##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON D.C. 20549
 FORM 10-K
 Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
 For the fiscal year ended October 28, 2007
Commission File Number: 0-11514
 Max & Ermas Restaurants, Inc.
  Delaware
    
    No. 31-1041397(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)4849 Evanswood Drive, Columbus, Ohio
    
    43229(Address of principal executive offices)
    
    (Zip Code)
 (614) 431-5800
  Title of Each Class
    
    Name of Each
Exchange on Which RegisteredCommon Stock, $0.10 Par Value
    
    NASDAQ Global Market
  o þ
 o þ
 þ o
 o
  o o þ
 o þ




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Item 1. BUSINESS
   Description of Business
      1




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2




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Competition
  Associates
  Restaurant Operations
     3




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Managing Partner Program
  Purchasing and Inventory
   4




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Technology
     Government Regulation
  Future Expansion
  5




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Company Owned
    
    FranchisedExisting
    
    Under Development
    
    Existing
    
    Under DevelopmentFloridaWellington
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1GeorgiaAtlanta
    
    
    1IllinoisChicago
    
    
    8IndianaAztar Casino
    
    
    
    
    
    
    
    
    
    
    1Columbus
    
    
    
    
    
    
    
    
    
    
    1Indianapolis
    
    
    4Merrillville
    
    
    
    
    
    
    
    
    
    
    1Mishawaka
    
    
    
    
    
    
    
    
    
    
    1Seymour
    
    
    
    
    
    
    
    
    
    
    1KentuckyCrestview Hills
    
    
    1Lexington
    
    
    2Louisville
    
    
    2MichiganAnn Arbor
    
    
    1Detroit
    
    
    11
    
    
    
    
    
    
    
    1Grand Rapids
    
    
    1Lansing
    
    
    1MissouriSt. Louis
    
    
    
    
    
    
    
    
    
    
    2NevadaLas Vegas
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2North CarolinaCharlotte
    
    
    2OhioAkron
    
    
    1Canton
    
    
    1Chillicothe
    
    
    
    
    
    
    
    
    
    
    1Cincinnati
    
    
    5
    
    
    
    
    
    
    
    1
    
    
    
    1Cleveland
    
    
    5
    
    
    
    
    
    
    
    2Columbus
    
    
    12
    
    
    
    1
    
    
    
    2Dayton
    
    
    4
    
    
    
    
    
    
    
    1Findlay
    
    
    
    
    
    
    
    
    
    
    1Lancaster
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Niles
    
    
    1Sandusky
    
    
    
    
    
    
    
    
    
    
    1Toledo
    
    
    3Wilmington
    
    
    
    
    
    
    
    
    
    
    1PennsylvaniaErie
    
    
    1Philadelphia
    
    
    
    
    
    
    
    
    
    
    2Pittsburgh
    
    
    9Washington
    
    
    1
 6




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Company Owned
    
    FranchisedExisting
    
    Under Development
    
    Existing
    
    Under DevelopmentSouth CarolinaMyrtle Beach
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1VirginiaNorfolk
    
    
    1
    
    
    
    
    
    
    
    1Richmond
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1Virginia Beach
    
    
    1
    
    
    
    
    
    
    
    1West VirginiaHuntington
    
    
    
    
    
    
    
    
    
    
    1Washington, D.C
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1TOTAL
    
    
    79
    
    
    
    1
    
    
    
    24
    
    
    
    8
  Item 1A. RISK FACTORS
   1.
    
    Dependence on Senior Management. Two of our three senior management officials have over 47
years combined experience with us. The third senior management official joined us in
September 2007, but has over 30 years of industry experience. Although we have attempted to
develop additional management capabilities, the loss of one or more of these senior executives
could have a material adverse effect on operation of our business or the quality of restaurant
operations which could affect future sales.2.
    
    Competition. The casual dining segment of the restaurant industry is highly competitive with
respect to price, service, food quality, location, and employees, including restaurant
managers. Many of our competitors are larger in size, have greater financial and other
resources, and have longer operating histories. Typically, increased competition has a
negative effect on a specific restaurants sales.
 7




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3.
    
    Restaurant Industry Changes. The restaurant industry is affected by changes in consumer
tastes and attitudes, economic conditions, traffic patterns and changes, and other factors,
which requires regular changes in the operation of restaurants to remain competitive. There
is a risk that we will not effectively adapt to changes in the industry, which could put us
at a competitive disadvantage and negatively impact restaurant sales.4.
    
    Cost of Doing Business. The restaurant business is subject to sudden cost changes,
particularly for food, energy, labor and insurance. We may not be able to recover cost
increases by increasing prices for our menu items, which could increase cost of sales as a
percentage of revenues.5.
    
    Legal. We may be exposed to various tort and other claims, including, notably, liability
claims resulting from the sale of alcoholic beverages. While we currently maintain insurance
for such claims, there can be no assurance that such insurance will be adequate or available
in the future. An uninsured or excess claim could have a material adverse effect on our
business, results of operations and financial condition.6.
    
    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. Changes in regulations or the suspension or inability to renew any of the
related licenses and permits could force a restaurant to cease operations, which would result
in operating losses during such period. Also, government actions affecting minimum wages,
payroll tax rates, and mandated benefits could adversely affect operating results by
increasing the related operating expense.7.
    
    Franchising. We intend to expand the franchising of the Max Ermas concept. Failure to
properly select, train, and supervise franchisees could have a detrimental effect on the
overall reputation and results of operations of the restaurants owned by us. The effect of
this could be to negatively impact both Company-owned and franchised restaurants sales and
the ability to continue franchising.8.
    
    Unfavorable Publicity. Adverse publicity resulting from poor food quality, illness, injury
or other health concerns or operations at one or a limited number of our restaurants or any
franchisees restaurants could have material adverse effect on our business, results of
operations and financial condition.9.
    
    Acts of God, Terrorism. Our business could be materially adversely affected by acts of God,
including extremely harsh weather or natural disasters, and by terrorist acts such as the
events of September 11, 2001. Sales could be negatively impacted during such periods.10.
    
    Consumer Perceptions of Food Safety. Our business and sales could be materially adversely
affected by consumer perceptions of food safety in the United States or in the market areas in
which we operate, whether such perceptions are based on fact or not and whether such
perceptions are caused by acts of terrorism or other events.11.
    
    Leverage; Interest Rate Risk. Our business is significantly leveraged, resulting in long
term indebtedness (including current maturities) of approximately $29.8 million as of October
28, 2007, $22.8 million of which represents the balance due under our revolving credit
agreement and bears interest at variable rates. We cannot be sure that continued debt
financing will be available to us in the future or that any financing will be available
 8




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on favorable terms. Our ability to make payments of principal and interest on, or to refinance
our indebtedness, will depend on our future performance and successful execution of our
business strategy. A one-percentage point increase or decrease in interest rates could
increase or decrease our pre-tax income by approximately $228,000. A change in interest
rates will likely have a significant impact on our earnings.
 12.
    
    Utilization of FICA Tax on Tips Credit. We have recorded a deferred tax asset of $4.5
million for unused FICA Tax on Tips Credit net of a $1.3 million valuation allowance recorded
at October 28, 2007. The credits expire from 2023 through 2027. To utilize the credits, we
must return to a continued level of profitability. If we do not return to sustained
profitability, we may not be able to recognize the tax benefit of future credits and could be
required to write off all or a portion of the remaining deferred tax asset associated with
credits previously earned, both of which could negatively impact future net income.13.
    
    Bank Covenants. We have obtained waivers and/or amendments of certain bank loan covenant
violations under our revolving credit agreement over the last three quarters of 2005, the
first, second and fourth quarters of 2006, the third quarter of 2007. To avoid anticipated
covenant violations during the fourth quarter of 2007, we entered into an agreement with our
lenders which amended our financial covenants. The agreement also prohibits the opening of
additional Company-owned restaurants and limits capital expenditures through March 31, 2009 or
until our Company is re-capitalized or sold. During the term of the agreement, we are
exploring all strategic options which include the raising of equity capital, the sale of our
Company or the sale of assets. There can be no assurances that this will happen. We believe
that we will return to a sufficient level of profitability and cash flow to sustain our
business. However, if we are unable to raise equity capital, sell our Company, or sell assets
to raise capital, the ability to grow our Company may be limited to additional franchised
restaurants.14.
    
    NASDAQ Listing. On December 13, 2007, we received a NASDAQ Deficiency Letter from The NASDAQ
Stock Market informing us that we had not maintained a minimum market value of publicly held shares (MVPHS) of $5,000,000 as required for continued listing on the NASDAQ Global Market
under Marketplace Rule 4450(a)(2). We have been granted until March 12, 2008, to regain
compliance if the MVPHS of our common stock is $5,000,000 or greater for a minimum of 10
consecutive trading days. If compliance is not demonstrated by March 12, 2008, the NASDAQ
Staff will provide written notification that our common stock will be delisted, which could
limit our ability to raise additional capital as needed in the future. As an alternative, we
may apply for listing on the NASDAQ Capital Market. We currently meet all the qualifications
for listing on the NASDAQ Capital Market.15.
    
