Item 1. BUSINESS - ----------------
Max & Erma's Restaurants, Inc. (the "Company"), directly and through affiliated partnerships, owns and operates a chain of forty-one Max & Erma's restaurants at December 31, 1996. 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 provide generous servings of consistently high quality food at moderate prices in the casual setting of a neighborhood gathering place. The menu includes Max & Erma's signature gourmet hamburgers, specialty sandwiches, salads, appetizers, pasta dishes, chicken, seafood, steaks, other entrees prepared in a variety of cuisines, desserts and 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.
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 1996, the average check was approximately $7.83 at lunch and $9.58 at dinner, although during the second half of the year the dinner check average was $9.68 as a result of the Company's efforts to increase the dinner check average through the introduction of higher priced entrees. The lunch and dinner meal periods accounted for approximately 35.9% and 64.1% of net sales, respectively. Alcoholic beverages constituted approximately 13.6% of net sales in fiscal 1996.
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.
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. Waiters and waitresses are trained based on the "Fifty-two Moments of Truth," a program based on the Company's consumer research which measures the events that impact the customer's dining experience. 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 as necessary, the menu twice each year, and in addition offers an annual summer menu. In fiscal 1992, nightly dinner specials, such as fajitas, southwestern style steak and jumbo fried shrimp, were introduced to increase weekday dinner volume and to provide variety for frequent customers. Weekday lunch specials were added in fiscal 1993, and separate lunch and dinner menus were introduced during 1994. "Five Great Ways to be Good," a selection of healthy, low fat menu items, was introduced at the start of 1995. During 1996 the Company expanded its entree offerings in an effort to increase its per person dinner check average. 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 spends approximately 3.25% of net sales annually on advertising and uses television, radio, direct mail, billboards, special events and localized store marketing designed to increase customer awareness and repeat business.
The Company owns thirty-nine of the Max & Erma's restaurants currently in operation. Two are owned by separate affiliated partnerships. In addition to the specified percentage interest in the profits and losses of the affiliated partnerships, the Company is paid an annual fee equal to 6% or 7% of gross revenues for managing the two Max & Erma's restaurants owned by the partnerships. Each 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.
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 November 30, 1996, the Company had 3,611 employees, of which 1,054 were full-time restaurant employees, 2,357 were part-time restaurant employees, 53 were corporate staff personnel and 147 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. Nine 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 60 to 125 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.
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 - ----------------
In addition to two restaurants opened during the first quarter of 1997, the Company intends to open four additional Max & Erma's restaurants during the remainder of fiscal 1997 and an additional five to six restaurants during fiscal 1998. All but four of the existing Max & Erma's restaurants are located in suburban areas. Of the existing restaurants, 25 are free-standing and 16 are in-line shopping center/mall locations. The following table sets forth the location of each existing Max & Erma's restaurant and the locations of two (all free-standing) of the four restaurants scheduled to open during the remainder of 1997:
The Company's preference is to acquire the land and build new free-standing restaurants. However, in order to acquire suitable sites, the Company will utilize ground leases, or lease and convert existing premises. 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 new "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). The Reform Act only became law in late December 1995 and, except for the Conference Reports, no official interpretations of the Reform Act's provisions have been published. 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 case have affected, and in the future could affect, the Company's actual results and could cause the Company's actual consolidated results of operations for Fiscal 1997 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 cost along with the availability of employees and suitable restaurant sites could affect future operating results.
4. Legal - The Company is exposed to various tort 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.
Item 2.

Item 2. PROPERTIES - -------------------
All but thirteen of the Company's restaurants are occupied under leases expiring from 1997 to 2025, with renewal options for five to 20 additional years. The affiliated partnership which owns one of the restaurants 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 (15,000 square feet) and general warehouse and storage facilities (17,000 square feet) in Columbus, Ohio under an operating lease expiring in October 2000.
The last 21 restaurants opened are based on a new design which the Company has used as its prototype. 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 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 6,700 square feet and seats 200 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 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 27, 1996.
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 27, 1996, page 10.
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 27, 1996, pages 11 through 13.
Item 8.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------
The balance sheets as of October 27, 1996 and October 29, 1995 and the related statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 27, 1996, 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 27, 1996, pages 14 through 24 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 1997 Annual Meeting of Stockholders, 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 11 are filed as part of this report.
(a)(3) and (c): Exhibits The exhibits listed in the accompanying index to exhibits on pages 12 through 15 are filed as part of this report.
(b): Reports on Form 8-K Form 8-K was filed on September 26, 1996.
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 13, 1997 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.