Nathan’s Famous, Inc. — Q1 FY2017 Form 10-Q
Reporting period: Thirteen weeks ended June 26, 2016; comparable period ended June 28, 2015. Amounts are in U.S. dollars. Results are unaudited and interim results may be seasonal.
Business context
Nathan’s markets its branded food products through foodservice and retail programs, licenses products, and operates and franchises restaurants. At quarter-end, its system included 261 franchised units and five company-operated restaurants, compared with 291 franchised units and five company-operated restaurants a year earlier.
Financial results and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 | Change / context |
|---|---|---|---|
| Total revenue | $29.416 million | $30.654 million | Down 4.0% |
| Net income | $3.550 million | $2.310 million | Up 53.7% |
| Diluted EPS | $0.85 | $0.50 | Up 70.0% |
| Operating income | $8.824 million | $7.616 million | Up 15.9% |
| Gross profit on sales | $5.804 million | $4.785 million | Gross margin 27.3% vs. 20.9% |
| Operating cash flow | $4.945 million | $6.616 million | Down $1.671 million |
| Capital expenditures | $0.277 million | $0.154 million | — |
Sales declined 7.1% to $21.262 million: Branded Product Program sales fell 6.7% to $16.254 million, and company-operated restaurant sales fell to $4.843 million from $5.299 million. License royalties increased to $6.824 million from $6.536 million; franchise fees and royalties rose to $1.330 million from $1.227 million. Total revenue includes these sales and royalty/fee streams.
Lower beef costs materially improved product economics: beef costs were down 20.4%, while average Branded Product selling prices declined about 9.6% under the company’s cost-based pricing strategy and volume rose 2.7%. Restaurant sales were hurt by rainy and unseasonably cool weather in April and May. General and administrative expense increased 6.2%, principally due to 100th-anniversary marketing.
Cash and cash equivalents were $52.838 million at June 26, 2016, up $2.610 million from March 27, 2016. Working capital was $51.916 million. Current assets were $67.176 million and current liabilities $15.260 million. Cash used in investing was $0.277 million and cash used in financing was $2.058 million, including $1.272 million of share repurchases and $0.705 million of withholding taxes on share settlements.
Senior secured notes had $135 million principal outstanding, carried at $130.577 million net of discounts and issuance costs. The notes bear 10% interest, mature in 2020, and have no scheduled principal amortization before maturity. Quarterly interest expense was $3.676 million; management expects approximately $13.5 million of annual cash interest. The company reported compliance with note covenants. Debt fair value was reported as $145 million.
Non-GAAP EBITDA was $9.193 million versus $7.986 million; Adjusted EBITDA was $9.366 million versus $8.257 million. These measures exclude specified expenses and should be considered alongside GAAP results.
Material changes and unusual items
- Net income benefited from a $0.621 million excess tax benefit on share-based compensation following early adoption of new accounting guidance. The reported effective tax rate was 31.3%, versus 41.3% a year earlier; excluding the share-compensation benefit and other stated adjustments, management cited effective rates of 43.1% and 39.9%, respectively.
- Receivables increased by $4.169 million from quarter-start, substantially reflecting seasonally higher branded-product sales and royalty receivables, plus seasonal advances to the advertising fund.
- The company repurchased 30,616 shares for $1.272 million during the quarter; 260,258 shares remained authorized for repurchase under its existing program.
- The quarter included completion of a purchase commitment for approximately 662,000 pounds of hot dogs, which management said reduced overall hot-dog costs by about 110 basis points. No hot-dog purchase commitments remained open at quarter-end.
Outlook, risks and contingencies
Management gave no revenue or earnings forecast. It estimated a FY2017 annual tax rate of approximately 42%–44%, excluding share-compensation excess tax benefits and any reduction in uncertain tax benefits. Management said cash, securities and operating cash flow should be sufficient for operations, debt service and planned repurchases for at least 12 months.
Key risks cited include volatile beef and other commodity costs, reliance on principal supplier John Morrell & Co., and the ability to pass cost increases through pricing. New York minimum-wage increases and labor costs may pressure company and franchisee margins; the company was evaluating pricing and operating efficiencies. Weather, consumer demand, receivable collectibility, franchise growth, food-safety events, and debt-service obligations are also identified risks. The company noted ordinary-course litigation, with management not expecting a material adverse outcome, while acknowledging litigation uncertainty. The IRS notified the company it would review its federal return for April 1, 2014–March 31, 2015.
The company remains contingently liable for costs on a property it leases and sublets to a franchisee. Total net cash contractual obligations were reported as $149.208 million, including the $135 million notes principal and operating leases. Management cautioned that beef prices and restaurant labor costs could adversely affect future results.
Important facts for investors to verify
- Whether higher earnings persist after removing the one-time $0.621 million tax benefit and considering the stated 42%–44% annual tax-rate estimate.
- Whether lower beef costs continue, and whether price reductions, commodity costs, and purchase commitments support or erode margins.
- Sales and comparable-sales trends in branded products, company-operated restaurants, and franchise locations, including the effect of weather and unit closures.
- Cash generation and the company’s ability to service 10% notes, meet contractual commitments, and fund repurchases; principal repayment or refinancing is due in 2020.
- Potential impacts from New York minimum-wage increases, the IRS review, uncertain tax positions, and the contingent lease obligation.