    Asset Valuation Risk. We make a significant investment in each restaurant we own. If a
restaurant does not perform well financially, we may have to recognize impairment reserves
under applicable accounting rules. Also, if we decide to close a restaurant, we are likely to
have a substantial impairment charge as we can recover very little of our investment in a
restaurant upon closing and sometimes are required to expend money to restore the leased
building back to its original condition. Both the impairment of assets and expense associated
with closing restaurants would have a negative effect on net income.
 9




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16.
    
    Risk of Default on Indebtedness. If we do not satisfy the terms of our debt agreements which
include covenants that restrict our ability to engage in certain activities and specify
certain financial performance criteria, our lenders could declare a default. In the event of
a default, our lenders could pursue the remedies available to them under these agreements.
These remedies could include terminating our ability to make any new borrowings and
accelerating the repayment of all existing indebtedness. Our inability at that point to
obtain alternative financing would have a material adverse effect on the Companys financial
position, results of operations and cash flows and would likely require that the Company
consider seeking protection from its creditors under the federal bankruptcy laws. There is
no assurance that we will be able to comply with our financial covenants, obtain waivers for
non-compliance or obtain alternative financing.17.
    
    Judgments in Application of Critical Accounting Policies. In preparing our financial
statements, management is required to make certain estimates and assumptions that affect the
annual and quarterly reported amounts of assets, liabilities, revenues and expenses, and
disclosure about contingent assets and liabilities. Our actual results could be different
from these estimates and assumptions and could require adjustments for future operating
results. Some of our more critical accounting policies include: estimates of future sales and
operating income to determine restaurant asset impairment; estimates of costs to determine
self-insurance reserves for health insurance and Ohio workers compensation; and estimates of
future sales and income to determine deferred tax assets.
 Item 1B. UNRESOLVED STAFF COMMENTS
  Item 2. PROPERTIES
    10




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Item 3. LEGAL PROCEEDINGS
  Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  11




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Item 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
   CommonStock PriceHigh
    
    
    LowFiscal 2007First Quarter
    
    $
    8.50
    
    
    $
    7.00Second Quarter
    
    
    9.63
    
    
    
    7.85Third Quarter
    
    
    9.25
    
    
    
    8.08Fourth Quarter
    
    
    8.45
    
    
    
    3.72Year
    
    $
    9.63
    
    
    $
    3.72
 CommonStock PriceHigh
    
    
    LowFiscal 2006First Quarter
    
    $
    12.75
    
    
    $
    10.05Second Quarter
    
    
    10.99
    
    
    
    9.22Third Quarter
    
    
    9.84
    
    
    
    7.06Fourth Quarter
    
    
    8.60
    
    
    
    7.75Year
    
    $
    12.75
    
    
    $
    7.06
  12




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Performance Graph
 
 Fiscal Year EndingCompany/Index/Market
    
    10/25/2002
    
    10/24/2003
    
    10/29/2004
    
    10/28/2005
    
    10/27/2006
    
    10/26/2007Max & Ermas Restaurants, Inc.
    
    
    100.00
    
    
    
    126.79
    
    
    
    95.36
    
    
    
    88.29
    
    
    
    58.21
    
    
    
    26.86SIC Eating Places
    
    
    100.00
    
    
    
    133.08
    
    
    
    146.45
    
    
    
    165.28
    
    
    
    209.75
    
    
    
    241.81NASDAQ Market Index
    
    
    100.00
    
    
    
    145.24
    
    
    
    148.44
    
    
    
    159.81
    
    
    
    179.95
    
    
    
    217.22
 
  13




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Item 6. SELECTED FINANCIAL DATA
  (In Thousands, except per share and
    
    October 28,
    
    October 29,
    
    October 30,
    
    October 31,
    
    October 26,Other data and ratios)
    
    2007
    
    2006
    
    2005
    
    2004
    
    2003RESULTS OF OPERATIONSRevenues
    
    $
    174,854
    
    
    $
    180,290
    
    
    $
    183,705
    
    
    $
    182,959
    
    
    $
    167,083Operating Income (Loss)
    
    
    (1,133
    )
    
    
    1,069
    
    
    
    (140
    )
    
    
    3,134
    
    
    
    3,213Interest Expense
    
    
    3,678
    
    
    
    3,079
    
    
    
    2,431
    
    
    
    2,154
    
    
    
    1,680Income (Loss) Before Income Taxes
    
    
    (4,869
    )
    
    
    (2,069
    )
    
    
    (2,610
    )
    
    
    960
    
    
    
    1,494Cumulative Effect of Change
in Accounting Principle(1)
    
    
    
    
    
    
    (115
    )Net Income (Loss)
    
    
    (3,530
    )
    
    
    (579
    )
    
    
    (1,315
    )
    
    
    1,097
    
    
    
    1,494Proforma Net Income (Loss)Assuming Retroactive Change(2)
    
    
    
    
    
    
    (359
    )
    
    
    (1,325
    )
    
    
    1,087
    
    
    
    1,484Depreciation and Amortization
    
    
    8,221
    
    
    
    8,024
    
    
    
    8,444
    
    
    
    8,219
    
    
    
    6,364Capital Expenditures
    
    
    9,409
    
    
    
    5,524
    
    
    
    9,967
    
    
    
    19,444
    
    
    
    19,055PER DILUTED SHARE DATAIncome (Loss) Before Cumulative Effect
    
    $
    (1.38
    )
    
    $
    (0.18
    )
    
    $
    (0.52
    )
    
    $
    0.42
    
    
    $
    0.56Cumulative Effect of Change in
Accounting Principle
    
    
    
    
    
    
    (0.05
    )Net Income (Loss)
    
    
    (1.38
    )
    
    
    (0.23
    )
    
    
    (0.52
    )
    
    
    0.42
    
    
    
    0.56Proforma Net Income (Loss)Assuming Retroactive Change(2)
    
    
    
    
    
    
    (0.14
    )
    
    
    (0.52
    )
    
    
    0.42
    
    
    
    0.56Average Shares Outstanding (000)
    
    
    2,555
    
    
    
    2,551
    
    
    
    2,537
    
    
    
    2,584
    
    
    
    2,648FINANCIAL POSITIONCash and Equivalents
    
    $
    2,466
    
    
    $
    2,492
    
    
    $
    2,911
    
    
    $
    2,188
    
    
    $
    2,616Working Capital Deficit
    
    
    (13,146
    )
    
    
    (8,682
    )
    
    
    (12,089
    )
    
    
    (9,568
    )
    
    
    (7,723
    )Property  Net
    
    
    55,017
    
    
    
    50,809
    
    
    
    55,663
    
    
    
    55,350
    
    
    
    47,037Total Assets
    
    
    78,560
    
    
    
    72,335
    
    
    
    73,857
    
    
    
    71,107
    
    
    
    61,742Long-Term Obligations(Less Current Maturities)
    
    
    47,164
    
    
    
    43,065
    
    
    
    41,817
    
    
    
    41,053
    
    
    
    35,837Stockholders Equity
    
    
    9,687
    
    
    
    13,034
    
    
    
    13,307
    
    
    
    14,056
    
    
    
    12,189OTHER DATA AND RATIOSAverage Restaurant Sales
    
    $
    2,234
    
    
    $
    2,300
    
    
    $
    2,344
    
    
    $
    2,376
    
    
    $
    2,385Same-Store Sales Decrease
    
    
    (3.5
    )%
    
    
    (2.7
    )%
    
    
    (3.2
    )%
    
    
    (0.4
    )%
    
    
    (0.3
    )%Company-owned RestaurantsIn Operation at Year End
    
    
    79
    
    
    
    78
    
    
    
    79
    
    
    
    78
    
    
    
    73Operating Profit (Loss) Margin
    
    
    (0.6
    )%
    
    
    0.6
    %
    
    
    (0.1
    )%
    
    
    1.7
    %
    
    
    1.9
    %Long-Term Debt-to-Equity Ratio
    
    
    4.9
    
    
    
    3.3
    
    
    
    3.1
    
    
    
    2.9
    
    
    
    2.9Market Price Per Share at Year End
    
    $
    3.76
    
    
    $
    8.15
    
    
    $
    12.36
    
    
    $
    13.35
    
    
    $
    17.75Price Earnings Ratio (High/Low)
    
    
    N/M
    
    
    
    N/M
    
    
    
    N/M
    
    
    
    45.2/31.8
    
    
    
    32.5/23.2Return on Beginning Assets
    
    
    (4.9)
    %
    
    
    (0.8
    )%
    
    
    (1.8
    )%
    
    
    1.8
    %
    
    
    2.4
    %Return on Beginning Equity
    
    
    (27.1
    )%
    
    
    (4.4
    )%
    
    
    (9.4
    )%
    
    
    9.0
    %
    
    
    13.2
    %
 
 (1)
    
