##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended May 14, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 0-1154
 MAX & ERMAS RESTAURANTS, INC.
  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    31-1041397
(I.R.S. Employer
identification no.)4849 Evanswood Drive, Columbus, Ohio
(Address of principal executive offices)
    
    43229
(Zip Code)
 (614) 431-5800
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer þ
 o þ




---



TABLE OF CONTENTS  PART I  FINANCIAL INFORMATIONITEM 1  FINANCIAL STATEMENTSITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSItem 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKItem 4  CONTROLS AND PROCEDURESPART II  OTHER INFORMATIONItem 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSItem 6  EXHIBITSSIGNATURESEXHIBIT INDEXEX-31.1EX-31.2EX-32.1EX-32.2    Table of Contents  
 PART I  FINANCIAL INFORMATION
 
 ITEM 1  FINANCIAL STATEMENTS
 MAX & ERMAS RESTAURANTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 May 14, 2006(UNAUDITED)
    
    
    October 30, 2005ASSETSCurrent Assets:Cash
    
    $
    3,121,525
    
    
    $
    2,910,889Inventories
    
    
    1,206,800
    
    
    
    1,401,368Other Current Assets
    
    
    2,473,507
    
    
    
    2,387,896Total Current Assets
    
    
    6,801,832
    
    
    
    6,700,153Property  At Cost
    
    
    105,316,493
    
    
    
    104,292,729Less Accumulated Depreciation and Amortization
    
    
    52,154,852
    
    
    
    48,686,165Property  Net
    
    
    53,161,641
    
    
    
    55,606,564Other Assets
    
    
    13,002,180
    
    
    
    11,550,568Total
    
    $
    72,965,653
    
    
    $
    73,857,285LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Current Maturities of Long-Term Obligations
    
    $
    2,728,829
    
    
    $
    4,227,282Accounts Payable
    
    
    4,219,315
    
    
    
    5,589,058Accrued Payroll and Related Taxes
    
    
    2,681,753
    
    
    
    2,718,540Accrued Liabilities
    
    
    5,988,194
    
    
    
    6,197,616Total Current Liabilities
    
    
    15,618,091
    
    
    
    18,732,496Long-Term Obligations  Less Current Maturities
    
    
    43,785,312
    
    
    
    41,817,482Stockholders Equity:Preferred Stock  $.10 Par Value;
Authorized 500,000 Shares  None OutstandingCommon Stock  $.10 Par Value;
Authorized 5,000,000 Shares,
Issued and Outstanding 2,551,974 Shares
At 05/14/06 and 2,546,778 Shares at 10/30/05
    
    
    255,196
    
    
    
    254,677Additional Paid-In Capital
    
    
    802,720
    
    
    
    678,225Retained Earnings
    
    
    12,504,334
    
    
    
    12,374,405Total Stockholders Equity
    
    
    13,562,250
    
    
    
    13,307,307Total
    
    $
    72,965,653
    
    
    $
    73,857,285
  1




---



##### Table of Contents



MAX & ERMAS RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Twelve Weeks Ended
    
    
    Twenty-eight Weeks EndedMay 14, 2006
    
    
    May 15, 2005
    
    
    May 14, 2006
    
    
    May 15, 2005REVENUES:
    
    $
    42,781,321
    
    
    $
    43,024,863
    
    
    $
    100,398,728
    
    
    $
    100,295,691COSTS AND EXPENSES:Costs of Goods Sold
    
    
    10,819,642
    
    
    
    11,098,173
    
    
    
    25,753,263
    
    
    
    25,610,149Payroll and Benefits
    
    
    13,773,438
    
    
    
    13,844,390
    
    
    
    31,947,741
    
    
    
    31,850,514Other Operating Expenses
    
    
    14,116,571
    
    
    
    14,362,187
    
    
    
    33,345,853
    
    
    
    33,055,194Pre-Opening Expenses
    
    
    8,149
    
    
    
    116,989
    
    
    
    8,149
    
    
    
    124,038Impairment of Assets
    
    
    
    
    
    
    1,450,000
    
    
    
    504,524
    
    
    
    1,450,000Administrative Expenses
    
    
    3,408,131
    
    
    
    3,413,598
    
    
    
    7,852,711
    
    
    
    7,921,698Total Operating Expenses
    
    
    42,125,931
    
    
    
