MAXWELL RESOURCES, INC. (MAXE) - Description of business

Company Description
     Our restaurants are famous for gourmet burgers, overstuffed sandwiches, homemade pasta dishes, chargrilled steak and chicken specialties, super salads and taste-tempting munchies. Unique to the Max & Erma’s concept is the Build-Your-Own-Sundae Bar, a bathtub filled with vanilla ice cream, special sauces and lots of toppings along with fresh baked chocolate chip cookies. In addition, the restaurants offer a full complement of alcoholic and non-alcoholic beverages. We believe that the decor and theme of our restaurants allows the introduction of a broad range of menu items, thus permitting rapid adjustment to changing customer preferences.     Antique artifacts and local paraphernalia make Max & Erma’s a fun, unique place to take friends and family. The use of brick, a combination of light and dark colors, and dropped lighting creates a roomy, yet cozy feel for customers to enjoy while dining. The neighborhood atmosphere of each restaurant is enhanced by inclusion of local items in each restaurant’s decor, including sports team paraphernalia and historical artifacts. Additional décor items include a giant bubble gum machine, a three-dimensional burger, an antique love tester and many other things. Giant murals, both inside and outside the restaurant, combine the history and tradition of each market with the Max & Erma’s story.     Our restaurants are open for both lunch and dinner seven days a week. Hours of operation are generally 11:00 a.m. to midnight. During fiscal 2006, the average check was approximately $12.10 at lunch and $14.24 at dinner. The lunch and dinner meal periods accounted for approximately 37.8% and 62.2% of net sales, respectively. Alcoholic beverages constituted approximately 9.2% of restaurant sales in fiscal 2006. Generally, our business does not experience seasonal fluctuations of sales.     Our strategy is to compete in the casual dining segment of the restaurant industry by offering a variety of high quality food in a casual, comfortable and fun atmosphere and with a uniquely personable service style. Our philosophy is to focus on the details of the customer experience that instill customer loyalty and promote repeat business. The purpose of every associate is to “help our guests enjoy their total dining experiences so they can’t wait to come back.” Being a “purpose-driven” company requires an ability to understand what guests want, and a dedication to focus all associates’ energies on exceeding those expectations. This means that associates treat guests withrespect, like friends or neighbors, and provide them with the kind of food, service and atmosphere that will make them want to return often.     We believe the dining experience starts with the food and therefore we use only the freshest and highest quality ingredients in every menu item. Freshness and quality are truly the foundations upon which Max & Erma’s was built. We strive to do things the right way, not the easy way. We believe this dedication makes us better and that our guests return more often. Market research indicates that customers often know what they are going to order before they get to our restaurants because they crave certain signature items.     We believe that our reputation is built every day with every customer served and that a key to customer loyalty is the server. Food is delivered to the table by the server instead of a food runner, and servers are required to recheck the table two minutes after delivering the meal. Moreover, the wait staff is empowered to address customer problems without the assistance of restaurant management.     Max & Erma’s restaurants have always been known for gourmet hamburgers and specialty sandwiches; however, one part of our focus on the customer is an evolving menu that changes to meet consumer tastes. We believe our menu should be fun as well as innovative. We review and revise the menu twice each year, and in addition offer seasonal menu inserts at various times of the year. By periodically modifying our menu through the introduction of a broad range of appealing new menu items we have achieved a more diversified sales mix.     We make use of consumer focus groups to conduct marketing research. We incorporate the findings of this market research in our advertising, menu development, employee training, and building design and decor. According to customers, the major point of difference between us and our competitors is that Max & Erma’s restaurants are perceived as being more of a “fun place,” an image we try to foster in our advertising. We spent approximately 2.6% of sales on advertising in 2006. We primarily use special events and localized store marketing designed to increase customer awareness and repeat business, and to a lesser extent billboards, direct mail, radio and television.     We own the business, exclusive of the real estate, for 77 of the Max & Erma’s restaurants in operation at October 29, 2006. The business and real estate for one restaurant is owned by a separate affiliated partnership. In addition to a 60% interest in the profits and losses of the affiliated partnership, we are paid an annual fee equal to 6% of gross revenues for managing the Max & Erma’s restaurant owned by the partnership. The management contract provides for monthly payments to us for an initial term of two years and renewal terms aggregating 20 additional years upon the mutual agreement of the parties. As general partner we are potentially liable for 100% of the partnership losses.     We franchise 21 restaurants to unaffiliated franchisees at October 29, 2006. The first two franchised restaurants opened in 1998 in the Columbus and Cleveland, Ohio airports. From 2000 through 2005, three to four franchised restaurants opened annually. In fiscal 2006 one franchised location opened in the Detroit, Michigan airport. Three franchised restaurants closed in 2006. Two of the closed franchised locations were test sites on the Ohio Turnpike involving limited table service and no alcoholic beverages. Ultimately, the locations did not generate sufficient sales to expand the test and the locations were closed. Terms of franchise agreements call for an initial franchise fee plus a monthly royalty generally equal to 4% of sales.     