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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 August 1, 2004
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 0-11514
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 August 1, 2004, there were 2,459,796 shares of common stock outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
August 1,
2004 October 26,
(UNAUDITED) 2003
------------ ------------
ASSETS
Current Assets:
Cash $ 3,003,637 $ 2,616,324
Inventories 1,280,021 1,161,927
Other Current Assets 2,534,016 2,215,619
------------ ------------
Total Current Assets 6,817,674 5,993,870
Property - At Cost 95,932,442 82,885,574
Less Accumulated Depreciation and Amortization 41,287,371 35,848,525
------------ ------------
Property - Net 54,645,071 47,037,049
Other Assets 9,021,231 8,711,176
------------ ------------
Total $ 70,483,976 $ 61,742,095
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities of Long-Term Obligations $ 4,057,040 $ 2,664,166
Accounts Payable 6,274,408 4,140,765
Accrued Payroll and Related Taxes 3,108,127 2,966,718
Accrued Liabilities 4,662,008 3,944,917
------------ ------------
Total Current Liabilities 18,101,583 13,716,566
Long-Term Obligations - Less Current Maturities 38,314,930 35,836,887
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 2,459,796 Shares
at 08/01/04 and 2,449,601 Shares at 10/26/03 245,979 244,960
Additional Paid-In Capital 180,407
Accumulated Other Comprehensive Loss (268,739) (648,373)
Retained Earnings 13,909,816 12,592,055
------------ ------------
Total Stockholders' Equity 14,067,463 12,188,642
------------ ------------
Total $ 70,483,976 $ 61,742,095
============ ============
(See notes to interim unaudited condensed consolidated financial statements)
1
MAX & ERMA'S RESTAURANTS,INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ---------------------------
August 1, August 3, August 1, August 3,
2004 2003 2004 2003
------------ ------------ ------------ ------------
REVENUES: $ 42,090,386 $ 39,589,993 $137,394,100 $127,599,012
COSTS AND EXPENSES:
Costs of Goods Sold 11,210,700 9,833,941 35,282,125 31,413,934
Payroll and Benefits 13,813,500 12,994,300 44,650,628 41,758,349
Other Operating Expenses 13,426,463 12,240,073 43,229,881 39,727,347
Pre-Opening Expenses 162,976 275,496 412,010 642,994
Loss on Disposition of Assets 158,239 158,239
Administrative Expenses 3,176,174 3,009,247 10,557,008 9,871,428
------------ ------------ ------------ ------------
Total Operating Expenses 41,789,813 38,511,296 134,131,652 123,572,291
------------ ------------ ------------ ------------
Operating Income 300,573 1,078,697 3,262,448 4,026,721
Interest Expense 473,766 373,606 1,585,440 1,259,704
Minority Interest in Income
of Affiliated Partnerships 19,251 19,252 38,502
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (173,913) 685,840 1,657,756 2,728,515
INCOME TAXES (BENEFIT) (103,000) 66,000 340,000 551,000
------------ ------------ ------------ ------------
NET INCOME(LOSS) $ (70,193) $ 619,840 $ 1,317,756 $ 2,177,515
============ ============ ============ ============
NET INCOME (LOSS) PER SHARE:
Basic $ (0.03) $ 0.25 $ 0.54 $ 0.89
============ ============ ============ ============
Diluted $ (0.03) $ 0.24 $ 0.51 $ 0.82
============ ============ ============ ============
SHARES OUTSTANDING:
Basic 2,458,631 2,474,839 2,455,575 2,437,502
============ ============ ============ ============
Diluted 2,458,631 2,628,741 2,586,922 2,652,408
============ ============ ============ ============
(See notes to interim unaudited condensed consolidated financial statements)
2
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Forty Weeks Ended
----------------------------
August 1, August 3,
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,317,756 $ 2,177,515
Depreciation and amortization 6,233,073 4,692,102
Minority interest in income of Affiliated Partnerships 19,252 38,502
Changes in other assets and liabilities 742,566 (2,072,880)
------------ ------------
Net cash provided by operating activities 8,312,647 4,835,239
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (14,939,399) (14,356,756)
Proceeds from sale of assets 2,805,729 7,754,957
Decrease (increase) in other assets (8,410) 174,932
------------ ------------
Net cash used by investing activities (12,142,080) (6,426,867)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under long-term obligations (60,085,698) (46,445,517)
Proceeds from long-term obligations 64,371,500 46,196,152
Proceeds from sale of stock 49,682 232,155
Purchase of common stock (20,721) --
Debt issue costs (78,765) (12,380)
Distributions to minority interests in Affiliated Partnerships (19,252) (38,502)
------------ ------------
Net cash provided by (used by) financing activities 4,216,746 (68,092)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 387,313 (1,659,720)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 2,616,324 3,406,702
