Nathan’s Famous, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Third quarter (13 weeks) and year to date (39 weeks) ended December 24, 2017; comparisons are with periods ended December 25, 2016. Amounts below are in millions of dollars unless otherwise noted.
Business context
Nathan’s markets branded food products through its Branded Product Program, product licensing, and restaurant operations. At quarter-end, its system included 285 locations: 280 franchised and five company-operated. The company reported three operating segments: Branded Product Program, product licensing, and restaurant operations.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | 39 weeks FY2018 | 39 weeks FY2017 |
|---|---|---|---|---|
| Total revenue | $22.1 | $19.9 | $84.6 | $77.4 |
| Operating income | $5.4 | $4.8 | $22.6 | $21.6 |
| Net income (loss) | $(3.8) | $0.7 | $2.3 | $6.8 |
| Diluted EPS | $(0.90) | $0.17 | $0.54 | $1.61 |
| Adjusted EBITDA (non-GAAP) | $5.9 | $5.3 | $24.1 | $23.2 |
Q3 revenue rose 10.8% and operating income rose 13.0%. Gross profit as a share of sales fell to 24.9% from 27.4%, mainly because beef costs increased and company restaurant labor costs rose. The quarterly net loss chiefly reflects an $8.9 million loss on extinguishment of debt; the company refinanced its notes during the quarter. YTD revenue grew 9.4%, but net income declined, reflecting the debt-extinguishment loss and lower gross margin.
Q3 Branded Product Program sales increased 14.0%, with volume up approximately 10.4% and average selling prices up approximately 3.0%; beef costs were approximately 8.0% higher. License royalties increased 6.0%. Franchise fees and royalties were flat at $1.1 million, while comparable domestic franchise sales declined. For the 39-week period, Branded Product Program sales rose 14.4% and licensing royalties rose to $17.4 million; company-operated restaurant sales and franchise fees and royalties declined.
YTD cash provided by operations was $7.8 million, versus $9.8 million a year earlier. Capital expenditures were $0.5 million. Cash increased to $67.3 million from $56.9 million at fiscal year-end. Current assets were $82.9 million and current liabilities were $31.1 million; working capital was $51.8 million. Current liabilities included a $21.1 million special dividend payable at quarter-end, paid January 4, 2018.
At December 24, 2017, the company had $150.0 million face value of 6.625% senior secured notes due 2025, carried at $144.6 million net of unamortized issuance costs. Total liabilities were $178.0 million and stockholders’ deficit was $85.0 million. Management stated available cash and operating cash flows should fund operations and debt service for at least 12 months.
Material changes, outlook and risks
- Refinancing and dividend: Nathan’s issued $150 million of 6.625% notes due 2025 and redeemed its $135 million 10.0% notes due 2020. It recorded an $8.9 million extinguishment loss, including the call premium and write-off of debt issuance costs. Management expects annual cash interest expense to decline by approximately $3.6 million; the new notes have no scheduled principal amortization before maturity.
- Capital return: The board declared a $5.00-per-share special dividend, approximately $20.9 million, paid after quarter-end. The debt indenture restricts certain dividends, repurchases, additional debt, liens, asset sales, and other transactions.
- Operating pressures: Management cited volatile beef costs, rising New York minimum wages and other labor costs, and weather sensitivity at seasonal restaurants. It warned that margins could be pressured if pricing and operating efficiencies do not offset cost increases. A New York City fair-workweek law could create scheduling penalties; management estimated these could reach $10,000 per day at two beach restaurants during peak summer periods, with the ultimate impact uncertain.
- Concentration and execution risks: The company depends on John Morrell & Co. as its principal supplier and on related licensing and supply arrangements. Other stated risks include customer demand, franchisee recruitment and viability, receivable collection, food safety, and commodity and distribution costs.
- Taxes and accounting: The company recorded an estimated $0.4 million tax benefit related to the Tax Cuts and Jobs Act. It cautioned that the net effect of the lower corporate tax rate and limits on interest deductions is unclear. It estimated a 40.8%–43.1% annual tax rate for FY2018 excluding discrete items and excess stock-compensation tax benefits. New revenue guidance may affect the timing of certain franchise and development fees and require advertising fund contributions and expenses to be reported gross; implementation was planned for fiscal 2019.
- Other matters: The company recorded a $0.2 million liability for a lease guarantee related to a refranchised Brooklyn restaurant; additional potential costs were not reasonably determinable. Management said ordinary litigation was not expected to materially affect results, though unfavorable outcomes remain possible. No formal revenue or earnings guidance was provided.
Most important facts for investors to verify
- Whether Branded Product Program volume and pricing can offset further increases in beef and other input costs, and whether gross margins stabilize.
- The realized interest savings and compliance with the 2025 notes’ covenants, including restrictions on dividends and additional debt.
- The ongoing effect of New York labor and scheduling rules on company-operated restaurant costs and franchisee economics.
- The trajectory of comparable franchise sales, restaurant openings and closures, and reliance on key supplier and licensing relationships.
- The final tax impact of the Tax Cuts and Jobs Act, including any effect from limits on interest deductibility.