    44,285,337
    
    
    
    99,412,241
    
    
    
    100,011,593Operating Income (Loss)
    
    
    655,390
    
    
    
    (1,260,474
    )
    
    
    986,487
    
    
    
    284,098Interest Expense
    
    
    646,202
    
    
    
    538,233
    
    
    
    1,470,055
    
    
    
    1,244,235Minority Interest in Income
of Affiliated Partnerships
    
    
    38,503
    
    
    
    
    
    
    
    38,503
    
    
    
    19,252LOSS BEFORE INCOME TAXES
    
    
    (29,315
    )
    
    
    (1,798,707
    )
    
    
    (522,071
    )
    
    
    (979,389
    )INCOME TAXES (CREDIT)
    
    
    (191,000
    )
    
    
    (855,000
    )
    
    
    (652,000
    )
    
    
    (690,000
    )NET INCOME (LOSS)
    
    $
    161,685
    
    
    $
    (943,707
    )
    
    $
    129,929
    
    
    $
    (289,389
    )NET INCOME (LOSS) PER SHAREBasic
    
    $
    .06
    
    
    $
    (0.37
    )
    
    $
    0.05
    
    
    $
    (0.11
    )Diluted
    
    $
    .06
    
    
    $
    (0.37
    )
    
    $
    0.05
    
    
    $
    (0.11
    )SHARES OUTSTANDING:Basic
    
    
    2,551,974
    
    
    
    2,549,083
    
    
    
    2,550,198
    
    
    
    2,529,133Diluted
    
    
    2,556,195
    
    
    
    2,549,083
    
    
    
    2,559,169
    
    
    
    2,529,133
  2




---



##### Table of Contents



MAX & ERMAS RESTAURANTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Twenty-eight Weeks EndedMay 14, 2006
    
    
    May 15, 2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    129,929
    
    
    $
    (289,389
    )Depreciation and amortization
    
    
    4,359,082
    
    
    
    4,608,310Loss on Disposition of Assets
    
    
    148,647
    
    
    
    112,122Impairment of Assets
    
    
    45,598
    
    
    
    1,011,000Minority interest in income of Affiliated Partnerships
    
    
    38,503
    
    
    
    19,252Changes in other assets and liabilities
    
    
    (2,452,488
    )
    
    
    362,553Net cash provided by operating activities
    
    
    2,269,271
    
    
    
    5,823,848CASH FLOWS FROM INVESTING ACTIVITIES:Property additions
    
    
    (2,326,157
    )
    
    
    (4,258,270
    )Decrease in other assets
    
    
    24,764
    
    
    
    75,283Net cash used by investing activities
    
    
    (2,301,393
    )
    
    
    (4,182,987
    )CASH FLOWS FROM FINANCING ACTIVITIES:Principal payments under long-term obligations
    
    
    (24,943,097
    )
    
    
    (42,536,563
    )Proceeds from long-term obligations
    
    
    25,767,000
    
    
    
    40,557,697Proceeds from exercise of stock options
    
    
    64,171
    
    
    
    259,694Debt issue costs
    
    
    (606,813
    )
    
    
    (40,950
    )Distributions to minority interests in Affiliated Partnerships
    
    
    (38,503
    )
    
    
    (19,252
    )Net cash provided by (used by) financing activities
    
    
    242,758
    
    
    
    (1,779,374
    )NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    
    
    210,636
    
    
    
    (138,513
    )CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    2,910,889
    
    
    
    2,187,529CASH AND EQUIVALENTS AT END OF PERIOD
    
    $
    3,121,525
    
    
    $
    2,049,016SUPPLEMENTAL DISCLOSURES:Cash paid during the period for:Interest (net of $5,000 and $41,000 capitalized in 2006
and 2005)
    
    $
    1,550,922
    
    
    $
    1,517,224Income taxes
    
    $
    12,188
    
    
    $
    342,539Non-cash activities:Property additions financed by accounts payable
    
    $
    553,583
    
    
    $
    1,818,048
  3




---



##### Table of Contents



MAX & ERMAS RESTAURANTS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 1.
    
    PresentationThe accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and include all of the information and disclosures
required by accounting principles generally accepted in the United States of America for interim
reporting, which are less than those required for annual reporting. In the opinion of
management, all adjustments, consisting of only normal recurring accruals, considered necessary
for a fair presentation have been included.The Company and its Affiliated Partnership each have a 52-53 week fiscal year, which ends on the
last Sunday in October. Fiscal 2006 and 2005 consist of 52 weeks and includes, one sixteen-week
and three twelve-week quarters.2.
    