------------ ------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 3,003,637 $ 1,746,982
============ ============
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest $ 1,497,173 $ 1,763,079
Income taxes $ 903,523 $ 834,864
Non-cash activities:
Property additions financed by accounts payable $ 2,784,637 $ 1,380,025
(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 2003 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 January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities". FIN 46 clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements", to certain entities in which equity investors do
not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN
46 requires a variable interest entity to be consolidated by a company, if
that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of
the entity's residual returns or both. FIN 46 also requires disclosures
about variable interest entities that a company is not required to
consolidate but in which it has a significant variable interest. In
December 2003, the FASB issued FIN 46R. It changed the effective date for
interests in special-purpose entities for periods ending after December
15, 2003, and for all other types of entities for periods ending after
March 15, 2004. The adoption of FIN 46R for variable interest entities did
not have a material impact on the Company's consolidated financial
statements. Management does not expect the adoption of FIN 46R for all
other types of entities to have a material impact on the Company's
financial statements.
SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity," requires that an issuer
classify a financial instrument that is within its scope as a liability
(or an asset in some circumstances), many of which were previously
classified as equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003 and otherwise
shall be effective for the Company's 2004
4
financial statements. The adoption of SFAS 150 did not have a material
impact on the Company's consolidated financial statements.
3. Long-Term Obligations
On October 27, 2003, the first day of fiscal 2004, the Company borrowed
$6,000,000 to finance the purchase of previously leased equipment. The
loan provides for monthly payments of $125,000 plus interest, beginning
December 31, 2003 through December 31, 2007. The loan bears interest at a
fluctuating rate based upon the prime or LIBOR rate determined by the
ratio of indebtedness of the Company to the earnings before interest,
taxes, depreciation and amortization of the Company (5.0% at August 1,
2004).
4. Net Income (Loss) 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 (loss) per share amounts are based on the weighted average number
of shares of common stock and dilutive stock options outstanding during
the periods presented. Diluted shares outstanding for the third quarter of
2004 excludes 114,420 common stock equivalents, which we considered to be
antidilutive.
5. Stock Options
During the 40-weeks ended August 1, 2004, the Company's stock options
activity and weighted average exercise prices were as follows:
Shares Exercise Price
-------- --------------
Outstanding, October 26, 2003 378,700 $ 10.91
Granted 30,950 17.51
Exercised (13,999) (6.75)
Forfeited (3,000) (7.75)
-------- -------------
Outstanding, August 1, 2004 392,651 $ 11.60
======== =============
The Company accounts for employee and director stock options using the
intrinsic value method. Under this method, no compensation expense was
recorded in any year 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 (loss) and earnings (loss) per
share for the 40-weeks ending August 1, 2004 would have been as follows:
5
Twelve Weeks Ended Twelve Weeks Ended Forty Weeks Ended Forty Weeks Ended
August 1, 2004 August 3, 2003 August 1, 2004 August 3, 2003
---------------- ------------------ ----------------- -----------------
Net income (loss), as reported $ (70,193) $ 619,840 $ 1,317,756 $ 2,177,515
Deduct: total stock-based
compensation expense
determined under the fair value
method for all awards, net of
related tax benefits (41,369) (283,257) (470,718) (593,810)
-------------- -------------- ------------------ -----------
Pro forma net income (loss) $ (111,562) $ 336,583 $ 847,038 $ 1,583,705
============== ============== ================== ===========
Earnings (loss) per common share,
basic:
As reported $ (0.03) $ 0.25 $ 0.54 $ 0.89
============== ============== ================== ===========
Pro forma $ (0.05) $ 0.14 $ 0.35 $ 0.65
============== ============== ================== ===========
Earnings per common share, diluted:
As reported $ (0.03) $ 0.24 $ 0.51 $ 0.82
============== ============== ================== ===========
Pro forma $ (0.05) $ 0.13 $ 0.33 $ 0.60
============== ============== ================== ===========
The fair value of options granted was estimated on the date of the grant using
the Black-Scholes option-pricing model.
