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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 February 20, 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 February 20, 2005 there were 2,538,983 shares of common stock outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
February 20,
2005 October 31,
(UNAUDITED) 2004
------------- ------------
ASSETS
Current Assets:
Cash $ 2,915,381 $ 2,187,529
Inventories 1,311,186 1,377,366
Other Current Assets 2,717,313 2,865,251
------------- ------------
Total Current Assets 6,943,880 6,430,146
Property - At Cost: 99,389,647 98,070,311
Less Accumulated Depreciation and Amortization 45,171,290 42,720,109
------------- ------------
Property - Net 54,218,357 55,350,202
Other Assets 9,610,226 9,326,737
------------- ------------
Total $ 70,772,463 $ 71,107,085
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities of Long-Term Obligations $ 4,161,105 $ 4,160,314
Accounts Payable 3,901,404 5,334,219
Accrued Payroll and Related Taxes 2,916,307 1,914,099
Accrued Liabilities 5,767,723 4,589,203
------------- ------------
Total Current Liabilities 16,746,539 15,997,835
Long-Term Obligations - Less Current Maturities 38,878,400 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 2,538,983 Shares
at 2/20/05 and 2,507,328 Shares at 10/31/04 253,897 250,732
Additional Paid In Capital 670,880 319,404
Accumulated Other Comprehensive (Loss) (121,061) (203,406)
Retained Earnings 14,343,808 13,689,490
------------- ------------
Total Stockholders' Equity 15,147,524 14,056,220
------------- ------------
Total $ 70,772,463 $ 71,107,085
============= ============
(See notes to interim unaudited condensed consolidated financial statements)
1
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Sixteen Weeks Ended
---------------------------------------
February 20, February 15,
2005 2004
------------ -------------
REVENUES: $ 57,270,828 $ 53,421,522
COSTS AND EXPENSES:
Costs of Goods Sold 14,511,976 13,238,458
Payroll and Benefits 18,006,124 17,203,869
Other Operating Expenses 18,693,007 16,780,990
Pre-Opening Expenses 7,049 147,288
Administrative Expenses 4,508,100 4,250,484
------------ -------------
Total Operating Expenses 55,726,256 51,621,089
------------ -------------
Operating Income 1,544,572 1,800,433
Interest Expense 706,002 596,554
Minority Interest in Income
of Affiliated Partnership 19,252
------------ -------------
INCOME BEFORE INCOME TAXES 819,318 1,203,879
INCOME TAXES 165,000 313,000
------------ -------------
NET INCOME $ 654,318 $ 890,879
============ =============
NET INCOME PER SHARE:
Basic $ 0.26 $ 0.36
============ =============
Diluted $ 0.25 $ 0.34
============ =============
SHARES OUTSTANDING:
Basic 2,514,171 2,451,811
============ =============
Diluted 2,576,853 2,602,471
============ =============
(See notes to interim unaudited condensed consolidated financial statements)
2
MAX & ERMA'S RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Sixteen Weeks Ended
---------------------------------------
February 20, February 15,
2005 2004
------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 654,318 $ 890,879
Depreciation and amortization 2,866,738 2,402,506
Minority Interest in Income
of Affiliated Partnership 19,252
Changes in other assets and liabilities 1,183,473 1,034,107
------------ -------------
Net cash provided by operating activities 4,723,781 4,327,492
------------ -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (2,206,230) (10,024,530)
Net Increase in other assets (125,763) (226,060)
------------ -------------
Net cash used in investing activities (2,331,994) (10,250,590)
------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under long-term obligations (29,521,793) (24,364,015)
Proceeds from long-term obligations 27,672,488 30,085,951
Proceeds from sale of stock 244,006 25,059
Purchase of common stock (20,251)
Debt issue costs (39,384) (35,727)
Distributions to Minority Interest
in Affiliated Partnership (19,252)
------------ -------------
Net cash (used in) provided by financing activities (1,663,935) 5,691,017
------------ -------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 727,852 (232,081)
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD 2,187,529 2,616,324
------------ -------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 2,915,381 $ 2,384,243
============ =============
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest $ 974,994 $ 927,689
Income taxes $ 580,024 $ 85,868
Non-cash activities:
Property additions financed by accounts payable $ 330,684 $ 778,787
(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 consist of 52
weeks and includes one sixteen-week and three twelve-week quarters. Fiscal
2004 consist 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 interim and 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.
4
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 171,950 shares of common stock were
outstanding at February 25, 2005 (none at February 15, 2004) but were not
included in the computation of diluted earnings per share because the
options' exercise prices were greater than the average market price of the
common shares and, therefor, the effect would be antidilutive. The
difference between basic shares outstanding and diluted shares outstanding
is entirely due to the dilutive effect of stock options.