    Fiscal 2006 includes the cumulative effect of change in accounting principle, net of $60,000 tax benefit, due to the adoption of FIN 47
Accounting for Conditional Asset Retirement Obligations.(2)
    
    Proforma amounts reflect the amounts the Company would have reported had the asset retirement obligations been recorded at the
Inception of the leases. 14




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Item 7 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 OVERVIEW
    15




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16




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YEAR-TO-YEAR COMPARISONS AND ANALYSIS
 RESULTS OF OPERATIONS
  2007
    
    2006
    
    2005Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of Goods Sold
    
    
    (25.1
    )
    
    
    (25.4
    )
    
    
    (25.5
    )Payroll & Benefits
    
    
    (32.5
    )
    
    
    (32.2
    )
    
    
    (32.3
    )Other Operating Expenses
    
    
    (33.6
    )
    
    
    (33.2
    )
    
    
    (33.3
    )Administrative Expenses
    
    
    (8.7
    )
    
    
    (8.0
    )
    
    
    (8.0
    )Pre-Opening Expenses
    
    
    (0.4
    )
    
    
    (0.1
    )
    
    
    (0.2
    )Impairment of Fixed Assets
    
    
    (0.4
    )
    
    
    (0.5
    )
    
    
    (0.8
    )Interest Expense
    
    
    (2.1
    )
    
    
    (1.7
    )
    
    
    (1.3
    )(Income Taxes) Tax Credit
    
    
    0.8
    
    
    
    0.9
    
    
    
    0.7Change in Accounting Principle
    
    
    
    
    
    
    (0.1
    )
    
    
    Net Loss
    
    
    (2.0
    )%
    
    
    (0.3
    )%
    
    
    (0.7
    )%
 REVENUES
   17




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##### 



18




---



##### 



COSTS AND EXPENSES
     19




---



##### 



ASSET IMPAIRMENT
       20




---



##### 



ADMINISTRATIVE EXPENSES
  INTEREST EXPENSE
  3 4
   21




---



##### 



INCOME TAXES
  22




---



##### 



LIQUIDITY AND CAPITAL RESOURCES
      23




---



##### 



24




---



##### 



Contractual Obligation
 Less than 1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    More than 5 Years
    
    
    TotalOperating Leases
    
    $
    15,097,142
    
    
    $
    28,682,239
    
    
    $
    27,559,164
    
    
    $
    120,722,524
    
    
    $
    192,061,069Capital Leases
    
    
    90,000
    
    
    
    180,000
    
    
    
    180,000
    
    
    
    540,000
    
    
    
    990,000Long-Term Debt(1)
    
    
    5,263,085
    
    
    
    9,741,094
    
    
    
    24,810,369
    
    
    
    
    
    
    
    39,814,548Financing Leases
    
    
    158,406
    
    
    
    316,812
    
    
    
    316,812
    
    
    
    2,141,307
    
    
    
    2,933,337Total
    
    $
    20,608,633
    
    
    $
    38,920,145
    
    
    $
    52,866,345
    
    
    $
    123,403,831
    
    
    $
    235,798,954
 
 (1)
    
    Includes interest at 8.0%, which was the rate in effect at December 11, 2007
under the Companys Revolving Credit Agreement and 14.5% (17.5% from October 1, 2007 through March
31, 2008) which was the rate of the $7.0 million senior subordinated note issued May 5, 2006. INFLATION
  RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
 Accounting for Uncertainty in Income
Taxes Accounting for Income Taxes
 Accounting Changes and Error Corrections
 Fair Value Measurements
 Establishing the Fair Value Option for
Financial Assets and Liabilities
 25




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##### 



How
Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the
Income Statement (That Is Gross Versus Net Presentation)
 CRITICAL ACCOUNTING POLICIES AND ESTIMATES
      26




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SAFE HARBOR STATEMENT UNDER THE PRIVATE  SECURITIES LITIGATION REFORM ACT OF 1995
  27




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##### 



Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
   28




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##### 



Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
  Item 9A. CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures.
  Internal Controls.
 29




---



##### 



Item 9B. OTHER INFORMATION
   Items 10, 11, 12, 13 and 14. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS; CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE AND PRINCIPAL ACCOUNTING FEES AND SERVICES
   Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 (a)
    
    The following documents are filed as part of this report:
 (1)
    
    The following financial statements are included in the Annual
Report on Form 10-K on the pages indicated.
 
    
    Report of Independent Registered Public Accounting Firm
    
    Consolidated Balance Sheets as of October 28, 2007
and October 29, 2006
  
    
    Consolidated Statements of Operations
    
    Consolidated Statements of Stockholders Equity
    
    Consolidated Statements of Cash Flow
    
    Notes to Consolidated Financial Statements
 (2)
    
    No financial statement schedules are required to be filed
because the conditions requiring their filing do not exist or because the
information is given in the consolidated financial statements or notes thereto.(a)(3) and (b): The
exhibits listed in the accompanying index to exhibits on pages 32
through 34 are filed as part of this report.
 30




---



##### 



SIGNATURES
  Dated:  January 25, 2008
    Max & Ermas Restaurants, Inc.By:
    /s/ Robert A. LindemanRobert A. LindemanPresident and Chief Executive Officer
(Principal Executive Officer) th
 Signature
    
    
    
    Title/s/ Todd B. Barnum

Todd B. Barnum
    
    
    
    Chairman of the Board/s/ Robert A. Lindeman

Robert A. Lindeman
    
    
    
    President & Chief Executive Officer (Principal
Executive Officer)/s/ William C. Niegsch, Jr.

William C. Niegsch, Jr.
    
    
    
    Executive Vice President, Chief Financial
Officer, Treasurer, Secretary and
Director (Principal Financial and
Accounting Officer)*/s/ Jay B. Barney

Jay B. Barney
    
    
    
    Director*/s/ Mark F. Emerson

Mark F. Emerson
    
    
    
    Director*/s/ Michael G. Giulioli

Michael G. Giulioli
    
    
    
    Director*/s/ Curtis A. Loveland

Curtis A. Loveland
    
    
    
    Director*/s/ Donal H. Malenick

Donal H. Malenick
    
    
    
    Director*/s/ William C. Niegsch, Jr.

William C. Niegsch, Jr.
 Attorney-in-Fact
 31




---



##### 



Index to Exhibits
 ExhibitNo.
    
    Description
    
    Page No.3(a)
    
    Restated Certificate of Incorporation, as amended
April 4, 1985.
    
    Reference is made
to Exhibit 4(c) of
Report on Form 10-Q
filed June 26,
1985.3(b)
    
    Certificate of Amendment of Certificate of
Incorporation, dated September 22, 1986.
    
    Reference is made
to Exhibit 3(c) of
Report on Form 10-K
filed January 23,
1987.3(c)
    
    Certificate of Amendment of Certificate of
Incorporation, dated May 30, 1990.
    
    Reference is made
to Exhibit 3(d) of
Report on form 10-K
filed January 25,
1991.3(d)
    
    Amended and Restates By-Laws, adopted March 16, 2007.
    
    Reference is made
to Exhibit 3 of
Report on Form 8-K
filed March 21,
2007.4(a)
    
    Form of Common Stock Certificate.
    
    Reference is made
to Exhibit 4(a) of
Registration
Statement on Form
S-1 (Registration
No. 2-85585).4(b)
    
    Articles FOURTH, SEVENTH, EIGHTH, NINTH, TENTH and
ELEVENTH of the Companys Restated Certificate of
Incorporation and amendments thereto and Articles
II, IV, VI, and VII of the Companys Amended and
Restated By-Laws.
    
    Reference is made
to Exhibits 3(a),
3(b), 3(c), and
3(d) of this Report
on Form 10-K.10(a)
    
    Max & Ermas Ltd. Agreement of Limited Partnership,
dated May 17, 1972.
    
    Reference is made
to Exhibit 10(b) of
Registration
Statement on Form
S-1 (Registration
No. 2-85585).10(b)
    
    First Amendment to Agreement of Limited Partnership
of Max & Ermas Ltd., dated September 9, 1974.
    
    Reference is made
to Exhibit 10(b) of
Registration
Statement on Form
S-1 (Registration
No. 2-85585).10(c)*
    
    1992 Stock Option Plan.
    
    Reference is made
to Exhibit 10(q) of
Report on Form 10-K
filed January 25,
1993.10(d)*
    
    1996 Stock Option Plan.
    
    Reference is made
to Exhibit 10(p) of
Report on Form 10-K
filed January 1996.10(e)*
    
    2002 Stock Option Plan.
    
    Reference is made
to Exhibit 4(a) of
Form S-8 filed June
28, 2002.10(f)*
    
    2007 Stock Incentive Plan.
    
    Reference is made
to Exhibit 4(a) of
Form S-8 filed
April 16, 2007.10(g)*
    
    Form of [Incentive/Non-Statutory] Stock Option
Agreement under the 2007 Stock Incentive Plan.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 10-Q
filed June 20,
2007.10(h)*
    
    Form of Indemnification Agreement between Max &
Ermas Restaurants, Inc. and each of its directors.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed June 16,
2006.
 32




---



##### 



ExhibitNo.
    