At October 29, 2006 three franchised restaurants were under construction with openings planned for the first quarter of 2007. In addition to those three restaurants, we anticipate the opening of an additional four to five franchised restaurants during the remainder of fiscal 2007. At October 29, 2006, we had seven multi-unit franchised agreements signed, requiring the total development of an additional 31 restaurants over the next ten years. Competition     The restaurant business, particularly in the casual dining segment, is highly competitive in terms of quality and value of products served, type and variety of menu offered, quality and efficiency of service, ambiance and attractiveness of facilities and site location. Max & Erma’s restaurants compete with food service operations of various types within their respective locations, including national and regional chains as well as locally-owned and operated restaurants. Many of our competitors are substantially larger than us and have greater financial resources. Employees     At October 29, 2006, we had 5,158 employees, of which 1,689 were full-time restaurant employees, 3,101 were part-time restaurant employees, 81 were corporate staff personnel and 287 were restaurant managerial personnel. None of our employees are represented by a labor union or a collective bargaining unit. We consider relations with our employees to be good. Restaurant Operations     We strive to maintain quality and uniformity in our restaurants through careful training and supervision of personnel. All restaurants are operated in accordance with uniform Company specifications, which are set forth in detailed operating manuals relating to food and beverage preparation, maintenance of premises and employee conduct. Through the end of 2005, we utilized an independent shopping service to monitor implementation of our operating standards.     In 2006, we discontinued the use of the independent shopping service and commenced using an internet-based Guest Satisfaction Survey. With this program our point of sale system randomly selects a number of customers to be surveyed at each restaurant. Selected customers can respond by telephone or via the Internet. The purpose of the survey is to measure customer satisfaction. We believe this is a better measurement tool than the independent shopping service because it measures what the customer considers important through their feedback. Additionally, the sample size, approximately 300 per quarter per restaurant versus four, is much greater thus giving a statistically more accurate indication of customer satisfaction. When the program is fully operational by mid-2007, we will utilize it in our regional and general manager bonus program.     Restaurant operations are administered by a management staff headed by the Chief Operating Officer. Three Regional Vice Presidents of Operations report directly to the Chief Operating Officer. Sixteen regional managers, each of whom supervises the operations of four to five restaurants, report to one of the Regional Vice Presidents of Operations. Three franchise regional managers also report to one of the Regional Vice Presidents. Each restaurant has a general manager, who is responsible for training and supervising approximately 40 to 100 employees, and two or three assistant managers. Regional managers are responsible for hiring their general and assistant managers. General managers, with the assistance of the regional manager, are responsible for hiring restaurant employees. We seek to hire experienced restaurant personnel who must complete a 14-week training program conducted by us before becoming an assistant manager. We have historically promoted from within to fill our regional and general manager positions.     Both regional and general managers receive a base salary plus a bonus based upon performance against budget income and sales. General managers prepare quarterly budgets for their stores and regional managers prepare quarterly budgets for their regions. Bonuses are based on specific goals derived from these quarterly budgets. Both regional and general managers are eligible for a cash bonus equal to one-half of the purchase price of the first 250 shares of our common stock they purchase each quarter. We believe that our bonus system and the ability to purchase common stock promotes loyalty and highly motivates managers to meet our goals.     We believe that the combination of the authority delegated to our regional and general managers, particularly with respect to hiring employees, together with our goal-specific bonus plans, results in a positive work environment and has contributed to relatively low management turnover. Managing Partner Program     At the start of 1999 we introduced our Managing Partner Program. Under this program we enter into a five-year agreement with an eligible general manager in which the general manager places either 500 or 1,000 shares of Max & Erma’s common stock which he or she owns in escrow with us and agrees to manage his or her restaurant for a five year period. The shares of stock are forfeited if the general manager terminates their employment during the term of the agreement. In return we agree to not relocate the general manager during the term of the agreement. During the term of the agreement the general manager’s base salary is fixed. As additional compensation he or she receives 25% of the increase in profit before fixed expenses over a pre-established base profit (generally the average of profit before fixed expenses for the most recent three fiscal years). We believe the program encourages the general manager to both build sales and control margins, creates a sense of ownership, reduces management turnover and promotes a longer-term perspective. At the end of fiscal 2006, we had a total of 17 Managing Partners. We also added seven additional Managing Partners at the start of fiscal 2007. Purchasing and Inventory     Meat and most other food and restaurant supply items are purchased through one major distributor in order to obtain favorable prices and to ensure consistent quality and delivery. For major items, we typically negotiate prices directly with producers. For other items, we provide the distributor with specifications and receive monthly prices for such items, generally based upon a “cost plus” formula. Restaurant managers purchase these items directly from the distributor, and each restaurant is billed directly for its purchases. Although most of our food and supplies are presently furnished by one distributor, we believe alternate food suppliers are available and we have not experienced a shortage of food or supplies. A daily inventory is taken for high cost items, such as steaks, ground meat, seafood and liquor. A physical inventory of all items is made at the end of each four-week accounting period. Government Regulation     We are subject to federal, state and local laws affecting the operation of our restaurants, including zoning, health, sanitation and safety regulations and alcoholic beverage licensing requirements. Each restaurant is operated in accordance with standardized procedures designed to assure compliance with all applicable codes and regulations. The suspension of a food service or liquor license could cause an interruption of operations at affected restaurants. Future Expansion     We intend to open three