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, i.e. 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.
6
The restaurant industry is very competitive. We typically compete with
several larger, national restaurant chains in most of our locations. By focusing
on becoming the "Hometown Favorite", we believe we compete very favorably with
larger chains. 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 2003 and 2004, our restaurants experienced margin pressure due to
rising beef and chicken prices. Through the forty weeks of 2004, cost of goods
sold is approximately a full percentage point over its targeted range due
entirely to higher beef, chicken and dairy prices. We believe that much of the
reason for this is an increased demand for a "Lo-Carb", more healthful diet. The
demand for these types of menu items has pushed beef and chicken prices to
record highs. 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 goods sold. To mitigate the
current cost pressure, during the third quarter of 2004, we entered into an
eighteen month contract to purchase chicken from one vendor at a fixed price for
the term of the agreement. This resulted in an immediate 22% reduction in the
price of chicken and reduced cost of goods sold, as a percentage of revenue, by
a full percentage point during the last four weeks of the third quarter as
compared to the prior eight weeks of the quarter.
We also have experienced sharply rising healthcare and worker's
compensation insurance costs over the past several years. We are implementing
several safety incentives and have applied to the State of Ohio to self-fund our
Ohio Worker's Compensation insurance. We believe this will lower worker's
compensation expense for our Ohio restaurants. During the first quarter of 2004,
we implemented a new health insurance program and increased our employee
contribution rates in an effort to reduce our health insurance costs. Through
the third quarter of 2004, health insurance costs had declined by approximately
25 basis points or approximately $200,000 over 2003. However, we believe that
the rising cost of healthcare will continue to be a challenge.
We have bank borrowings in excess of $30.6 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 an
interest rate swap, which essentially fixes the rate on approximately 30% of the
outstanding balance. However, rising interest rates would subject us to higher
interest expense and could significantly affect profitability.
Approximately two thirds of the outstanding balance under our loan
agreement relates to the repurchase of our common stock. In late 1998, we began
a repurchase program, which has resulted in the repurchase of approximately two
million shares of our common stock. We believe this has contributed
significantly to the increase in our common stock price since 1998. We currently
maintain a share repurchase program, but do not anticipate repurchasing a
significant number of shares due to the limited trading volume of our common
stock.
