizing that
these restaurants may take 24 to 36 months to become or return to profitability.
INFLATION
We believe the effects of inflation have not had a material impact on our
results of operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and
Section 27A of the Securities Act of 1933, as amended. The words "plan,"
"anticipate," "believe," "expect," "estimate," and "project" and similar words
and expressions identify forward-looking statements which speak only as of the
date hereof. Forward-looking statements in this MD&A include statements
regarding sales at new Company-owned restaurants (paragraph 2), royalties at new
franchised locations (paragraph 2), the expectation that cost of sales will
decline further in 2005 (paragraph 4), the belief that self-funding of Ohio
workers' compensation insurance will lower our expense by $300,000 in 2005
(paragraph 5), the expectation that two under-performing restaurants will close
(paragraph 6), the belief that internally generated cash flow will fund growth,
replacement capital expenditures and debt service (paragraph 9), the belief that
we have adequate borrowing capacity (paragraph 9), the expectation of future
restaurant openings (paragraph 15 and 31), the expectation of increased
franchise fees and royalties from future franchised openings (paragraph 16), the
expectation that we will continue to operate the four restaurants associated
with the asset impairment charge (paragraph 21), the belief that the closing of
two restaurants and the write-down of assets will result in annual savings of
$800,000 (paragraph 21), the belief
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that we have appropriately estimated the effect of the FICA tax on tips credit
on our 2005 income tax expense (paragraph 27), the estimated cost to complete
restaurants currently under contract (paragraph 32), the source of funds for new
restaurants (paragraph 32), and the expectation that we will expend $3.0 million
and $3.9 million on fixed asset replacements and debt service, respectively
(paragraph 33).
Investors are cautioned that forward-looking statements involve risks and
uncertainties that could cause actual results to differ materially from
historical or anticipated results due to many factors, including, but not
limited to, our ability to open or franchise new restaurants as planned, changes
in competition in markets where we operate restaurants, the availability of
restaurant workers, our ability to control administrative expenses, changes in
interest rates, changes in cash flows from operations, the availability of real
estate for purchase or lease, and other risks, uncertainties and factors
described in our most recent Annual Report on Form 10-K and other filings from
time to time with the Securities and Exchange Commission. We undertake no
obligation to publicly update or revise any forward-looking statements.
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our Company's primary market risk results from fluctuations in interest
rates. We are exposed to interest rate risk through borrowings under our
revolving credit agreement, which permits borrowings up to $34.1 million. To
minimize the effect of interest rate fluctuations, we have entered into an
interest rate swap arrangement. Under this agreement, we pay a fixed rate of
interest on approximately 30% of the outstanding balance.
Item 4 - CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Disclosure controls and procedures are
controls and other procedures that are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information we are
required to disclose in the reports that we file under the Exchange Act is
accumulated and communicated to our management as appropriate to allow timely
decisions regarding required disclosure.
As of the end of the period covered by this report, our management, with
the participation of our chief executive officer and chief financial officer,
carried out an evaluation of the effectiveness of our disclosure controls and
procedures pursuant to Rule 13a-15 promulgated under the Exchange Act. Based
upon this evaluation, our chief executive officer and our chief financial
officer concluded that our disclosure controls and procedures were (1) designed
to ensure that material information relating to our company is accumulated and
made known to our management, including our chief executive officer and chief
financial officer, in a timely manner, particularly during the period in which
this report was being prepared and (2) effective, in that they provide
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reasonable assurance that information we are required to disclose in the reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms.
Management believes, however, that a controls system, no matter how well
designed and operated, cannot provide absolute assurance that the objectives of
the controls system are met, and no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within a
company have been detected.
Internal Controls. There has been no change in our internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated
under the Exchange Act) during our fiscal quarter ended May 15, 2005 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 6 - EXHIBITS
Exhibit 31.1* - Rule 13a-14(a) Certification of Principal Executive Officer
Exhibit 31.2* - Rule 13a-14(a) Certification of Principal Financial Officer
Exhibit 32.1+ - Section 1350 Certification of Principal Executive Officer
Exhibit 32.2+ - Section 1350 Certification of Principal Financial Officer
* Filed with this report.
+ Furnished with this report.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MAX & ERMA'S RESTAURANTS, INC.
------------------------------
Registrant
/s/ Todd B. Barnum
-----------------------------------
Todd. B. Barnum
Chairman of the Board, President
and Chief Executive Officer
(Principal Executive Officer)
/s/ William C. Niegsch, Jr.
------------------------------------
William C. Niegsch, Jr.
Executive Vice President &
Chief Financial Officer
(Principal Financial and Accounting
Officer)
June 22, 2005
- -------------
Date
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EXHIBIT INDEX
Exhibit No. Exhibit Page No.
- ----------- ------- --------
31.1* Rule 13a-14(a) Certification of Principal Executive Officer Page 20
31.2* Rule 13a-14(a) Certification of Principal Financial Officer Page 22
32.1+ Section 1350 Certification of Principal Executive Officer Page 24
32.2+ Section 1350 Certification of Principal Financial Officer Page 25
* Filed with this report.
+ Furnished with this report.
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