Item 1. BUSINESS
Max & Erma's Restaurants, Inc. (the "Company"), directly and through an affiliated partnership, owns, operates and franchises (three) a chain of fifty-five Max & Erma's restaurants at December 31, 1999. In addition, Ironwood Cafe, LLC, a wholly-owned limited liability company owns and operates two Ironwood Cafe restaurants, which are in the process of being closed or sold (see Note 9 to Financial Statements in Part II, Item 8). The Company is a Delaware corporation organized in 1982, as the successor to a restaurant business founded in 1971. The Company has registered the phrase "Max & Erma's - Neighborhood Gathering Place" and its associated logo as a service mark with the United States Patent and Trademark Office.
The Company's executive offices are located at 4849 Evanswood Drive, Columbus, Ohio 43229, and its telephone number is (614) 431-5800.
Description of Business
Max & Erma's restaurants are famous for gourmet burgers, overstuffed sandwiches, homemade pasta dishes, chargrilled steak and chicken specialties, super salads and taste-tempting munchies. Unique to the Max & Erma's concept is the Build-Your-Own-Sundae Bar, a bathtub filled with vanilla ice cream, special sauces and lots of toppings. In addition, the restaurants offer a full complement of alcoholic and non-alcoholic beverages. Management believes that the decor and theme of Max & Erma's restaurants allow the introduction of a broad range of menu items, thus permitting rapid adjustment to changing customer preferences.
Antique artifacts and local paraphernalia make Max & Erma's a fun, unique place to take friends and family. The use of brick, a combination of light and dark colors, and dropped lighting creates a roomy, yet cozy feel for customers to enjoy while dining. The neighborhood atmosphere of each restaurant is enhanced by inclusion of local items in each restaurant's decor, including sports team paraphernalia and historical artifacts. Additional decor items include a giant bubble gum machine, a three-dimensional burger, an antique love tester and many other things. Giant murals, both inside and outside the restaurant, combine the history and tradition of each market with Max & Erma's story.
Max & Erma's restaurants are open for both lunch and dinner seven days a week. Hours of operation are generally 11:00 a.m. to midnight. During fiscal 1999, the average check was approximately $8.67 at lunch and $9.91 at dinner. The lunch and dinner meal periods accounted for approximately 38.2% and 61.8% of net sales, respectively. Alcoholic beverages constituted approximately 11.0% of net sales in fiscal 1999.
The Company's strategy is to compete in the casual dining segment of the restaurant industry by offering a variety of high quality food in a casual, comfortable and fun atmosphere and with a uniquely personable service style. The philosophy of the Company is to focus on the details of the customer experience that instill customer loyalty and promote repeat business. The purpose
of every associate is to "help our guests enjoy their total dining experiences so they can't wait to come back." The Company believes the dining experience starts with the food and therefore uses only the freshest, high quality ingredients in every menu item.
Freshness and quality are truly the foundations upon which Max & Erma's was built. The Company strives to do things the right way, not the easy way. It believes this dedication makes it better and that its guests return more often. Market research indicates that customers often know what they are going to order before they get to the restaurants because they crave certain signature items.
Being a "purpose-driven" company requires an ability to understand what guests want, and a dedication to focus all associates' energies on exceeding those expectations. Management believes that the best expressions of guests' desires can be translated to a phrase that captures Max & Erma's character. Specifically, the concept of the "Hometown Favorite" evokes images of trust, friendliness and wholesomeness. This means that associates treat guests with respect, like friends or neighbors, and provide them with the kind of food, service and atmosphere that will make them want to return often.
Management believes that Max & Erma's reputation is built every day with every customer served and that a key to customer loyalty is the server. Food is delivered to the table by the server instead of a food runner, and servers are required to recheck the table two minutes after delivering the meal. Moreover, the wait staff is empowered to address customer problems without the assistance of restaurant management.
Max & Erma's restaurants have always been known for gourmet hamburgers and specialty sandwiches; however, one part of the Company's focus on the customer is an evolving menu that changes to meet consumer tastes. The Company believes its menu should be fun as well as innovative, and reviews and revises the menu twice each year, and in addition offers an annual summer menu. By periodically modifying its menu through the introduction of a broad range of appealing new menu items the Company has achieved a more diversified sales mix.
The Company makes extensive use of consumer focus groups to conduct marketing research. Management incorporates the findings of this market research in its advertising, menu development, employee training, and building design and decor. According to customers, the major point of difference between the Company and its competitors is that Max & Erma's restaurants are perceived as being more of a "fun place," an image the Company tries to foster in its advertising. The Company spent approximately 2.3% of sales on advertising in 1999. It primarily uses radio, direct mail, billboards, special events and localized store marketing designed to increase customer awareness and repeat business.