Company-owned and seven to eight franchised Max & Erma’s restaurants during fiscal 2007. In 2006 we hired a Director of Franchise Development to more aggressively market franchises as we believe that is a key element of our future growth. All but three of the existing Company-owned Max & Erma’s restaurants are located in suburban areas. Of the existing Company-owned Max & Erma’s restaurants, 65 are freestanding and 13 are in-line shopping center/mall locations. The following table sets forth the location of each Max & Erma’s restaurant as of October 29, 2006 and the locations of restaurants currently under negotiation or development and scheduled to open during fiscal 2007:                                       Company Owned   Franchised     Existing   Under Development   Existing   Under Development Arizona                                 Phoenix             1                   Georgia                                 Atlanta     1                           Illinois                                 Chicago     8                           Indiana                                 Aztar Casino                     1           Columbus                     1           Indianapolis     4                           Merrillville                             1   Mishawaka                     1           Seymour                     1           Kentucky                                 Crestview Hills     1                           Lexington     2                           Louisville     2                           Michigan                                 Ann Arbor     1                           Detroit     10               1           Grand Rapids     1                           Lansing     1                           Missouri                                 St. Louis                     2           Nevada                                 Las Vegas                             2   North Carolina                                 Charlotte     2                                                                 Company Owned   Franchised     Existing   Under Development   Existing   Under Development Ohio                                 Akron     1                           Canton     1                           Chillicothe                     1           Cincinnati     5               1           Cleveland     5               2           Columbus     13       2       2           Dayton     4               1           Findlay                             1   Niles     1                           Sandusky                     1           Toledo     3                           Wilmington                     1           Pennsylvania                                 Erie     1                           Philadelphia                     2           Pittsburgh     9                           Virginia                                 Norfolk     1                       1   Richmond                     1       1   Virginia Beach     1                       1   West Virginia                                 Huntington                     1           Wisconsin                                 Green Bay                     1                                                                               TOTAL     78       3       21       7                                          Our preference is to acquire the land and build new freestanding restaurants for Max & Erma’s. However, in order to acquire suitable sites, we will utilize ground leases, or lease and convert existing premises. The three sites under development are freestanding. We believe that the clustering of three or more restaurants in markets of sufficient size increases customer awareness, enhances the effectiveness of advertising and improves management efficiency. Item 1A. RISK FACTORS     We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Many of the following important factors have been discussed in our prior filings with the Securities and Exchange Commission.     In addition to the other information in this Report, readers should carefully consider that the following important factors, among others, in some cases have affected, and in the future could affect, our actual results and could cause our actual results of operations for fiscal 2006 and beyond, to differ materially from those expressed in any forward-looking statements made by us. 1.   Dependence on Senior Management. Our four senior management officials have over 94 years combined experience with us. Although we have attempted to develop additional management capabilities, the loss of one or more of the senior executives could have a material adverse effect on us. 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.   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.   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.   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 us.   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 adversely affect our operations. Also, government actions affecting minimum wages, payroll tax rates, and mandated benefits could adversely affect operating results.   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.   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 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. 10.   Consumer Perceptions of Food Safety. Our business 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 relatively highly leveraged, resulting in long term indebtedness (including current maturities) of approximately $31.1 million as of October 29, 2006, $24.1 million of which represents the balance due under our revolving credit agreement and bears interest at variable rates. A one-percentage point increase or decrease in interest rates could increase or decrease our pre-tax income by approximately $241,000. A change in interest rates will likely have a significant impact on our earnings. In addition, as a result of our substantial leverage, we are restricted by loan covenants that may impact our ability to grow in the future.   12.   Utilization of FICA Tax on Tips Credit. We have recorded a deferred tax asset of $4,170,000 for unused FICA Tax on Tips Credit. The credits expire from 2023 through 2026. 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 forced to write off all or a portion of the existing deferred tax asset associated with credits previously earned.   13.   Bank Covenants. We have attained waivers and/or amendments of certain loan covenant violations under our revolving credit agreement over the last three quarters of 2005 and the first, second and fourth quarters of 2006. While we have a very good relationship with our lenders, there can be no assurance that they will continue to waive covenant violations or make further amendments to our credit agreement. To assure compliance with our loan covenants, we must return to profitability. Item 1B. UNRESOLVED STAFF COMMENTS     None.