Max & Erma's Staying Power

Aging Max & Erma's, a new management team at the ready, remains a scrappy casual-dining competitor.

By David Farkas, Senior Editor -- Chain Leader, 5/1/2003

Max & Erma’s CEO Todd Barnum (r.) and Rob Lindeman, vice president of franchising.

Max & Erma’s, one of the nation’s oldest casual-dining chains, seems surprisingly spry for a 31-year-old duking it out with more youthful competitors. For one thing, until last quarter it had posted 14 consecutive periods of comparable-store sales gains. Officials blamed bad weather over Valentine’s Day weekend for the 1-percent shortfall in the quarter ended Feb. 16. For another, both the company and its franchisees are steadily opening new units—10 in all this year—which are expected to help boost revenues 12 percent to an estimated $170 million. Earnings per share will grow 18 percent, to $1.50, the company predicts. These gains and others are scarcely the makings of a national contender like, say, P.F. Chang’s, California Pizza Kitchen or The Cheesecake Factory. In fact, MAXE’s tiny float (900,000 shares) and market cap ($37 million) barely rate a glance from analysts. And, truth be told, that’s just fine with Max & Erma’s management.

“We are much, much more focused on the customer than on the Street,” declares CEO Todd Barnum, leaning his tanned frame back into a plush chair in his well-ordered, Columbus, Ohio, headquarters office. “We’re really more of a quasi-public company.” Barnum, two key executives and a director own 60 percent of the stock.

The Payoff
That approach, and a tendency to cluster its stores and grow concentrically, has allowed the 83-unit chain to dominate three sizeable markets: Columbus, Pittsburgh and Detroit. It also wins praise from industry observers. Says one-time investor Roger Lipton of Lipton Financial Services, “Max & Erma’s is a great example of a regional chain, and in the long run it has been very successful.” Adds former Morgan Keegan restaurant analyst Craig Weichmann, “They have strong operations and disciplined growth, and now they are reaping the rewards.”

Max & Erma’s is fairly typical of casual-dining restaurants, with a varied menu featuring a mix of trendy (Salmon Burger) and traditional dishes (French Onion Soup) with an $11 average check. The signature item has long been hamburgers, which accounted for nearly 50 percent of sales until the late 1990s, Barnum says. Although burger sales have dropped in recent years, research shows they still remain top of mind among some customers.

Development strategies have shifted over the years; the company now likes to build free-standing units, 6,200 square feet in size, near residential areas with household incomes that range from $60,000 to $75,000. Officials also look for spots that will provide lunch business. The restaurants usually feature local memorabilia to tie the unit to its community, a crucial aspect of local-store marketing efforts.

Tough Times
The company hasn’t always found good sites. Share price languished between $5 and $9 in the ’90s as the company missed earnings projections and investor interest withered. The company was slow to open restaurants at a time when Wall Street demanded 20 percent unit growth. Some observers blamed management for an inability to raise money, a charge Barnum denies. “Capital wasn’t the constraining issue,” he says. “It was just not having enough good sites in the pipeline. And that’s because we hadn’t professionalized our real estate effort. Anyway, I’m not sure we had the operations in place to grow more than eight units a year.”

To placate Wall Street, the company launched a second concept called Ironwood Cafe in 1998. It was an upscale restaurant with 4,000 square feet and a $14 check average. Three units opened and all failed to make money. Barnum shuttered them 18 months later. “It was an attempt to satisfy analysts as opposed to a smart strategic decision,” he concedes.

Times have changed. Despite no coverage, the thinly traded shares have shot up 120 percent since 1998, faster than either PFCB or CPKI. CAKE climbed 209 percent during the period. In early April, shares were changing hands for $15.25 each, about $3 off a 52-week high.

Marketing and development efforts underlie the strong financials and are providing momentum, officials contend. Both departments have come a long way from the days when the Max & Erma’s had a reputation as a “meat market” and for chasing deals. Longtime CFO William Niegsch Jr. recalls that the concept’s initial popularity eventually got the chain into trouble.

“When you are successful too easily, you don’t take time to sort things out. You think, ‘Hey, we can go anywhere,’” he explains. The company has closed units, for example, in Kansas City, Kan.; Toledo, Ohio; and, more recently, Cleveland, mistakenly opened in an entertainment district that attracted drinkers but not families.

Far-Flung Franchising
The current expansion strategy is to add corporate units in existing markets and franchise stores in areas farther away. Franchisees operate in places like Green Bay, Wis.; St. Louis; and Philadelphia, relatively far from Max & Erma’s core markets in Ohio, western Pennsylvania and Michigan. Four more franchised units are expected to open this year. Six new company restaurants are scheduled for fiscal ’03, ending Oct. 31.

Franchising began as an experiment in 1998 after a deal was struck with Host Marriott (now HMS Host) for a restaurant at the Columbus airport. Searching for a new growth formula, Barnum put a promising regional manager named Rob Lindeman in charge of the program and hired consultants to help him lay the groundwork for future multiunit deals. The 34-year-old Lindeman was named vice president of franchising two years ago, when the program began in earnest. So far nine franchisees operate 14 restaurants.