    New Financial Accounting StandardsIn March 2005, the FASB issued Interpretation
No. 47, Accounting for Conditional Asset
Retirement Obligations, an interpretation of FASB No. 143, (FIN 47). FIN 47 addresses
financial accounting and reporting for obligations associated with retirement of tangible
long-lived assets and the associated asset retirement costs. FIN 47 clarifies that the term
conditional asset retirement obligation as used in FASB 143 refers to a legal obligation to
perform an asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the entity. FIN 47
also clarifies when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. The provisions of FIN 47 are effective no later than
the end of fiscal years ending after December 15, 2005. The Company has not yet completed its
assessment of the impact of FIN 47 on its consolidated financial statements.In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections (SFAS
154). SFAS 154 replaces APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting
Changes in Interim Financial Statements, and changes the requirements for the accounting for and
reporting of a change in accounting principle. SFAS 154 requires retrospective application of
changes in accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. SFAS 154 defines retrospective
application as the application of a different accounting principle to prior accounting periods
as if that principle had always been used or as the adjustment of previously issued financial
statements to reflect a change in the reporting entity. SFAS 154 also redefines restatement as
the revising of previously issued financial statements to reflect the correction of an error.
SFAS 154 is effective for accounting changes and correction of errors made in fiscal years
beginning after December 15, 2005.
 4




---



##### Table of Contents



In October 2005, the FASB issued FASB Staff Position (FSP) 13-1, Accounting for Rental Costs
Incurred during a Construction period. The guidance requires the rental costs recognized for
ground or building operating leases during the construction period be recognized as rental
expense. The guidance permits either retroactive or prospective treatment for periods beginning
after December 15, 2005. The Company will prospectively change its policy from capitalization
to expensing beginning in fiscal 2006. The adoption of the FSP 13-1 will result in an increase
of approximately $60,000 in preopening expenses for each new restaurant opened.3.
    
    Net Income Per ShareBasic income per share amounts are based on the weighted average number of shares of common
stock outstanding during the years presented. Diluted income per share amounts are based on the
weighted average number of shares of common stock and dilutive stock options outstanding during
the periods presented. Options to purchase 305,950 shares of common stock were outstanding at
May 14, 2006, but options to purchase 296,979 were not included in the computation of diluted
earnings per share because the exercise prices were greater than the average market price of the
common shares and, therefore, the effect would be antidilutive. Options to purchase 231,950
shares of common stock were outstanding at May 15, 2005, but were not included in the
computation of diluted earnings per share because the Company reported a net loss for the
quarter and year-to-date periods and, therefore, the effect would be antidilutive. The
difference between basic shares outstanding and diluted shares outstanding were as follows:
 Twelve Weeks Ended
    
    
    Twenty-eight Weeks EndedMay 14, 2006
    
    
    May 15, 2005
    
    
    May 14, 2006
    
    
    May 15, 2005Basic Shares Outstanding
    
    
    2,551,974
    
    
    
    2,549,083
    
    
    
    2,550,198
    
    
    
    2,529,133Dilutive Effect of Stock Options
    
    
    4,221
    
    
    
    
    
    
    
    8,971Diluted Shares Outstanding
    
    
    2,556,195
    
    
    
    2,549,083
    
    
    
    2,559,169
    
    
    
    2,529,133
 5




---



##### Table of Contents



4.
    
    Stock OptionsDuring the twenty-eight weeks ended May 15, 2006, the Companys stock option activity and
weighted average exercise prices were as follows:
 Shares
    
    
    Exercise PriceOutstanding, October 30, 2005
    
    
    221,950
    
    
    $
    13.44Granted
    
    
    95,196
    
    
    
    11.67Forfeited
    
    
    (6,000
    )
    
    
    (16.50
    )Exercised
    
    
    (5,196
    )
    