4. Stock Options
During the three months ended February 20, 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 (48,101) (10.03)
Forfeited (18,400) (13.83)
------- ---------
Outstanding, February 20, 2005 247,150 $ 13.13
======= =========
The Company accounts for employee and director stock options using the
intrinsic value method. Under this method, no compensation expense was
recorded in all periods 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
quarters ending February 20, 2005 and February 15, 2004 would have been as
follows:
2005 2004
---------- ------------
Net income, as reported $ 654,318 $ 890,879
Deduct: total stock-based compensation
expense determined under the fair value
method for all awards, net of related tax
benefits (5,107) (308,833)
---------- ------------
Pro forma net income $ 649,211 $ 582,046
========== ============
Earnings per common share, basic:
As reported $ 0.26 $ 0.36
========== ============
Pro forma $ 0.26 $ 0.24
========== ============
Earnings per common share, diluted:
As reported $ 0.25 $ 0.36
========== ============
Pro forma $ 0.25 $ 0.24
========== ============
The fair value of options granted was estimated on the date of the grant
using the Black-Scholes option-pricing model.
5
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 auditor's
report 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 the 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 (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 for 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
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 quarter 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. We expect some further reduction in costs of
sales as additional cost savings measures are implemented in 2005.
We also have experienced sharply rising healthcare and worker's
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 efforts, health insurance expense declined in both 2004 and the first
quarter of 2005. Late in 2004,
7
we began self-funding our Ohio worker's compensation insurance. We believe this
program will lower our worker's compensation expense by $300,000 or more in
2005.
We have bank borrowings of approximately of $29.2 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 two
million shares of our common stock.
At our current growth rate of three to five 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.
8
YEAR-TO-YEAR COMPARISONS AND ANALYSIS
RESULTS OF OPERATIONS
The following table sets forth our operating results as a percentage of
revenues:
Sixteen Weeks Ended
-------------------
February 20, February 15,
2005 2004
------------ ------------
Revenues 100.0 100.0
Cost of Goods Sold (25.3) (24.8)
Payroll & Benefits (31.5) (32.2)
Other Operating Expenses (32.6) (31.4)
Pre-opening Opening Expenses (0.3)
Administrative Expenses (7.9) (7.9)
Interest Expense (1.3) (1.1)
Income Taxes (0.3) (0.6)
----- -----
Net Income 1.1 1.7
===== =====
REVENUES
Revenues for the first quarter of 2005 increased $3,849,000 or 7.2% from
the first quarter of 2004. The increase was a result of i) the opening of five
restaurants during 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 quarter of 2005. Same-store sales
at restaurants opened at least eighteen months declined $538,000 or
approximately 1.1%. Franchised fees and royalties increased 36%.
The decline in same-store sales was almost entirely the result of the
Christmas holiday falling on Saturday in the current quarter as compared to
mid-week last year. Same-store sales for the week of Christmas in fiscal 2005
declined $487,000 from Christmas week in fiscal 2004, when Christmas fell on
Thursday. In addition to this, a major winter storm during the fourth week of
January 2005 impacted most of our markets and resulted in a $383,000 sales
decline for the three day week-end. Excluding these two events same-store sales
increased $332,000 or 0.7% from the first quarter of 2004 to the first quarter
of 2005.
During the first quarter of 2005 we tested an advertising campaign in the
Cleveland market that included television and radio in conjunction with a very
moderate amount of coupon discounting. During the eleven-week run of television
and radio, sales in the market were up
9
$273,000 or 10.3%. Media costs for the campaign were approximately $191,000. We
plan to evaluate the retention of the sales increase, after the advertising
stopped, during the second quarter of 2005. At this time we consider the
campaign a success. We also plan to run a similar campaign in our Columbus and
Toledo, Ohio and Pittsburgh, Pennsylvania markets during the second quarter of
2005.
We expect to open three restaurants during the remainder of 2005. Two
restaurants were under construction at the end of the first quarter of 2005. We
were under contract to lease one additional site. We were in some stage of
negotiating for the purchase or lease of five 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 seventeen at the end of the
first quarter of 2004 to twenty at the end of the first quarter of 2005. Two
franchised restaurants were under construction in Richmond, Virginia and South
Bend, Indiana at the end of the first quarter of 2005. In addition to the two
franchised restaurants under construction, we anticipate the opening of two to
three additional franchised restaurants during 2005.
COSTS AND EXPENSES
Cost of goods sold, as a percentage of revenues, increased from 24.8% for
the first quarter of 2004 to 25.3% for the first quarter of 2005. The increase
was a result of continued high beef, chicken, produce and dairy prices. However
due to costs savings measures and declining market prices, chicken, produce and
dairy costs were at or below last year by the end of the first quarter of 2005.