The Company owns fifty-one of the Max & Erma's restaurants currently in operation. One is owned by a separate affiliated partnership. In addition to the specified percentage interest in the profits and losses of the affiliated partnership, the Company is paid an annual fee equal to 6% of gross revenues for managing the Max & Erma's restaurant owned by the partnership. The
management contract provides for monthly payments to the Company for an initial term of two years and renewal terms aggregating 20 additional years upon the mutual agreement of the parties.
During 1998 two separate franchised Max & Erma's restaurants opened in the Columbus, Ohio airport and in the Cleveland, Ohio airport. An additional franchise opened in early fiscal 2000 on the Ohio Turnpike. Terms of the agreements generally call for an initial franchise fee plus a monthly royalty of 4 or 5% of sales. The Ohio Turnpike location is similar in design to the airport locations except it does not sell alcoholic beverages.
During 1998 the Company initiated a test of a second restaurant concept, Ironwood Cafe. Ironwood Cafes occupy approximately 3,500 to 4,000 square feet of leased space, open for dinner only, and primarily serve pasta and gourmet pizzas prepared in a wood-burning oven. The first Ironwood Cafe did not achieve a profitable sales level and was closed during the second quarter of 1999. Two additional Ironwood Cafes opened during 1999 in Cleveland and Cincinnati, Ohio, also did not achieve profitable sales levels, and are in the process of being closed or sold during the first quarter of fiscal 2000.
Competition
The restaurant business, particularly in the casual dining segment, is highly competitive in terms of quality and value of products served, type and variety of menu offered, quality and efficiency of service, ambiance and attractiveness of facilities and site location. Max & Erma's restaurants compete with food service operations of various types within their respective locations, including national and regional chains as well as locally-owned and operated restaurants. Many of the Company's competitors are substantially larger and have greater financial resources than the Company.
Employees
At October 31, 1999, the Company had 4,486 employees, of which 673 were full-time restaurant employees, 3,577 were part-time restaurant employees, 70 were corporate staff personnel and 166 were restaurant managerial personnel. None of the Company's employees are represented by a labor union or a collective bargaining unit. The Company considers relations with its employees to be good.
Restaurant Operations
The Company strives to maintain quality and uniformity in its restaurants through careful training and supervision of personnel. All restaurants are operated in accordance with uniform Company specifications, which are set forth in detailed operating manuals relating to food and beverage preparation, maintenance of premises and employee conduct. The Company utilizes an independent shopping service to monitor implementation of Company operating standards. The Company and the shopping service have developed testing standards for the major aspects of restaurant operation, including physical appearance, cleanliness, wait staff and food quality. The shopping service has "mystery shoppers" visit each restaurant four times each quarter to evaluate
and grade the restaurant. A report is prepared by the shopping service for each visit and is reviewed by the Company's Chief Operating Officer and the respective regional and general managers. A portion of the bonus for each regional and general manager is based on the scores received on the shopping service reports. The Company also makes available at each table postage-paid comment cards addressed to the Company's President. The President responds to any negative comments on a weekly basis.
Restaurant operations are administered by a management staff headed by the Chief Operating Officer. A Regional Vice President of Operations reports to the Chief Operating Officer. Twelve regional managers, each of whom supervises the operations of four to five restaurants, report to either the Chief Operating Officer or the Regional Vice President of Operations. Each restaurant has a general manager, who is responsible for training and supervising approximately 40 to 100 employees, and two or three assistant managers. Regional managers are responsible for hiring their general and assistant managers. General managers, with the assistance of the regional manager, are responsible for hiring restaurant employees. The Company seeks to hire experienced restaurant personnel who must complete a 14-week training program conducted by the Company before becoming an assistant manager. The Company has historically promoted from within to fill its regional and general manager positions.
Both regional and general managers receive a base salary plus a bonus based upon performance against budget and average independent shopping service scores. General managers prepare quarterly budgets for their stores and regional managers prepare quarterly budgets for their regions. Bonuses are based on specific goals derived from these quarterly budgets. Managers may elect to receive some or all of their bonuses in the Company's common stock at a one-half discount from fair market value. In addition, all regional managers and general managers are eligible to receive stock options on a periodic basis. Management believes that its bonus system and the ability to purchase common stock promote loyalty and highly motivate managers to meet Company goals.
Management believes that the combination of the authority delegated to its regional and general managers, particularly with respect to hiring employees, together with its goal-specific bonus plans, results in a positive work environment and has contributed to relatively low management turnover.