7
At our current growth rate of three to four restaurants per year, we
believe internally generated cash flow 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
RESULTS OF OPERATIONS
The following table sets forth our operating results as a percentage of
revenues:
Twelve Weeks Ended Forty Weeks Ended
------------------ --------------------
August 1 August 3 August 1 August 3,
2004 2003 2004 2003
------- ------- ------- --------
Revenues 100.0 100.0 100.0 100.0
Cost of Goods Sold (26.6) (24.8) (25.7) (24.6)
Payroll & Benefits (32.8) (32.8) (32.5) (32.7)
Other Operating Expenses (31.9) (30.9) (31.5) (31.1)
Pre-Opening Expenses (0.4) (0.7) (0.3) (0.5)
Loss or Disposition of Assets - (0.4) - (0.1)
Administrative Expenses (7.6) (7.6) (7.7) (7.8)
Interest Expense (1.1) (0.9) (1.1) (1.0)
Minority Interest - (0.1) - -
(Income Taxes) Tax Credit 0.2 (0.2) (0.4) (0.4)
------- ------- ------- -------
Net Income (Loss) (0.2) 1.6 0.8 1.8
======= ======= ======= =======
REVENUES
Revenues for the third quarter of 2004 increased $2,500,000 or 6.3% from
the third quarter of 2004. The increase was a result of, i) the opening of three
restaurants during the fourth quarter of 2003, ii) the opening of two
restaurants during the first three quarters of 2004 and iii) increased franchise
fees and royalties resulting from the opening of four franchised locations
during 2003 and four franchised openings thus far in 2004. Same-store sales at
restaurants opened at lease eighteen months declined $467,000 or 1.25% from the
third quarter of 2003 to the third quarter of 2004.
Year-to-date revenues increased $9,795,000 or 7.7% from 2003 to 2004. The
increase was a result of, i) opening six restaurants during 2003, ii) the
opening of two restaurants during the first half of 2004 and iii) increased
franchise fees and royalties. Year-to-date same-store sales increased by
$24,000, which is essentially flat.
For the quarter and year-to-date periods our average guest check increased
by approximately 4.0% due largely to menu price increases over last year.
Customer counts
8
declined by approximately an equal percentage for the year-to-date period
resulting in flat same-store sales. For the third quarter of 2004 customer
counts declined by approximately 5.0%, which resulted in the 1.25% decline in
same-store sales during the quarter.
We expect to open three additional restaurants during the fourth quarter
of 2004. All three restaurants were under construction at the end of the third
quarter. We also expect to open three restaurants during 2005. All three sites
are either under contract or in the final stages of negotiations at August 1,
2004.
We also expect continued increases in franchise fees and royalties. The
number of franchised restaurants increased from fifteen at the end of the third
quarter of 2003 to twenty at the end of the third quarter of 2004. Year-to-date
franchise fees and royalties increased 35%. We anticipate the opening of five to
six additional franchised restaurants during 2005.
COSTS AND EXPENSES
Costs of goods sold, as a percentage of revenues, increased from 24.8% for
the third quarter of 2003 to 26.6% for the third quarter of 2004. Year-to-date
cost of goods sold, as a percentage of revenues, increased from 24.6% for 2003
to 25.7% for 2004. The increase for the year-to-date period was a result of
record high ground beef and chicken prices. The increase for the quarter was
exacerbated by higher dairy prices and even further increases in chicken prices.
Late in the third quarter we entered into an eighteen month contract to purchase
chicken at a fixed price that was then approximately 22% below the current
market price we were paying. This contract will save us approximately $1.3
million dollars over the highest price we have recently paid for chicken, but is
also approximately 20% higher than our historical average price. These higher
commodity costs have entirely offset the effect of an approximate 2.0 to 3.0%
menu price increase each of the last two years.
Payroll and benefits, as a percentage of revenue, remained level at 32.8%
for both the third quarter of 2003 and 2004. Year-to-date payroll and benefits
as a percentage of revenue, decreased from 32.7% for 2003 to 32.5% for 2004. The
year-to-date decrease was primarily a result of lower health insurance expense
due to a change in our health plan during the first quarter of 2004.
Other operating expenses, as a percentage of revenues, increased from
30.9% for the third quarter of 2003 to 31.9% for the third quarter of 2004.
Year-to-date, other operating expenses increased from 31.1% for 2003 to 31.5%
for 2004. The increases, which occurred primarily during the third quarter and
affected the year-to-date results, were a result of higher advertising,
utilities, repairs and maintenance and carry-out supplies.
Pre-opening expenses, as a percentage of revenues, declined from 0.7% for
the third quarter of 2003 to 0.4% for the third quarter of 2004 and year-to-date
declined from 0.5% for 2003 to 0.3% for 2004. The declines were a result of the
number and timing of restaurant openings in 2004 versus 2003.