    Description
    
    Page No.10(i)*
    
    Description of the Material Terms of Max & Ermas
Restaurants, Inc.s Fiscal 2007 Executive
Compensation Program.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed October 23,
2006.10(j)*
    
    Description of the Material Terms and Conditions of
Max & Ermas Restaurants, Inc.s Fiscal 2008
Executive Compensation Bonus Program.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed November 9,
2007.10(k)*
    
    Description of the Base Salaries of the Executive
Officers of Max & Ermas Restaurants, Inc.
    
    Reference is made
to Exhibit 10.2 of
Report on Form 8-K
filed November 9,
2007.10(l)
    
    Sixth Amended and Restated Revolving Credit
Agreement, dated May 4, 2006, between Max & Ermas
Restaurants, Inc. and National City Bank.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed May 9, 2006.10(m)
    
    First Amendment to Sixth Amended and Restated
Revolving Credit Agreement, dated December 14, 2006,
between Max & Ermas Restaurants, Inc. and National
City Bank.10(n)
    
    Letter Agreement, dated September 4, 2007, between
Max & Ermas Restaurants, Inc. and National City
Bank.10(o)
    
    Note Purchase Agreement, dated May 5, 2006, between
Max & Ermas Restaurants, Inc. and the purchasers
listed on Schedule A attached thereto.
    
    Reference is made
to Exhibit 10.2 of
Report on Form 8-K
filed May 9, 2006.10(p)
    
    First Amendment to Note Purchase Agreement, dated
October 26, 2007, between Max & Ermas Restaurants,
Inc. and the Purchasers.
    
    Reference is made
to Exhibit 10.2 of
Report on Form 8-K
filed November 1,
2007.10(q)
    
    Forbearance Agreement, dated October 26, 2007,
between Max & Ermas Restaurants, Inc. and National
City Bank, individually and as agent.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed November 1,
2007.10(r)
    
    Convertible Promissory Note, dated October 29, 2007,
executed by Max & Ermas Restaurants, Inc. in favor
of Donal H. Malenick.
    
    Reference is made
to Exhibit 10.3 of
Report on Form 8-K
filed November 2,
2007.10(s)*
    
    Employment Agreement, dated September 10, 2007,
between Max & Ermas Restaurants, Inc. and Michael
A. Nahkunst.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed September 10,
2007.10(t)*
    
    Retirement Agreement, dated September 19, 2007,
between Max & Ermas Restaurants, Inc. and Todd B.
Barnum.
    
    Reference is made
to Exhibit 10.1 of
Report on Form 8-K
filed September 25,
2007.10(u)*
    
    Employment Agreement, dated September 19, 2007,
between Max & Ermas Restaurants, Inc. and Robert A.
Lindeman.
    
    Reference is made
to Exhibit 10.2 of
Report on Form 8-K
filed September 25,
2007.10(v)*
    
    Employment Agreement, dated September 19, 2007,
between Max & Ermas Restaurants, Inc. and William
C. Niegsch, Jr.
    
    Reference is made
to Exhibit 10.3 of
Report on Form 8-K
filed September 25,
2007.10(w)*
    
    Schedule of Max & Ermas Restaurants, Inc.s
Director Fees, effective commencing with fiscal
2007.
    
    Reference is made
to Exhibit 10.2 of
Report on Form 8-K
filed October 23,
2006.
 33




---



##### 



ExhibitNo.
    
    Description
    
    Page No.23**
    
    Consent of Deloitte & Touche LLP.24**
    
    Power of Attorney.31.1**
    
    Rule 13a-14(a) Certification of Chief Executive Officer.31.2**
    
    Rule 13a-14(a) Certification of Chief Financial Officer.32.1***
    
    Section 1350 Certification of Chief Executive Officer.32.2***
    
    Section 1350 Certification of Chief Financial Officer.
 
 *
    
    Management contract or compensatory plan or arrangement required to be filed as an exhibit to
this Report on Form 10-K pursuant to Item 15(a)(3) of the Report on Form 10-K.**
    
    Filed with this Annual Report on Form 10-K.***
    
    Furnished with this Annual Report on Form 10-K. 34




---



##### 



Index to Consolidated Financial Statements
 Description
    
    Page No. Report of Independent Registered Public Accounting Firm
    
    F-1 Consolidated Balance Sheets as of October 28, 2007 and
October 29, 2006
    
    F-2  F-3For the years ended October 28, 2007, October 29, 2006 and October 30, 2005: Consolidated Statements of Operations
    
    F-4 Consolidated Statements of Stockholders Equity
    
    F-5 Consolidated Statements of Cash Flow
    
    F-6 Notes to Consolidated Financial Statements
    
    F-7  F-22
  35




---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
    
 F-1




---



##### 



MAX & ERMAS RESTAURANTS, INC.
 
 CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 28, 2007 AND OCTOBER 29, 2006
 October 28,
    
    
    October 29,2007
    
    
    2006ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    2,465,852
    
    
    $
    2,491,877Receivables:Landlord receivables and other
    
    
    2,242,821
    
    
    
    1,748,635Franchise
    
    
    434,320
    
    
    
    305,301Total receivables
    
    
    2,677,141
    
    
    
    2,053,936Inventories
    
    
    1,320,669
    
    
    
    1,260,537Supplies
    
    
    504,155
    
    
    
    515,456Prepaid expenses
    
    
    645,272
    
    
    
    526,546Deferred income taxes
    
    
    950,000
    
    
    
    725,000Total current assets
    
    
    8,563,089
    
    
    
    7,573,352PROPERTY, PLANT, AND EQUIPMENT  At cost:Land and buildings
    
    
    37,062,513
    
    
    
    33,558,261Leasehold improvements
    
    
    32,598,491
    
    
    
    30,714,247Equipment and fixtures
    
    
    41,192,846
    
    
    
    39,432,387Construction in process
    
    
    2,135,258Total property, plant, and equipment
    
    
    112,989,108
    
    
    
    103,704,895Less accumulated depreciation and amortization
    
    
    57,971,840
    
    
    
    52,896,054Property, plant, and equipment  net
    
    
    55,017,268
    
    
    
    50,808,841OTHER ASSETS:Goodwill
    
    
    51,980
    
    
    
    51,980Deferred costs (less accumulated amortization of
2007  $958,717 and 2006  $453,240)
    
    
    516,495
    
    
    
    1,065,647Deferred income taxes
    
    
    11,958,000
    
    
    
    10,677,000Liquor licenses and other (less accumulated amortization of
2007  $167,429 and 2006  $167,429)
    
    
    2,453,457
    
    
    
    2,177,845Total other assets
    
    
    14,979,932
    
    
    
    13,972,472TOTAL
    
    $
    78,560,289
    
    
    $
    72,354,665(Continued)
 F-2




---



##### 



MAX & ERMAS RESTAURANTS, INC.
 CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 28, 2007 AND OCTOBER 29, 2006
 October 28,
    
    
    October 29,2007
    
    
    2006LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Current maturities of long-term obligations
    
    $
    2,914,530
    
    
    $
    2,729,989Accounts payable
    
    
    6,629,523
    
    
    
    4,245,631Construction payables
    
    
    2,650,901
    
    
    
    584,046Accrued liabilities:Payroll and related taxes
    
    
    2,966,378
    
    
    
    2,770,583Taxes  other than income taxes
    
    
    1,888,610
    
    
    
    1,718,683Interest
    
    
    612,781
    
    
    
    657,715Gift cards
    
    
    2,584,490
    
    
    
    1,903,767Utilities
    
    
    888,228
    
    
    
    846,111Other
    
    
    573,926
    
    
    
    799,256Total accrued liabilities
    
    
    9,514,413
    
    
    
    8,696,115Total current liabilities
    
    
    21,709,367
    
    
    
    16,255,781LONG-TERM OBLIGATIONS  Less current maturities
    
    
    47,164,076
    
    
    
    43,065,227COMMITMENTS AND CONTINGENCIES (Note 1)STOCKHOLDERS EQUITY:Preferred stock  $0.10 par value  authorized, 500,000
shares; none outstandingCommon stock  $0.10 par value  authorized, 2007 and
2006  5,000,000 shares; issued and outstanding: 2007
 2,554,474 and 2006  2,551,974 shares
    
    
    255,446
    
    
    
    255,196Additional paid-in capital
    
    
    1,165,389
    
    
    
    982,697Retained earnings
    
    
    8,266,011
    
    
    
    11,795,764Total stockholders equity
    
    
    9,686,846
    
    
    
    13,033,657TOTAL
    
    $
    78,560,289
    
    
    $
    72,354,665See notes to consolidated financial statements.
    