Payroll and benefits, as a percentage of revenues, declined from 32.2% for
the first quarter of 2004 to 31.5% for the first quarter of 2005. The decrease
was a result of reduced health insurance and workers' compensation expenses.
Payroll costs were even with the first quarter of last year. The decline in
health insurance expense was due to a change in our health plan early in 2004
and increased employee contribution levels. 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
31.4% for the first quarter of 2004 to 32.6% for the first quarter of 2005. The
increase was primarily a result of increased marketing expenses, carry out
supplies, credit and gift card fees and higher natural gas prices. The increase
in other operating expenses, as a percentage of revenue, was exacerbated by the
decline in same store sales from last year, as most of this expense category is
of a somewhat fixed nature.
10
Pre-opening expenses, as a percentage of revenues, declined from 0.4% for
the first quarter of 2004 to 0% for the first quarter of 2005 as no restaurants
were opened during the first quarter of this year.
ADMINISTRATIVE EXPENSES
Administrative expenses, as a percentage of revenues, remained at 7.9% for
the first quarter of 2004 and 2005. In dollar terms, administrative expenses
increased $258,000 or 6% from the first quarter of 2004 to the first quarter of
2005. The increase was a result of raises for corporate personnel, higher
professional fees and costs associate with converting from paper gift
certificates to an electronic gift card program.
INTEREST EXPENSE
Interest expense increased 18% from the first quarter of 2004 to the first
quarter of 2005 due to an increase in the prime interest rate and LIBOR. 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 and 2004, the interest rate under our credit agreement was LIBOR plus 3.5%
or prime plus 3/4 percent for both the first quarter of 2004 and 2005. As a
result of increases in prime and LIBOR, the interest rate under our revolving
credit line was 6.25% at February 20, 2005, as compared to 4.75% at February 15,
2004. Through the use of an interest rate swap, the interest rate on
approximately 30% of our two term loans was essentially fixed at 9.9% at both
February 20, 2005 and February 15, 2004. The interest rate on the balance of the
two term loans increased from 4.75% at February 15, 2004 to 6.25% at February
20, 2005.
Total interest bearing debt decreased from $32.0 million at February 15,
2004 to $29.2 million at February 20, 2005. The decrease was due to scheduled
principal amortization. The outstanding balance under our revolving credit line
increased due to cash flow needs during the second half of 2004, when our
profitability dipped. We capitalized $7,000 of construction period interest
during the first quarter of 2005 versus $80,000 during the first quarter of
2004. The decline was a result of less construction activity.
INCOME TAXES
Our effective tax rate declined from 26.0% for the first quarter of 2004
to 20% for the first quarter of 2005. The decline was due to an increase in our
FICA tax on tips credit, which had the effect of decreasing our effective tax
rate.
11
LIQUIDITY AND CAPITAL RESOURCES
Our working capital ratio remained at .4 to 1 at October 31, 2004 and
February 20, 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 quarter of 2005, we expended approximately $2,206,000 for
property additions, $29,522,000 to reduce long-term obligations and increased
cash on hand $728,000. Funds for such expenditures were provided primarily by
$27,672,000 from proceeds of long-term obligations, $4,724,000 from operations
and $244,000 from the sale of common stock. 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
2005 and three to five Max & Erma's restaurants during fiscal 2006. At February
20, 2005, we were contractually committed to the lease of three sites, two of
which were under construction. Five 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 $5.4 million as of February 20,
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 February 20, 2005, we had approximately $5.8
million available under our $15.0 million revolving credit line and a $1.0
million landlord construction allowance. 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 are 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 quarter of 2005, net income represented
approximately 19% of net after tax cash flow. Depreciation represented the other
81% or approximately $2.9 million for the quarter. 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.
12
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 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 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.
13
Forward-looking statements in this MD&A include statements regarding
sales at new Company-owned restaurants (paragraph 2), royalties at new
franchised locations (paragraph 4), 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 belief that internally generated cash flow will fund growth
replacement capital expenditures and debt service (paragraph 8), the belief that
the Cleveland advertising campaign was a success (paragraph 12), the expectation
of future restaurant openings (paragraphs 13 and 25), the expectation of
increased franchise fees and royalties (paragraph 14), the estimated cost to
complete restaurants currently under contract (paragraph 26), the source of
funds for new restaurants (paragraph 26), and the expectation that we will
expend $3.0 million and $3.9 million on fixed asset replacements and debt
service, respectively (paragraph 27).
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 $35.0 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. The interest rate swap expires
October 31, 2005.
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
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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 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 February 20, 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)
March 31, 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 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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