Unlike corporate stores, financed with bank debt and cash flow and typically sold and then leased back to the company, Max & Erma’s franchisees pay their own way. That has had Lindeman looking for ways to trim initial costs. “So far, we have not done sites that require $500,000 worth of site work,” he says, adding the average franchise unit investment is $2.1 million. Company stores can run $2.6 million. “Some of that has been coincidence, some strategy.”

In Columbus, Ind., 100 miles south of Indianapolis, a franchisee saved $200,000 using “alternative brands,” Lindeman says, including less-expensive HVAC and electrical systems and prefabricated building materials. “We try to spend a little more time value-engineering [a franchise store] than we do on the corporate side.”

Gen Next
Lindeman is one of a handful of young executives who Barnum, 60, says may one day replace him. “I have five [people] fighting for this position, and that’s the way I like it,” he declares. In any case, they’re likely to replace the triumvirate that has managed the company since the 1970s—Barnum; Niegsch, 50; and COO Mark Emerson, 55. The three bought out late founder Barry Zacks, who retired in 1986.

Max and Erma’s went public in 1982, 11 years after its founding, at $5 a share. Zacks, a colorful Columbus entrepreneur, had acquired a dilapidated beer joint in German Village, a now-trendy district south of downtown. Zacks hired Barnum, then a department store buyer. With $250,000 in loans guaranteed by partners, the pair turned the place into a “gourmet burger” restaurant that featured brass, glass, Tiffany lamps and table-top telephones wired to other tables. Singles flocked there, and to the other 10 other units opened before the offering.

Interestingly, the first restaurant wasn’t part of the corporate roll-up in ’82 because none of the partners agreed to sell. The seven who remain today still won’t. The reason? Barnum claims the partnership, guaranteed 40 percent of profits, has so far distributed $4 million—an average $12,100 per partnership per year. “Fortunately, the partnership ends in eight or nine years,” he adds dryly.

Barnum says he began thinking about replacing himself five years ago, about the time he had decided to decentralize management, “to unchain the chain,” as he puts it. He also hired Bonnie Brannigan, one of the five in line for his job, naming her vice president of marketing and planning. She has successfully shifted marketing away from mass media and into the stores.

“The board and I are very comfortable that the next generation is in place, but I couldn’t tell you who’s going to be where,” Barnum allows. Or when, for that matter. “I still love getting up in the morning. I can’t wait to go to work. I was just on vacation for two weeks, and it just killed me,” he adds.

Not surprisingly, he remains vague about any exit strategy, though Max & Erma’s could prove a tempting target for an acquirer. Cash flow, for instance, will total $11 million this year, Barnum says. And unit economics, despite the high cost-to-build, are solid. “There’s always a heavy demand for a healthy company,” says Weichmann, who is now a financial consultant in Dallas.

Share Hold
A sale might be easier, and less costly, than taking Max & Erma’s private, another exit option. Barnum, for his part, says he won’t do that, although the company’s efforts to trim the float by buying back shares cast doubt on that assertion. “I like being a public company and the discipline it brings,” he maintains. “I like seeing our numbers in the newspaper.”

Still, Barnum admits that some shareholders are holding out on him, refusing to sell. Who can blame them? “Shareholders are saying, ‘I know this is a healthy company. The stock price isn’t reflective of what it’s really worth. I can get 30 percent to 50 percent more [from a financial buyer],’” Weichmann surmises.

While top management ponders its pending exit, Brannigan is devising ways to maintain sales momentum. The marketing plan she helped create five years ago, which favored local store marketing over television and radio, is being tweaked. Although her budget isn’t growing—about 2 percent of sales are allocated for marketing—she’s shifting spending toward mass media to get a new message out: There are more than burgers on the menu. There always has been. Max & Erma’s introduced fajitas and fried shrimp in 1992.

Beyond Burgers
But burgers (25 percent of sales) have been the chain’s signature from the start, and they continue play a big role in marketing communications, though not for much longer, Brannigan says. Recent focus-group research in Chicago, Detroit and Columbus showed that infrequent customers perceived them as burger specialists. Brannigan wants these folks to visit more often and believes a strong variety message will lure them in.

She won’t forgo the “Hometown Favorite” campaign launched in ’97. The gambit, in which individual stores raise money for local teams and charities, is firmly entrenched in many communities. Some stores in fact sponsor two events per month. “It’s nothing for us to raise $15,000 for our community partners,” she boasts.

Yet winning the hearts and minds of customers has gotten tougher as the recession continues. “This quarter is looking better than last quarter, and I’d love to be on the increase. But there are a lot of unknowns,” she says. “Maybe we’re the treat on the weekends as people trade down.”

While Barnum insists he doesn’t have a favorite successor or a time line, it seems clear he’d like Lindeman and Brannigan to play major roles once the original management team is gone. Both have helped grow revenues, and both have worked for the company for years.

“They are next-generation kind of people,” Barnum says.