Managing Partner Program
At the start of 1999 the Company introduced its Managing Partner Program on a test basis. Nine eligible general managers and the Company entered into five-year agreements in which the general manager places 1,000 shares of Max & Erma's common stock which he or she owns in escrow with the Company and agrees to manage their restaurant for a five year period. The shares of stock are forfeited if the general manager terminates their employment during the term of the agreement. In return the Company agrees to not relocate the general manager during the term of the agreement. During the term of the agreement the general manager's base salary is fixed. As additional compensation they receive 25% of the increase in profit before fixed expenses over a pre-established base profit (generally the average of profit before fixed expenses for the most recent
three fiscal years). The Company believes the program encourages the general manager to both build sales and control margins, creates a sense of ownership, reduces management turnover and promotes a longer-term perspective. At the start of fiscal 2000, the Company entered into nine additional Managing Partner Agreements.
Purchasing and Inventory Controls
Meat and most other food and restaurant supply items are purchased through one major distributor in order to obtain favorable prices and to ensure consistent quality and delivery. For major items, the Company typically negotiates prices directly with producers. For other items, the Company provides the distributor with specifications and receives monthly prices for such items, generally based upon a "cost plus" formula. Restaurant managers purchase these items directly from the distributor, and each restaurant is billed directly for its purchases. Although most of the Company's food and supplies are presently furnished by one distributor, the Company believes alternate food suppliers are available and has not experienced a shortage of food or supplies. A daily inventory is taken for high cost items, such as steaks, ground meat, seafood and liquor. A physical inventory of all items is made at the end of each four-week accounting period.
Future Expansion
The Company intends to open eight additional Max & Erma's restaurants per year during fiscal 2000 and 2001. All but four of the existing Max & Erma's restaurants are located in suburban areas. Of the existing Company-owned Max & Erma's restaurants, 36 are freestanding and 16 are in-line shopping center/mall locations. The following table sets forth the location of each Company-owned existing Max & Erma's restaurant as of December 31, 1999 and the locations of restaurants currently under development and scheduled to open during fiscal 2000 and 2001:
The Company's preference is to acquire the land and build new freestanding restaurants for Max & Erma's. However, in order to acquire suitable sites, the Company will utilize ground leases, or lease and convert existing premises. All sites under development are freestanding. Management believes that the clustering of three or more restaurants in markets of sufficient size increases customer awareness, enhances the effectiveness of advertising and improves management efficiency.
Government Regulation
The Company is subject to Federal, state and local laws affecting the operation of its restaurants, including zoning, health, sanitation and safety regulations and alcoholic beverage licensing requirements. Each restaurant is operated in accordance with standardized procedures designed to assure compliance with all applicable codes and regulations. The suspension of a food service or liquor license could cause an interruption of operations at affected restaurants.
Business Risks
The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Many of the following important factors have been discussed in the Company's prior filings with the Securities and Exchange Commission.
In addition to the other information in this Report, readers should carefully consider that the following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual results and could cause the Company's actual results of operations for Fiscal 2000 and beyond, to differ materially from those expressed in any forward-looking statements made by, or on behalf of the Company.
1. Dependence on Management - The Company's senior management has over 70 years experience with the Company. The loss of one or more key executives could have an adverse effect on the Company.
2. Competition - The casual dining segment of the restaurant industry is highly competitive. Many of the Company's competitors are larger national chains with greater financial resources.
3. Restaurant Industry - The restaurant industry is affected by changing trends, economic conditions, traffic patterns and weather. Increases in food, labor and benefits costs along with the availability of employees and suitable restaurant sites could affect future operating results.
4. Legal - The Company is exposed to various torts and other claims, most notably liability claims resulting from the sale of alcoholic beverages. While the Company currently maintains insurance for such claims, there is no assurance of its adequacy or future availability. An uninsured or excess claim could have a material adverse affect on the Company.
5. Government Regulation - The restaurant industry is subject to extensive government regulations relating to the sale of food and alcoholic beverages, and sanitation, fire and building codes. Suspension or inability to renew any of the related licenses and permits could adversely affect the Company's operations. Further more, government actions affecting minimum wage rates, payroll tax rates and mandated benefits could affect operating results.
6. Franchising - The Company has begun and will expand franchising the Max & Erma's concept. Failure to properly train, control and supervise franchisees could have a detrimental effect on the overall reputation and results of operations of Max & Erma's Company-owned restaurants. Additionally, there is no assurance that franchised restaurants will open or generate franchise fees as projected.
Item 2.
Item 2. PROPERTIES
All but one of the Company's restaurants are occupied under leases expiring from 2000 to 2025, with renewal options for five to twenty additional years. The affiliated partnership which owns one restaurant in Columbus, Ohio also owns the premises on which it is located. Restaurant leases are generally collateralized by liens on leasehold improvements, equipment, furniture and fixtures. The Company leases its executive offices (24,000 square feet) and general warehouse and storage facilities (17,000 square feet) in Columbus, Ohio under an operating lease expiring in January 2009.