    
    
    
    
    (Concluded)
 F-3




---



##### 



MAX & ERMAS RESTAURANTS, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 
 FOR THE YEARS ENDED OCTOBER 28, 2007, OCTOBER 29, 2006, AND OCTOBER 30, 2005
 October 28,
    
    
    October 29,
    
    
    October 30,2007
    
    
    2006
    
    
    2005(52 weeks)
    
    
    (52 weeks)
    
    
    (52 weeks)REVENUES
    
    $
    174,854,432
    
    
    $
    180,289,781
    
    
    $
    183,705,077OPERATING EXPENSES:Cost of goods sold
    
    
    43,912,169
    
    
    
    45,802,663
    
    
    
    46,868,766Payroll and benefits
    
    
    56,858,690
    
    
    
    57,969,321
    
    
    
    59,315,489Other operating expenses
    
    
    58,647,405
    
    
    
    59,922,708
    
    
    
    61,074,546Administrative expenses
    
    
    15,201,049
    
    
    
    14,490,692
    
    
    
    14,744,764Preopening costs
    
    
    653,455
    
    
    
    190,460
    
    
    
    391,789Impairment of assets
    
    
    715,064
    
    
    
    845,433
    
    
    
    1,450,000Total operating expenses
    
    
    175,987,832
    
    
    
    179,221,277
    
    
    
    183,845,354OPERATING (LOSS) INCOME
    
    
    (1,133,400
    )
    
    
    1,068,504
    
    
    
    (140,277
    )INTEREST EXPENSE
    
    
    3,677,599
    
    
    
    3,079,391
    
    
    
    2,431,305OTHER NONOPERATING EXPENSES
    
    
    57,754
    
    
    
    57,754
    
    
    
    38,503LOSS BEFORE INCOME TAXES
    
    
    (4,868,753
    )
    
    
    (2,068,641
    )
    
    
    (2,610,085
    )INCOME TAXES (BENEFIT)
    
    
    (1,339,000
    )
    
    
    (1,605,000
    )
    
    
    (1,295,000
    )LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
    
    
    (3,529,753
    )
    
    
    (463,641
    )
    
    
    (1,315,085
    )CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE  Net of
$60,000 deferred income tax benefit
    
    
    
    
    
    
    (115,000
    )NET LOSS
    
    $
    (3,529,753
    )
    
    $
    (578,641
    )
    
    $
    (1,315,085
    )NET LOSS PER SHARE:Basic and diluted loss per share before cumulative effect of change in
accounting principle
    
    $
    (1.38
    )
    
    $
    (0.18
    )
    
    $
    (0.52
    )Cumulative effect of change inaccounting principle
    
    
    
    
    
    
    (0.05
    )BASIC AND DILUTED LOSS PER SHARE
    
    $
    (1.38
    )
    
    $
    (0.23
    )
    
    $
    (0.52
    )WEIGHTED-AVERAGE SHARES OUTSTANDING  BASIC AND DILUTED
    
    
    2,554,804
    
    
    
    2,551,018
    
    
    
    2,537,277
  F-4




---



##### 



MAX & ERMAS RESTAURANTS, INC.
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
FOR THE YEARS ENDED OCTOBER 28, 2007, OCTOBER 29, 2006, AND OCTOBER 30, 2005
 AccumulatedAdditional
    
    
    OtherCommon Stock
    
    
    Paid-In
    
    
    Comprehensive
    
    
    RetainedShares
    
    
    Amount
    
    
    Capital
    
    
    (Loss) Income
    
    
    Earnings
    
    
    TotalBALANCE  October 31, 2004
    
    
    2,507,328
    
    
    $
    250,732
    
    
    $
    319,404
    
    
    $
    (203,406
    )
    
    $
    13,689,490
    
    
    $
    14,056,220Issuance of stock through option plans 
including $110,611 related tax benefit
    
    
    39,450
    
    
    
    3,945
    
    
    
    358,821
    
    
    
    
    
    
    
    
    
    
    
    362,766Comprehensive loss:Change in fair value of interest rate
protection agreement  net of income
tax ($109,526)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    203,406
    
    
    
    
    
    
    
    203,406Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,315,085
    )
    
    
    (1,315,085
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,111,679
    )BALANCE  October 30, 2005
    
    
    2,546,778
    
    
    
    254,677
    
    
    
    678,225
    
    
    
    
    
    
    
    12,374,405
    
    
    
    13,307,307Issuance of stock through option plans 
including $14,568 related tax benefit
    
    
    5,196
    
    
    
    519
    
    
    
    78,220
    
    
    
    
    
    
    
    
    
    
    
    78,739Stock compensation
    
    
    
    
    
    
    
    
    
    
    226,252
    
    
    
    
    
    
    
    
    
    
    
    226,252Net loss and comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (578,641
    )
    
    
    (578,641
    )BALANCE  October 29, 2006
    
    
    2,551,974
    
    
    
    255,196
    
    
    
    982,697
    
    
    
    
    
    
    
    11,795,764
    
    
    
    13,033,657Issuance of stock through option plans
    
    
    2,500
    
    
    
    250
    
    
    
    20,125
    
    
    
    
    
    
    
    
    
    
    
    20,375Stock compensation
    
    
    
    
    
    
    
    
    
    
    162,567
    
    
    
    
    
    
    
    
    
    
    
    162,567Net loss and comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,529,753
    )
    
    
    (3,529,753
    )BALANCE  October 28, 2007
    
    
    2,554,474
    
    
    $
    255,446
    
    
    $
    1,165,389
    
    
    $
    
    
    
    $
    8,266,011
    
    
    $
    9,686,846
  F-5




---



##### 



MAX & ERMAS RESTAURANTS, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 28, 2007, OCTOBER 29, 2006, AND OCTOBER 30, 2005
 October 28,
    
    
    October 29,
    
    
    October 30,2007
    
    
    2006
    
    
    2005(52 weeks)
    
    
    (52 weeks)
    
    
    (52 weeks)CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (3,529,753
    )
    
    $
    (578,641
    )
    
    $
    (1,315,085
    )Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization
    
    
    8,220,939
    
    
    
    8,024,286
    
    
    
    8,443,967Deferred income tax benefit
    
    
    (1,506,000
    )
    
    
    (1,968,000
    )
    
    
    (1,994,000
    )Stock compensation expense
    
    
    162,567
    
    
    
    226,252Cumulative effect of change in accounting principle
    
    
    
    
    
    
    175,000Accretion of deferred sale  leaseback gain
    
    
    (126,267
    )
    
    
    (126,267
    )
    
    
    (126,267
    )Other nonoperating expenses
    
    
    57,754
    
    
    
    57,754
    
    
    
    38,503Impairment of fixed assets
    
    
    715,064
    
    
    
    384,265
    
    
    
    1,011,000Loss on disposition of assets
    
    
    294,991
    
    
    
    243,416
    
    
    
    206,237Proceeds from lease incentives
    
    
    1,990,887
    
    
    
    
    
    
    
    1,000,000Changes in assets and liabilities:Receivables
    
    
    1,267,420
    
    
    
    113,573
    
    
    
    299,907Inventories
    
    
    (60,132
    )
    
    
    140,831
    
    
    
    (24,002
    )Supplies
    
    
    11,301
    
    
    
    64,710
    
    
    
    85,923Prepaid expenses
    
    
    (118,726
    )
    
    
    (55,076
    )
    
    
    41,380Other assets
    
    
    205,826
    
    
    
    (90,068
    )
    
    
    (387,936
    )Accounts payable
    
    
    2,383,892
    
    
    
    (480,292
    )
    
    
    381,170Accrued liabilities
    
    
    818,298
    
    
    
    (220,041
    )
    
    
    2,412,854Other liabilities
    
    
    112,397
    
    
    
    (121,697
    )
    
    
    401,170Net cash provided by operating activities
    
    
    10,900,458
    
    
    
    5,790,005
    
    
    
    10,474,821CASH FLOWS FROM INVESTING ACTIVITIES:Property additions
    
    
    (9,408,609
    )
    
    
    (5,524,182
    )
    
    
    (9,966,903
    )Changes in other assets
    
    
    (109,338
    )
    
    
    34,473
    
    
    
    77,731Proceeds from the sale of property
    
    
    47,016
    
    
    
    
    
    
    
    31,333Net cash used in investing activities
    
    
    (9,470,931
    )
    
    
    (5,489,709
    )
    
    
    (9,857,839
    )CASH FLOWS FROM FINANCING ACTIVITIES:Principal payments under long-term obligations
    
    
    (70,298,386
    )
    
    
    (54,881,248
    )
    