9
ADMINISTRATIVE EXPENSES
Administrative expenses, as a percentage of revenues, remained at 7.6% for
both the third quarter of 2003 and the third quarter of 2004. Year-to-date
administrative expenses, as a percentage of revenues, declined from 7.8% for
2003 to 7.7% for 2004. In dollar terms, administrative expenses increased 6% and
7% from 2003 to 2004 for the quarter and year-to-date periods, respectively. The
increase in dollars were a result of raises for corporate personnel and the
addition of several corporate support employees. The total increases in dollars
was generally in line with our revenue growth and, therefore, remained
relatively constant as a percentage of revenues.
INTEREST EXPENSE
Interest expense increased 27% from the third quarter of 2003 to the third
quarter of 2004 and year-to-date increased 26% from 2003 to 2004 due to an
increase in the interest rate charged under our revolving credit agreement and
due to an increase in interest bearing debt.
Our interest rate is based upon the ratio of bank indebtedness to earnings
before interest, taxes, depreciation and amortization. Based upon results for
fiscal 2003, 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 5.0% at August 1, 2004, as compared to 4.0% at August
3, 2003. Through the use of an interest rate swap, the interest rate on
approximately 30% ($9.3 million) of our two term loans is essentially fixed at
9.9% at August 1, 2004 as compared to 9.0% at August 3, 2003. The interest rate
on the balance of the two term loans increased from 4.0% at August 3, 2003 to
5.0% at August 3, 2004.
Total interest bearing debt increased from $28.7 million at August 3, 2003
to $30.6 million at August 1, 2004. The increase was a result of a second term
loan in the amount of $6.0 million which funded on October 27, 2003, the first
day of fiscal 2004. The proceeds of the loan were used to purchase $6.4 million
dollars of previously leased equipment. Scheduled principal amortization of the
two term loans resulted in the net increase in interest bearing debt of only
$1.9 million from the third quarter of 2003. We capitalized $143,000 of
construction period interest during the first 40 weeks of 2004 versus $376,000
during 2003.
INCOME TAXES
Our effective tax rate remained relatively constant at 20.0% for the first
40 weeks of 2004 and 2003. We expect our effective tax rate will remain at
approximately 20.0% for fiscal 2004, although at higher levels of pre-tax income
tax credits have a lesser effect and the effective tax rate rises.
10
LIQUIDITY AND CAPITAL RESOURCES
Our working capital ratio remained at 0.4 to 1 at October 26, 2003 and
August 1, 2004. Historically, we have been able to operate with a working
capital deficiency because i) restaurant operations are primarily conducted on a
cash basis, ii) high turnover (about once every 10 days) permits a limited
investment in inventory, and iii) trade payables for food purchases usually
become due after receipt of cash from the related sales.
During the first 40 weeks of 2004 we expended approximately $14,939,000,
for property additions, and $60,086,000 to reduce long-term obligations and
increased cash on hand by $387,000. Funds for such expenditures were provided
primarily by $64,372,000 from proceeds of long-term obligations, $8,313,000 from
operations and $2,806,000 from the sale and leaseback of one restaurant
property. 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 three Max & Erma's restaurants during the remainder of
2004 and three restaurants during fiscal 2005. At August 1, 2004, we were
contractually committed to the lease of four sites, three of which were under
construction. Two additional sites had been approved and were in the final stage
of negotiations.
The estimated cost to complete the four restaurants that we are
contractually committed to is approximately $5.4 million as of August 1, 2004.
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 August, 2004, we had approximately $7.1
million available under our $15.0 million revolving credit line and
approximately $2.4 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 40 weeks of 2004, net income represented
approximately 17% of net after tax cash flow. Depreciation represented the other
83% or approximately $6.2 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.
Due to the reduced profitability of our restaurants in 2004, we have made the
decision to reduce the number of new restaurants planned for 2005 from five to
three.