During the first quarter of fiscal 2000 the Company completed two sale-leaseback transactions for six restaurants. The Company received proceeds of approximately $2,900,000 (net of payoff of the approximately $5,200,000 mortgage loan), and $4,900,000, respectively. The transactions resulted in a deferred gain of approximately $970,000, which will be accreted to income as a reduction of rent expenses over the twenty year lease term and a loss on disposition of assets of approximately $119,000.
The last 34 Max & Erma's restaurants opened since mid-1993 are based on a standard prototype design. The prototype gives Max & Erma's restaurants a distinct identity and emphasizes an unpretentious neighborhood ambiance. The prototype design downplays the use of brass, Tiffany lamps and other design features common to the Company's 18 older restaurants and to many other casual dining restaurants. Max & Erma's restaurants established prior to the introduction of the prototype vary in design and appearance, but average 6,000 square feet and seat an average of 160 customers. The freestanding prototype is approximately 6,800 square feet and seats 210 patrons for dining in addition to the bar area. A 30 to 40 seat seasonal patio area is optional. The prototype design is readily adaptable to a variety of sites including shopping center and mall locations.
The Company believes that its focus on selecting high profile restaurant sites is critical to its success. The Company's present site selection strategy is to locate its restaurants in prime, high visibility, high traffic suburban locations. Management believes that selection of high profile sites along with the implementation of its prototype restaurant will result in improved unit economics.
Item 3.
Item 3. LEGAL PROCEEDINGS
The Company is a defendant in various legal proceedings regarded as normal to its business, and in the opinion of management, the ultimate outcome of such proceedings will not materially affect the Company's financial position or the results of its operations.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information contained under the captions "SELECTED QUARTERLY FINANCIAL DATA" and "SHAREHOLDER INFORMATION" is incorporated herein by reference to the inside back cover of the Company's Annual Report to Shareholders for the fiscal year ended October 31, 1999.
Item 6.
Item 6. SELECTED FINANCIAL DATA
Information required under this Item is incorporated herein by reference to the Company's Annual Report to Shareholders for the fiscal year ended October 31, 1999, page 5.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information required under this Item is incorporated herein by reference to the Company's Annual Report to Shareholders for the fiscal year ended October 31, 1999, pages 6 through 8.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As of October 31, 1999, the Company's total long-term indebtedness (including current maturities) was approximately $28.3 million. Approximately $23.1 million of such indebtedness is the Company's revolving credit line and bears interest at variable rates. A one percentage point increase or decrease in interest rates will increase or decrease the Company's pre-tax income by approximately $230,000. Based upon quarter ending balances the average borrowings under the Company's revolving credit line during 1999 was $18.3 million. The high and low balance outstanding under the revolving credit line during 1999 was $23.1 million and $12.1 million, respectively. As required under the Company's revolving credit agreement the Company has entered into a $20,000,000 interest rate protection agreement. The agreement does not convert any of the Company's borrowings from variable rate to fixed rate until fiscal 2001. For a further description of the Company's indebtedness, see Item 8, Financial Statements and Supplementary Data - Notes 3 and 4 to the Consolidated Financial Statements.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The balance sheets as of October 31, 1999 and October 25, 1998 and the related statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 31, 1999, and the related notes to the financial statements together with the independent auditors' report thereon and the Selected Quarterly Financial Data are incorporated by reference to the Company's Annual Report to Shareholders for the fiscal year ended October 31, 1999, pages 9 through 20 and the inside back cover.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
Items 10, 11, 12 and 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT: EXECUTIVE COMPENSATION: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT: AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under these Items is incorporated herein by reference to the Company's Proxy Statement for 2000 Annual Meeting of Stockholders to be held on April 12, 2000, pursuant to Regulation 14A.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) and (2) and (d): Financial Statements The financial statements listed in the accompanying index to financial statements on page 14 are filed as part of this report.
(a)(3) and (c): Exhibits The exhibits listed in the accompanying index to exhibits on pages 15 through 16 are filed as part of this report.
(b): Reports on Form 8-K None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: January 18, 2000 Max & Erma's Restaurants, Inc.
By: */s/Todd B. Barnum ------------------------------------- Todd B. Barnum Chairman of the Board, Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on the dates indicated.
MAX & ERMA'S RESTAURANTS, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES ITEMS 8, 14(a)(1)
REPORT ON FORM 10-K
MAX & ERMA'S RESTAURANTS, INC.
INDEX TO EXHIBITS
*Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Report on Form 10-K pursuant to Item 14(c) of the Report on Form 10-K.