    
    (52,820,697
    )Proceeds from long-term obligations
    
    
    69,142,000
    
    
    
    54,729,000
    
    
    
    52,793,019Debt issuance costs
    
    
    (261,787
    )
    
    
    (588,045
    )
    
    
    (79,596
    )Proceeds from exercise of stock options
    
    
    20,375
    
    
    
    78,739
    
    
    
    252,155Excess distributions to minority interests in Affiliated Partnership
    
    
    (57,754
    )
    
    
    (57,754
    )
    
    
    (38,503
    )Net cash (used in) provided by financing activities
    
    
    (1,455,552
    )
    
    
    (719,308
    )
    
    
    106,378NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS
    
    
    (26,025
    )
    
    
    (419,012
    )
    
    
    723,360CASH AND CASH EQUIVALENTS  Beginning of year
    
    
    2,491,877
    
    
    
    2,910,889
    
    
    
    2,187,529CASH AND CASH EQUIVALENTS  End of year
    
    $
    2,465,852
    
    
    $
    2,491,877
    
    
    $
    2,910,889SUPPLEMENTAL DISCLOSURES:Cash paid for:Interest    net of $107,932, $44,440, and $93,958 capitalized in 2007, 2006, and
2005, respectively
    
    $
    3,181,070
    
    
    $
    2,924,379
    
    
    $
    2,103,280Income taxes
    
    $
    185,663
    
    
    $
    274,088
    
    
    $
    299,245Noncash activities:Property additions financed by construction payables
    
    $
    2,650,901
    
    
    $
    584,046
    
    
    $
    863,135Property additions financed by long-term financing obligation
    
    $
    1,537,500
    
    
    $
    
    
    
    $
    Deferred lease incentives included in accounts receivable
    
    $
    1,890,625
    
    
    $
    1,537,500
    
    
    $
    
  F-6




---



##### 



MAX & ERMAS RESTAURANTS, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF OCTOBER 28, 2007 AND OCTOBER 29, 2006, AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED OCTOBER 28, 2007
 
 1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESDescription of Business Max & Ermas Restaurants, Inc. and subsidiary (the Company) owns
and operates restaurants under the trade name Max & Ermas  Neighborhood Gathering Place.
At October 28, 2007, there are 103 Max & Ermas restaurants in operation (99 at October 29,
2006) (principally located in the midwestern United States). The Company owns all of the
restaurants, except for one that is owned by a separate limited partnership (Affiliated
Partnership) in which the Company is the controlling general partner, and 24 which are
franchised to unrelated parties (21 at October 29, 2006).Consolidation The consolidated financial statements include the accounts of the Company and
the Affiliated Partnership. All intercompany transactions and balances have been eliminated.Fiscal Year-End The Company and its Affiliated Partnership each have a 5253 week
accounting period, which ends on the last Sunday in October. Fiscal years 2007, 2006, and 2005
each contained 52 weeks.Cash and Cash Equivalents The Company considers all checking accounts, cash funds, and
highly liquid debt instruments with a maturity of less than three months at the date of
purchase to be cash equivalents. All cash is principally on deposit with four banks.Inventories Inventories are valued at the lower of cost, using the first-in, first-out
method, or market and consist of food and beverages.Preopening Costs The Company expenses such costs as they are incurred in accordance with
Statement of Position No. 98-5, Reporting on the Costs of Start-Up Activities.Depreciation and Amortization of Property Depreciation and amortization of property are
computed generally using the straight-line method based on the estimated useful lives of the
assets or the terms of the leases as follows:
 YearsBuildings
    
    
    1530Leasehold improvements
    
    
    1015Equipment and fixtures
    
    
    315
 Leasehold Improvements
 F-7




---



##### 



Other Assets Goodwill and Other Intangible Assets,
 Asset Impairments
  Asset Retirement Obligations Accounting for Conditional Asset Retirement Obligations  An Interpretation of FASB Statement
No. 143
  Revenue Recognition
 F-8




---



##### 



Self-Insurance
 Advertising
 Contingent Rent
 Income Taxes Accounting for Income Taxes.
 Net Loss Per Share
 Stock-Based Employee Compensation Plans Share-Based Payment
  F-9




---



##### 



Net loss:As reported
    
    $
    (1,315,085
    )Pro forma
    
    $
    (1,468,036
    )Basic and diluted loss per share:As reported
    
    $
    (0.52
    )Pro forma
    
    $
    (0.58
    )
 Segment Disclosures About Segments of an Enterprise and Related Information.
 Estimates
 Commitments and Contingencies
 Recently Issued Financial Accounting Standards Accounting for Uncertainty in Income Taxes Accounting for Income Taxes
 Accounting Changes and Error Corrections
 Fair Value Measurements
 F-10




---



##### 



Establishing the Fair Value Option
for Financial Assets and Liabilities
 How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be
Presented in the Income Statement (That Is Gross Versus Net Presentation)
 2.
    
    OWNERSHIP OF RESTAURANT BY AFFILIATED PARTNERSHIPOne restaurant is owned by an Affiliated Partnership in which the Company is the general
partner. As a general partner, the Company is liable for all of the debts and liabilities of
the Affiliated Partnership. Because of depreciation, past partnership distributions at times
have cumulatively exceeded the limited partners capital accounts and the Company has absorbed
the limited partners capital account deficits. When this situation later reverses, the Company
appropriately recovers such deficits. This can create some variations in the annual allocation
of profits and losses of the partnership. During fiscal 2007, 2006, and 2005, the Companys
share of the remaining partnerships profits and losses was approximately 70%, 90%, and 70%,
respectively. In 2007, 2006, and 2005, the Company expensed $57,754, $57,754, and $38,503,
respectively, related to excess distributions to the minority
interest, which is included as other nonoperating
expenses. At October 28, 2007 and October 29, 2006, no amounts were due to Affiliated Partners.
 F-11




---



##### 



3.
    
    LONG-TERM OBLIGATIONSLong-term obligations as of October 28, 2007 and October 29, 2006, consist of the following:
 October 28,
    
    
    October 29,2007
    
    
    2006Debt:Revolving credit agreement
    
    $
    12,933,000
    
    
    $
    11,870,000Amended term loan
    
    
    9,800,000
    
    
    
    12,200,000Senior subordinated note
    
    
    7,114,188
    
    
    
    7,000,000Total debt
    
    
    29,847,188
    
    
    
    31,070,000Deferred gain on sale/leaseback (Note 4)
    
    
    1,261,318
    
    
    
    1,387,585Deferred lease incentives (Note 1)
    
    
    8,404,989
    
    
    
    5,099,147Accrued rent (Note 4)
    
    
    6,858,573
    
    
    
    6,482,252Deferred compensation plan
    
    
    1,054,170
    
    
    
    951,898Capital leases (Note 4)
    
    
    600,618
    
    
    
    629,334Long-term financing obligation (Note 4)
    
    
    1,506,353Asset retirement obligations
    
    
    177,636
    
    
    
    175,000Other obligations
    
    
    367,761Total long-term obligations
    
    
    50,078,606
    
    
    
    45,795,216Less current maturities of long-term obligations
    
    
    (2,914,530
    )
    
    
    (2,729,989
    )Total long-term obligations  less current maturities
    
    $
    47,164,076
    
    
    $
    43,065,227
   F-12




---



##### 



F-13




---



##### 



Years Endingin October2008
    
    $
    2,400,0002009
    
    
    2,400,0002010
    
    
    2,400,0002011
    
    
    15,533,0002012
    
    
    7,114,188Total
    
    $
    29,847,188
 4.
    