    
    (6.18
    )Outstanding, May 14, 2006
    
    
    305,950
    
    
    $
    12.95
 Adoption of SFAS 123(R)Effective October 31, 2005 under the modified prospective method, the Company adopted the
provisions of SFAS No. 123(R), Share-Based Payment, a replacement of SFAS No. 123, Accounting
For Stock-Based Compensation, and rescission of APB Option No. 25, Accounting for Stock Issued
to Employees. This statement applies to all awards granted after the effective date and to
modifications, repurchases, or cancellations of existing awards. Additionally, under this
modified prospective method of adoption, the Company recognizes compensation expense for the
portion of outstanding awards on the adoption date for which the requisite service period has
not yet been rendered based on the grant-date fair value of those awards calculated under SFAS
No. 123 and 148 for pro forma basis only. Using the fair value method of SFAS No. 123, the
weighted average fair value of options granted in fiscal 2004 and 2006 was $6.27 per share and
$4.49 per share, respectively (none granted in 2005). The fair value of the option grants is
estimated as of the date of the grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield equaling 0%, risk-free interest rate of 3.8% and 4.59%,
respectively, expected volatilities assumed to be 28% and 31%, respectively, and expected lives
of 3.5 to 10 years.The stock-based employee compensation expense for the twelve weeks ended May 14, 2006 was
$24,281 ($15,783 net of tax) and for the twenty-eight weeks ended May 14, 2006 was $46,269
($30,075 net of tax) leaving a remaining unrecognized compensation expense at May 14, 2006 of
$357,775 to be recognized over a weighted average period of 3.9 years.Prior to the adoption of SFAS 123(R)During fiscal 2004 and fiscal 2005, the Company had adopted the disclosure only provisions of
SFAS No. 123, Accounting for Stock-Based Compensation. The Company had recorded no compensation
expense for stock options because the exercise price of the stock options was equal to the fair
market value of the underlying common stock at the date of grant. Had compensation cost for the
plan been determined based on the fair value at the grant dates for
 6




---



##### Table of Contents



awards under
the plan consistent with the fair value method of SFAS No. 123, the effect on the Companys net
income and earnings per share would have been as follows:
 Twelve Weeks Ended
    
    
    Twenty-eight Weeks EndedMay 15, 2005
    
    
    May 15, 2005Net income (loss), as reported
    
    $
    (943,707
    )
    
    $
    (289,389
    )Deduct: total stock-based compensation
expense determined under the fair
value method for all awards, net of
related tax benefits
    
    
    (1,277
    )
    
    
    (6,384
    )Pro forma net income (loss)
    
    $
    (944,984
    )
    
    $
    (295,773
    )As reported earnings per common share:Basic
    
    $
    (0.37
    )
    
    $
    (0.11
    )Diluted
    
    $
    (0.37
    )
    
    $
    (0.11
    )Pro forma earnings per common share:Basic
    
    $
    (0.37
    )
    
    $
    (0.12
    )Diluted
    
    $
    (0.37
    )
    
    $
    (0.12
    )
 SFAS 123(R) requires that forfeitures be estimated over the vesting period, rather than being
recognized as a reduction of compensation expense when the forfeiture actually occurs. The
cumulative effect of the use of the estimated forfeiture method for prior periods upon adoption
of SFAS 123(R) was not material.5.
    
    Asset ImpairmentDuring the first quarter of 2006, the Company recorded a $505,000 asset impairment charge
related to the closing and write-off of restaurant assets at one restaurant. The charge
consisted primarily of the payment of a $440,000 lease termination fee.During the second quarter of 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
under-performing 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 2005. The Company also expensed $190,000 to write-off costs
associated with the proposed deregistration of its common stock which was terminated in 2005.
 7




---



##### Table of Contents



6.
    
    Debt RestructuringOn May 5, 2006, the Company amended its bank loan agreement and issued a $7.0 million,
interest-only senior subordinated note to an unrelated party. The note bears interest, payable
quarterly, at a fixed rate of 14.5% with principal due May 1, 2012. The net proceeds of
approximately $6.5 million were used to pay off a $2.4 million bank note that had required
annual principal payments of $1.5 million through December 2007, reduce borrowings under the
Companys revolving credit line by $2.8 million and increase working capital by $1.3 million.
As a result, the outstanding borrowings under the Companys new revolving credit agreement were
reduced to a $12.8 million five-year term loan, requiring quarterly principal payments of
$600,000 and approximately $12.2 million outstanding under a $15.0 million revolving credit
line. Both the term loan and revolving credit line bear interest, payable quarterly, at prime
+3/4% or LIBOR plus 3.5% at the Companys option, with the outstanding balance under both loans
due March 1, 2011. Both the bank loan agreement and the subordinated note agreement require the
maintenance of certain financial covenants. The Company was in compliance with all covenants at
May 14, 2006.
 
 ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 OVERVIEW
  8
    Table of Contents      9
    Table of Contents  10
    Table of Contents  YEAR-TO-YEAR COMPARISONS AND ANALYSIS
 RESULTS OF OPERATIONS
  Twelve
    
    Twelve
    
    Twenty-eight
    
    Twenty-eightWeeks Ended
    
    Weeks Ended
    
    Weeks Ended
    
    Weeks EndedMay 14, 2006
    
    May 15, 2005
    
    May 14, 2006
    
    May 15, 2005Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of Goods Sold
    
    
    (25.3
    )
    
    
    (25.8
    )
    
    
    (25.7
    )
    
    
    (25.5
    )Payroll & Benefits
    
    
    (32.2
    )
    
    
    (32.2
    )
    
    
    (31.8
    )
    
    
    (31.8
    )Other Operating Expenses
    
    
    (33.0
    )
    
    
    (33.4
    )
    
    
    (33.2
    )
    
    
    (33.0
    )Pre-Opening Expenses
    
    
    
    
    
    
    (0.3
    )
    
    
    
    
    
    
    (0.1
    )Impairment of Assets
    
    
    
    
    
    
    (3.4
    )
    
    
    (0.5
    )
    
    
    (1.4
    )Administrative Expenses
    
    
    (7.9
    )
    
    
    (7.9
    )
    
    
    (7.8
    )
    
    
    (7.9
    )Interest Expense
    
    
    (1.5
    )
    
    
    (1.2
    )
    
    
    (1.5
    )
    
    
    (1.2
    )Minority Interest
    
    
    (0.1
    )
    
    
    
    
    
    
    
    
    
    
    Income Tax Credit
    
    
    0.4
    
    
    
    2.0
    
    
    
    0.6
    
    
    
    0.7Net Income
    
    
    0.4
    %
    
    
    (2.2
    )%
    
    
    0.1
    %
    
    
    (0.2)
    %
 REVENUES
   11
    Table of Contents      COSTS AND EXPENSES
    12
    Table of Contents  ASSET IMPAIRMENT
    ADMINISTRATIVE EXPENSES
  13
    Table of Contents  INTEREST EXPENSE
 3 4
  INCOME TAXES
  LIQUIDITY AND CAPITAL RESOURCES
  14
    Table of Contents  15
    Table of Contents  CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  Derivative Instruments
  Same-Store Sales
  Asset Impairment
  INFLATION
  SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
 16
    Table of Contents     17
    Table of Contents  Item 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   
 Item 4  CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures.
  18
    Table of Contents  Internal Controls
 19
    Table of Contents  PART II  OTHER INFORMATION
 
 Item 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  Director Nominee
    
    For
    
    WithheldDonal H. Malenick
    
    
    1,310,430
    
    
    
    0Mark F. Emerson
    
    
    1,310,430
    
    
    
    0Timothy C. Robinson
    
    
    1,040,219
    
    
    
    99,762Robert A. Rothman
    
    
    1,020,307
    
    
    
    119,674
   
 Item 6  EXHIBITS
     
 *
    
    Filed with this report.+
    
    Furnished with this report. 20
    Table of Contents  SIGNATURES
  MAX & ERMAS RESTAURANTS, INC.Registrant/s/      Todd B. BarnumTodd. B. BarnumChairman of the Board andChief Executive Officer(Principal Executive Officer)/s/      William C. Niegsch, Jr.William C. Niegsch, Jr.Executive Vice President andChief Financial Officer(Principal Financial andAccounting Officer)June 21, 2006Date
 21
    Table of Contents  EXHIBIT INDEX
 Exhibit No.
    
    Exhibit
    
    Page No.31.1*
    
    Rule 13a-14(a) Certification of Principal Executive Officer
    
    Page 2331.2*
    
    Rule 13a-14(a) Certification of Principal Financial Officer
    
    Page 2532.1+
    
    Section 1350 Certification of Principal Executive Officer
    
    Page 2732.2+
    
    Section 1350 Certification of Principal Financial Officer
    
    Page 28
 
 *
    
    Filed with this report.+
    
    Furnished with this report. 22