Nathan’s Famous, Inc. — FY2019 Form 10-K
Business context and reporting period
Nathan’s Famous is a branded food company whose principal activities are foodservice product sales, retail licensing, and Company-owned and franchised restaurants. Its products were distributed through approximately 78,000 locations. At March 31, 2019, its restaurant system comprised 255 franchised units and four Company-owned units.
The filing reports the fiscal year ended March 31, 2019, a 53-week period, compared with 52 weeks ended March 25, 2018. The filing is an annual report, not a standalone quarterly filing; fourth-quarter figures are presented separately below.
Key financial metrics
| Metric | FY2019 | FY2018 |
|---|---|---|
| Total revenue | $101.849 million | $104.201 million |
| Operating income | $27.976 million | $27.100 million |
| Net income | $21.493 million | $2.630 million |
| Diluted EPS | $5.09 | $0.62 |
| Cash from operations | $11.156 million | $18.862 million |
| Cash and cash equivalents, year-end | $75.446 million | $57.339 million |
| Working capital, year-end | $72.237 million | $53.702 million |
| Long-term debt, face value | $150.0 million | $150.0 million |
Gross profit was $18.782 million, or 26.2% of sales, versus $17.956 million, or 23.4%, in FY2018. The filing reports $27.976 million of operating income, approximately 27.5% of reported revenue. Adjusted EBITDA, a non-GAAP measure, was $30.399 million versus $29.115 million.
FY2019 net income included an $11.177 million gain on sales of the Bay Ridge restaurant property and the Florida regional office. The gain materially lifted reported pretax income; it should not be viewed as recurring operating earnings. Cash from investing activities was $12.328 million, primarily from $12.775 million in property-sale proceeds, partly offset by $0.447 million of capital spending. Financing activities used $5.377 million, including $4.187 million of regular dividends and $1.0 million of share repurchases.
At year-end, the company had $150 million of 6.625% senior secured notes due November 2025, with no scheduled principal amortization before maturity. Net debt carrying value was $145.449 million after unamortized issuance costs. Annual interest on the notes is approximately $9.938 million. Management reported compliance with debt covenants.
Material changes versus the prior period
- Revenue declined 2.3% as reported. FY2019 included $2.502 million of advertising-fund revenue under newly adopted Topic 606; excluding that gross-up, revenue was $99.130 million. Topic 606 also changed the timing of franchise-fee recognition, and FY2018 comparatives were not restated.
- Branded Product Program sales fell to $57.960 million from $62.623 million. The company attributed the decline to a 3.8% lower product volume and a 3.5% lower average selling price; the 53rd week contributed $2.090 million of sales. On a comparable 52-week basis, reported BPP volume declined approximately 6.9%, though management estimated customer shipments rose 3.6% after excluding prior-year distributor inventory effects.
- Company-owned restaurant sales declined to $13.601 million from $14.085 million, reflecting unfavorable Northeast weather and the Bay Ridge restaurant sale. Comparable domestic franchise sales declined 0.4% on a 52-week basis. The system ended the year with 21 fewer franchised units: 13 opened and 34 closed.
- License royalties rose to $23.615 million from $23.020 million, including $21.271 million from John Morrell & Co. Franchise fees and royalties declined to $4.171 million from $4.473 million.
- Lower beef costs helped lift gross margin: the company said its hot-dog market price was approximately 7.7% lower year over year. Operating income increased modestly, while lower interest expense and the property-sale gain drove much of the increase in net income.
- Operating cash flow fell from $18.862 million to $11.156 million, in part reflecting changes in operating assets and liabilities, including a $3.367 million decrease in accounts payable, accrued expenses and other current liabilities.
Fourth-quarter revenue was $22.129 million versus $19.906 million, operating income was $5.513 million versus $4.546 million, and net income was $2.492 million versus $0.367 million. FY2019’s fourth quarter contained 14 weeks, compared with 13 weeks in FY2018, so the comparison is not like-for-like.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific financial forecast. Management expects continued investment in restaurants and branded programs, debt service, dividends and potentially share repurchases, funded from operating cash flow. It stated available cash and expected operating cash flow should be sufficient for operations, debt service and capital needs for at least 12 months.
- Costs: Management expects beef-price volatility in FY2020 and continued pressure from New York minimum-wage increases and other labor regulations. It cited pricing and operating efficiencies as responses, but said margins could be adversely affected if higher costs cannot be offset.
- Revenue concentration: John Morrell royalties represented about 20.9% of FY2019 revenue, and the company said licensing revenue and profitability depend substantially on that relationship. Approximately 72% of BPP business came from six accounts, one representing about 25% of BPP business.
- Supply and customer concentration: The primary hot-dog supplier represented 92% of product purchases. The filing also identifies dependence on key BPP customers and risks from supply interruptions, beef costs, retailer bargaining power and competition.
- Debt and shareholder returns: The $150 million notes, restrictive covenants and substantial interest burden constrain financial flexibility. Dividends are subject to board approval and indenture restrictions. After year-end, the board declared a $0.35-per-share quarterly dividend, payable June 28, 2019.
- Accounting and leases: Topic 606 adoption produced a $2.004 million after-tax reduction to opening accumulated deficit and deferred franchise-fee recognition over agreement terms. For FY2020 lease-standard adoption, the company expected approximately $8.5 million of additional operating lease liabilities and a $7.8 million right-of-use asset.
- Other items: The company sold the Bay Ridge restaurant and Florida office, recording gains of $10.854 million and $0.323 million, respectively. It reported ordinary-course litigation and a $217,000 recorded liability for a lease guaranty. Management did not expect routine litigation to have a material adverse effect, while noting litigation outcomes are uncertain.
The independent auditor issued an unqualified opinion on the FY2019 financial statements and internal control over financial reporting; management also reported effective disclosure controls and internal controls.
Important facts for investors to verify
- How much of earnings and cash generation is sustainable without the $11.177 million property-sale gain, and how operating cash flow trends in subsequent periods.
- Whether John Morrell royalties, BPP account concentration and key-supplier dependence change, including contract terms, volumes and any customer or supply disruptions.
- Whether beef, labor, distribution and other operating costs pressure margins, and whether pricing or efficiencies offset those increases.
- Franchise openings, closures and comparable sales, particularly given 34 closures versus 13 openings in FY2019.
- Cash available after interest, lease obligations, dividends and other capital needs, along with compliance with note covenants and the ability to refinance at maturity.
- The ongoing effects of Topic 606 and lease-standard adoption when comparing reported results across periods.