    LEASESThe Company leases certain land and buildings used in the restaurant operations under various
long-term capital and operating lease agreements. The initial lease terms range from 5 to 30
years and expire between 2008 and 2027. The leases include renewal options for 5 to 20
additional years. Several leases require, in addition to the base rent, additional rent based
on percentages of the restaurants annual gross revenue, as defined. The Company is also
obligated to pay certain real estate taxes, insurance, common area charges, and various other
expenses related to the properties. The leases are collateralized by subordinated liens on the
leasehold improvements, equipment, and fixtures.The Company leases vehicles and equipment used in the restaurant operations under both capital
and operating lease agreements. Lease terms range from two to six years and expire through
2009. The Company is required to pay certain taxes, insurance, and other expenses related to
the leased property. The Company also leases other equipment for periods of one year or less.A summary of property under capital leases at October 28, 2007 and October 29, 2006, included
in the accompanying consolidated balance sheets, is as follows:
 October 28,
    
    
    October 29,Asset Description
    
    2007
    
    
    2006Buildings
    
    $
    750,000
    
    
    $
    750,000Equipment and fixtures
    
    
    494,774
    
    
    
    496,207Total
    
    
    1,244,774
    
    
    
    1,246,207Less accumulated amortization
    
    
    (1,196,696
    )
    
    
    (1,148,130
    )Net
    
    $
    48,078
    
    
    $
    98,077
  F-14




---



##### 



Accounting for Leases, The Effect of Lessee Involvement in Asset Construction,
  Financing
    
    
    CapitalObligation
    
    
    Lease
    
    
    Total2008
    
    $
    158,406
    
    
    $
    90,000
    
    
    $
    248,4062009
    
    
    158,406
    
    
    
    90,000
    
    
    
    248,4062010
    
    
    158,406
    
    
    
    90,000
    
    
    
    248,4062011
    
    
    158,406
    
    
    
    90,000
    
    
    
    248,4062012
    
    
    158,406
    
    
    
    90,000
    
    
    
    248,406Thereafter
    
    
    2,141,307
    
    
    
    540,000
    
    
    
    2,681,307Total minimum lease payments
    
    
    2,933,337
    
    
    
    990,000
    
    
    
    3,923,337Less amount representing interest
    
    
    (1,426,984
    )
    
    
    (389,382
    )
    
    
    (1,816,366
    )Present value of minimum lease payments
    
    
    1,506,353
    
    
    
    600,618
    
    
    
    2,106,971Less current maturities
    
    
    (33,850
    )
    
    
    (31,705
    )
    
    
    (65,555
    )Total obligations under leases  less current
maturity
    
    $
    1,472,503
    
    
    $
    568,913
    
    
    $
    2,041,416
  Years Endingin October2008
    
    $
    15,097,1422009
    
    
    14,604,3722010
    
    
    14,077,8672011
    
    
    13,854,3602012
    
    
    13,704,804Thereafter
    
    
    120,722,524Total
    
    $
    192,061,069
 F-15




---



##### 



2007
    
    
    2006
    
    
    2005Minimum rent
    
    $
    15,639,799
    
    
    $
    15,545,618
    
    
    $
    15,709,259Contingent rent based on a percentage of
gross revenue
    
    
    102,266
    
    
    
    136,868
    
    
    
    139,471Total
    
    $
    15,742,065
    
    
    $
    15,682,486
    
    
    $
    15,848,730
  F-16




---



##### 



5.
    
    INCOME TAXESThe benefit for income taxes for the years ended October 28, 2007, October 29, 2006, and
October 30, 2005 consists of the following:
 2007
    
    
    2006
    
    
    2005Federal:Current
    
    $
    (77,000
    )
    
    $
    245,000
    
    
    $
    604,000Deferred
    
    
    (1,268,000
    )
    
    
    (1,830,000
    )
    
    
    (2,459,000
    )State and local:Current
    
    
    22,000
    
    
    
    58,000
    
    
    
    95,000Deferred
    
    
    (16,000
    )
    
    
    (78,000
    )
    
    
    465,000Total income taxes (benefit)
    
    $
    (1,339,000
    )
    
    $
    (1,605,000
    )
    
    $
    (1,295,000
    )
 The Companys effective tax benefit rate varies from the statutory federal income tax rate for
the years ended October 28, 2007, October 29, 2006, and October 30, 2005, as a result of the
following factors:
 2007
    
    
    2006
    
    
    2005Benefit at statutory rate
    
    $
    (1,655,000
    )
    
    $
    (703,000
    )
    
    $
    (887,000
    )State income taxes  net of federal benefit
    
    
    4,000
    
    
    
    (13,000
    )
    
    
    7,000Jobs-related tax credit
    
    
    (104,000
    )
    
    
    (13,000
    )
    
    
    (90,000
    )FICA tax tips credit
    
    
    (957,000
    )
    
    
    (913,000
    )
    
    
    (881,000
    )Nondeductible stock compensation
    
    
    57,000
    
    
    
    51,000State of Ohio adjustment
    
    
    
    
    
    
    
    
    
    
    550,000Valuation allowance for FICA tax tips credit
    
    
    1,317,000Other  net
    
    
    (1,000
    )
    
    
    (14,000
    )
    
    
    6,000Total benefit
    
    $
    (1,339,000
    )
    
    $
    (1,605,000
    )
    
    $
    (1,295,000
    )
 During fiscal 2007, the Company recorded a valuation allowance of $1,317,000 against the
deferred tax asset related to the FICA tax tips credit. The Company believes that it is more
likely than not it may not fully utilize the tips credit before they expire. The Company has
considered all available evidence, including expected future taxable income and ongoing prudent
and feasible tax planning strategies, in assessing the need for a valuation allowance. Due to
changes in facts and circumstances and the significant management judgments and estimates
involved in determining the proper valuation allowance, differences between actual future
events and prior judgments and estimates could result in adjustments. Decreases in the expected
future taxable income of the Company may trigger adjustments in future periods. In the event
the Company were to determine it is more likely than not that it will not fully recognize
deferred tax assets, an adjustment to the deferred tax assets would be charged to income in the
period such determination was made. The FICA tax tips credit, net of valuation allowance,
expire $591,000 in 2024, $1,155,000 in 2025, $1,148,000 in 2026, and $1,608,000 in 2027.During fiscal 2005, the Company expensed $550,000 of previously recorded state of Ohio deferred
tax assets because the state of Ohio eliminated its corporate franchise tax and replaced it
with a commercial activity tax included in administrative expenses.
 F-17




---



##### 



The tax effects of significant items comprising the Companys net deferred tax asset at October
28, 2007 and October 29, 2006, are as follows:
 2007
    
    
    2006Deferred tax assets (liabilities):Accrued rent
    
    $
    2,495,000
    
    
    $
    2,383,000Depreciation
    
    
    3,557,000
    
    
    
    2,994,000Deferred gain
    
    
    523,000
    
    
    
    579,000Officers benefits
    
    
    601,000
    
    
    
    570,000Gift cards
    
    
    946,000
    
    
    
    704,000FICA tax credit
    
    
    5,782,000
    
    
    
    4,170,000Partnership
    
    
    79,000
    
    
    
    162,000UNICAP and other
    
    
    208,000Net operating loss
    
    
    222,000Total deferred tax assets
    
    
    14,413,000
    
    
    
    11,562,000Prepaid insurance and other
    
    
    (188,000
    )
    
    
    (160,000
    )Total deferred tax liabilities
    
    
    (188,000
    )
    
    
    (160,000
    )Net deferred tax asset before valuation allowance
    
    
    14,225,000
    
    
    
    11,402,000Valuation allowance
    
    
    (1,317,000
    )Net deferred tax asset
    
    $
    12,908,000
    
    
    $
    11,402,000
 6.
    
    STOCK OPTION AND BONUS PLANSThe Companys fiscal 1996, 2002 and 2007 stock option plans (collectively, the Plans) provide
that the Company may grant options to certain key employees of the Company and its affiliates,
consultants, and advisers who render services to the Company and its affiliates and directors
of the Company who are employees of neither the Company nor any affiliate. The terms of the
Plans are at the sole discretion of a committee of three nonemployee and members of the
Companys board of directors (the Committee). Under the fiscal 1996, 2002, and 2007 Plans,
the Company may grant 400,000, 250,000, and 250,000 shares, respectively. The Committee will
determine the option price per share of each incentive stock option granted under the Plans.
The option price may not be less than the fair market value of a share on the date of grant of
such option. If the grantee owns more than 10% of the total combined voting stock of the
Company, the exercise price of the option must be at least 110% of the fair market value.
Options granted under the Plans are generally first exercisable three years after the date of
grant and expire 10 years after the date of grant. At October 28, 2007, 301,150 shares under
option were outstanding under the Plans. The reserve for future shares for the 2007 and 2002
plans are 147,500 and 71,654 shares, respectively.Under FASB Statement No. 123R, the Company calculates the fair value of option grants using the
Black-Scholes option-pricing model. Total compensation cost related to share-based payment
arrangements for the years ended October 28, 2007 and October 29, 2006, was $162,567 and
$258,337, respectively. This amount was reflected in administrative expenses. The tax benefit
recorded for this compensation cost on nonstatutory stock options was $27,000 and $14,568,
respectively.
 F-18




---



##### 



During fiscal 2007, the Company received $20,375 from the exercise of stock options (no
aggregate intrinsic value). During fiscal 2006, the Company received $64,171 from the exercise
of stock options. The aggregate intrinsic value of these options was $21,434.The following summarizes the stock option transactions:
 WeightedWeighted
    
    
    Average
    
    
    AggregateNumber of
    
    
    Average
    
    
    Remaining
    
    
    IntrinsicOptions
    
    
    Exercise Price
    
    
    Contractual Term
    
    
    ValueBalance  October 31, 2004
    
    
    313,651
    
    
    $
    12.69Exercised
    
    
    (63,301
    )
    
    
    (9.51
    )Cancelled
    
    
    (28,400
    )
    
    
    (13.96
    )Balance  October 30, 2005
    
    
    221,950
    
    
    
    13.44Granted
    
    
    100,196
    
    
    
    11.51Exercised
    
    
    (5,196
    )
    