11
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.
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. The evaluation of hedge
effectiveness is subject to assumptions based on the terms and timing of the
underlying exposures. All derivative instruments are recognized in the
Consolidated Balance Sheet at estimated fair value.
Asset Impairments
We review each restaurant to ascertain whether property and equipment,
goodwill and other 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 flows.
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.
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
12
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 anticipated revenues and profitability from new restaurants
(Paragraph 2), anticipated royalties from new franchised restaurants (Paragraph
2), the belief that we compete favorably with larger chains (Paragraph 3), the
belief that the demand for "Lo-Carb" menu items had contributed to higher beef,
chicken and dairy prices (Paragraph 4), the belief that safety programs and
self-funding will lower worker's compensation expense (Paragraph 5), the belief
that the rising cost of healthcare will continue to be a challenge (Paragraph
5), the belief that the repurchase of common stock has contributed to the
increase in our stock price (Paragraph 7), the anticipation that we will not be
purchasing a significant number of additional shares under our stock repurchase
program (Paragraph 7), the belief that we have sufficient internally generated
cash flow and borrowing capacity to meet our cash needs (Paragraph 8), the
opening of additional restaurants (Paragraphs 13 and 26), the expectation of
increased franchise fees and royalties (Paragraph 14), the opening of additional
franchise restaurants (Paragraph 14), the expectation that our effective tax
rate will remain approximately 20% for 2004 (Paragraph 23), the estimated costs
to complete new restaurants (Paragraph 27), the source and availability of
funding for new restaurants (Paragraph 27), the anticipated expenditures on
fixed assets and debt service (Paragraph 28) and the belief that we could
operate at a break even and still meet required debt service and fund fixed
asset replacements (Paragraph 28).
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 $37.7 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 a portion 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
13
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
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 August 1, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 2 - CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSURER PURCHASES OF
EQUITY SECURITIES
(e) The following table provides information about purchases by the Company
during the quarter ended August 1, 2004 of equity securities that are registered
by the Company pursuant to Section 12 of the Exchange Act:
14
ISSUER PURCHASES OF EQUITY SECURITIES
(c)
Total Number of (d)
Shares Purchased Maximum number of
(a) (b) as Part of Publicly Shares that May Yet
Total Number of Average Price Announced Plans Be Purchased Under
Four-Week Period Shares Purchased (1) Paid per Share or Programs (2) the Plans or Programs
- ------------------------------------------------------------------------------------------------------------------------------
5/10/04 - 6/6/04 -- -- 71,319 128,681
- ------------------------------------------------------------------------------------------------------------------------------
6/7/04 - 7/4/04 -- -- 71,319 128,681
- ------------------------------------------------------------------------------------------------------------------------------
7/5/04 - 8/1/04 -- -- 71,319 128,681
- ------------------------------------------------------------------------------------------------------------------------------
Total -- -- 71,319 128,681
- ------------------------------------------------------------------------------------------------------------------------------
(1) We did not repurchase any shares of our common stock pursuant to the
repurchase program that we publicly announced on September 4, 2003 (the
"program") during the quarter.
(2) Our board of directors approved the repurchase by us of up to an aggregate
of 200,000 shares of our common stock/shares of our common stock pursuant
to the Program. The expiration date of this Program was extended to August
21, 2005.
Item 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) 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.
(b) Reports on Form 8-K
8-K (Items 7 and 12) furnished June 10, 2004 regarding second
quarter 2004 financial results.
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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)
September 3, 2004
-----------------
Date
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EXHIBIT INDEX
Exhibit No. Exhibit Page No.
- ----------- ------- --------
31.1* Rule 13a-14(a) Certification of Principal Executive Officer Page 18
31.2* Rule 13a-14(a) Certification of Principal Financial Officer Page 20
32.1+ Section 1350 Certification of Principal Executive Officer Page 22
32.2+ Section 1350 Certification of Principal Financial Officer Page 23
* Filed with this report.
+ Furnished with this report.
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