    
    (6.18
    )Cancelled
    
    
    (28,000
    )
    
    
    (10.12
    )Balance  October 29, 2006
    
    
    288,950
    
    
    
    13.22Granted
    
    
    105,000
    
    
    
    8.38Exercised
    
    
    (2,500
    )
    
    
    (8.15
    )Cancelled
    
    
    (90,300
    )
    
    
    (13.86
    )Balance  October 28, 2007
    
    
    301,150
    
    
    $
    11.42
    
    
    
    6.99
    
    
    $
    .00Exercisable at October 28,
2007
    
    
    130,987
    
    
    $
    13.26
    
    
    
    5.15
    
    
    $
    .00
 A summary of information regarding stock options outstanding at October 28, 2007, is as
follows:
 Options Outstanding
    
    Options ExercisableWeighted-Average
    
    Weighted-
    
    
    
    
    
    Weighted-Number
    
    Remaining
    
    Average
    
    Number
    
    AverageRange of
    
    Outstanding at
    
    Contractual
    
    Exercise
    
    Exercisable at
    
    ExerciseExercise Price
    
    October 28, 2007
    
    Life
    
    Price
    
    October 28, 2007
    
    Price$8.50  $10.30
    
    
    125,500
    
    
    
    7.98
    
    
    $
    8.75
    
    
    
    19,667
    
    
    $
    10.15$10.90  $17.75
    
    
    175,650
    
    
    
    6.28
    
    
    $
    13.33
    
    
    
    111,320
    
    
    $
    13.81
 The weighted-average grant-date fair value of options granted during fiscal 2007 and 2006, was
$3.03, and $3.23, respectively. The total intrinsic value of options exercised during the
fiscal 2006 and 2005, was $21,434, and $318,792, respectively, (none in 2007).
 F-19




---



##### 



A summary of the status of, and changes to, unvested options during the year ended October 28,
2007, is as follows:
 WeightedNumber
    
    
    Averageof
    
    
    Grant DateShares
    
    
    Fair ValueUnvested  Beginning of year
    
    
    131,180
    
    
    $
    4.63Granted
    
    
    105,000
    
    
    
    3.03Forfeited
    
    
    (16,720
    )
    
    
    5.21Vested
    
    
    (49,297
    )
    
    
    4.31Unvested  End of year
    
    
    170,163
    
    
    $
    3.87
 As of October 28, 2007, there was $389,210 of total unrecognized compensation cost related to
nonvested share-based compensation arrangements granted under the Plans. That cost is expected
to be recognized over a weighted-average period of 4.43 years. The total fair value of shares
vested during fiscal 2007 was $162,567.The Plans permit optionees to tender shares to the Company in lieu of cash for the exercise of
stock options. In fiscal 2005, 23,351 shares, were tendered for the exercise of 34,800 options.
No shares were tendered in 2007 and 2006.7.
    
    EMPLOYEE BENEFIT PLANSMax & Ermas 401(k) Savings Plan and Trust allows employees who have attained age 21 and have
completed one year of service to defer receipt of a portion of their compensation and
contribute such amounts to various investment funds. The Company matches a percentage of the
employees contributions if certain pretax income is achieved.The Company adopted a deferred compensation plan effective January 1, 1999, to provide
tax-deferred compensation to a select group of management or highly compensated employees of
the Company through deferrals of cash compensation and Company-related contributions.
Participants in the plan may contribute up to 25% of their compensation. Employer contributions
are permitted up to the first 4% of compensation the participant has contributed in combination
with the Companys 401(k) savings plan and trust. Employer contributions are fully vested after
three years of service. The fair value of the investment included in other assets and
offsetting liability was approximately $1,054,000 and $952,000 at October 28, 2007 and October
29, 2006, respectively.Total expense for these plans for fiscal 2007, 2006, and 2005 was approximately $65,000,
$93,000, and $281,000, respectively.8.
    
    ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTSThe carrying amounts of cash and cash equivalents, receivables, accounts and construction
payables, and accrued liabilities at October 28, 2007 and October 29, 2006, approximate their
fair value due to the short-term maturities of these items.
 F-20




---



##### 



The carrying amount of the Companys amended term loan and revolving
credit agreement approximated its fair value at October 28,
2007 and October 29, 2006. The fair value of the Companys long-term debt is estimated based on
the current interest rates offered for debt of the same remaining maturities.
It is not practical for the Company to estimate the fair value of its senior subordinated
note as the note is part of an investment in an equity fund.9.
    
    IMPAIRMENT OF ASSETSDuring fiscal 2007, the Company recorded an $715,064 asset impairment charge relating to four
restaurants. The charges consisted of the write-off of restaurant assets at the four restaurant
based on a discounted cash flow analysis.During fiscal 2006, the Company recorded an $845,433 asset impairment charge, primarily for the
expected end of lease closings of three restaurants. Two of the restaurants closed in fiscal
2006, and the other closed in fiscal 2007 at the end of its lease. The charge primarily
consisted of the write-off of restaurant assets at the three restaurants based on a discounted
cash flow analysis, the payment of a $440,000 lease termination fee, and smaller charges for
three underperforming locations.During fiscal 2005, the Company recorded a $1,450,000 asset impairment charge. The charge
consisted of $1,260,000 (including $439,000 of cash charges) related to six underperforming
restaurants for the write-down of restaurant assets based on a discounted cash flow analysis
and the payment to a landlord to obtain a release from one of the leases. Two of the
restaurants were closed in fiscal 2005. The Company also expensed $190,000 to write-off costs
associated with the proposed deregistration of its common stock, which was terminated in fiscal
2005.10.
    
    CHANGE IN ACCOUNTING PRINCIPLEDuring the fourth quarter of 2006, the Company adopted FIN No. 47 as described in Note 1. FIN
No. 47 clarified the timing of liability recognition for legal obligations associated with the
retirement of a tangible long-lived asset when the timing and/or method of settlement of the
obligation are conditional on a future event. FIN No. 47 also clarified that an entity is
required to recognize a liability for the fair value of a conditional asset retirement
obligation when a tangible long-lived asset is obtained, if the liabilitys fair value can be
reasonably estimated. Prior to this change, the Company expensed such asset retirement costs
when incurred. The initial adoption resulted in a charge of $115,000 (net of income tax
benefit), which was recorded as a cumulative effect of a change in accounting principle. The
adoption increased asset retirement obligations by $175,000 and increased deferred tax assets
by $60,000. As of the end of 2007, the ARO liability was $177,000.
 F-21




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##### 



11.
    
    QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)A summary of the unaudited quarterly results of operations for the years ended October 28, 2007
and October 29, 2006, is as follows:
 Unaudited
    
    
    
    
    
    Operating
    
    
    Income
    
    
    Net
    
    
    Diluted(Thousands, except
    
    Total
    
    
    Income
    
    
    (Loss) Before
    
    
    Income
    
    
    Earnings (Loss)per share data)
    
    Revenues
    
    
    (Loss)
    
    
    Income Taxes
    
    
    (Loss)
    
    
    Per Share2007First Quarter
    
    $
    55,521
    
    
    $
    1,848
    
    
    $
    759
    
    
    $
    749
    
    
    $
    0.29Second Quarter
    
    
    41,135
    
    
    
    279
    
    
    
    (511
    )
    
    
    (101
    )
    
    
    (0.04
    )Third Quarter
    
    
    39,201
    
    
    
    (1,092
    )
    
    
    (1,889
    )
    
    
    (968
    )
    
    
    (0.38
    )Fourth Quarter
    
    
    38,997
    
    
    
    (2,168
    )
    
    
    (3,228
    )
    
    
    (3,210
    )
    
    
    (1.26
    )Year
    
    $
    174,854
    
    
    $
    (1,133
    )
    
    $
    (4,869
    )
    
    $
    (3,530
    )
    
    $
    (1.38
    )2006First Quarter
    
    $
    57,617
    
    
    $
    331
    
    
    $
    (493
    )
    
    $
    (32
    )
    
    $
    (0.01
    )Second Quarter
    
    
    42,781
    
    
    
    655
    
    
    
    (30
    )
    
    
    161
    
    
    
    0.06Third Quarter
    
    
    40,646
    
    
    
    14
    
    
    
    (811
    )
    
    
    (295
    )
    
    
    (0.12
    )Fourth Quarter
    
    
    39,246
    
    
    
    68
    
    
    
    (735
    )
    
    
    (413
    )(1)
    
    
    (0.16
    )(1)$
    180,290
    
    
    $
    1,068
    
    
    $
    (2,069
    )
    
    $
    (579
    )
    
    $
    (0.23
    )
 
 (1)
    
    Includes $115,000 ($.05 per share) cumulative effect of change in accounting
principle (net of $60,000 tax benefit) due to the adoption of FIN No. 47 Accounting for
Conditional Asset Retirement Obligations.  F-22