Nathan’s Famous, Inc. — Form 10-Q Summary
Business context and reporting period
For the 13 and 26 weeks ended September 27, 2015, corresponding to the second quarter and first half of fiscal 2016. Comparisons are with periods ended September 28, 2014. The business sells branded products, operates restaurants, and earns licensing and franchise royalties. Results are seasonal; interim performance is not necessarily indicative of the full year.
At quarter-end, the system included 272 franchised units and five company-operated restaurants. Management cited 267 operating franchised or Branded Menu outlets in its results discussion, versus 312 a year earlier.
Financial performance and liquidity
| Metric | 13 weeks | 26 weeks |
|---|---|---|
| Total revenue | $30.6 million, up 6.1% | $61.3 million, up 8.5% |
| Operating income | $8.4 million, versus $6.4 million | $16.0 million, versus $13.2 million |
| Net income | $2.8 million, versus $3.9 million | $5.2 million, versus $7.9 million |
| Diluted EPS | $0.64, versus $0.84 | $1.14, versus $1.73 |
| Gross margin on sales | 26.3%, versus 20.7% | 23.7%, versus 20.7% |
| Adjusted EBITDA (non-GAAP) | $9.0 million, versus $7.1 million | $17.3 million, versus $14.6 million |
For the quarter, sales rose 5.0% to $24.0 million, license royalties increased to $5.3 million from $4.5 million, while franchise fees and royalties declined to $1.4 million from $1.5 million. First-half sales rose 8.1% to $46.9 million; license royalties increased to $11.8 million from $10.1 million, while franchise fees and royalties fell to $2.6 million from $3.0 million.
Interest expense was $3.7 million for the quarter and $7.4 million for the half-year; there was no interest expense in the prior-year comparison. Cash from operations was $8.5 million for the half-year, versus $8.3 million. Investing provided $6.7 million and financing used $7.2 million, including $7.2 million of share repurchases. Cash increased by $8.0 million to $59.4 million.
At September 27, current assets were $71.2 million and current liabilities $10.5 million, yielding working capital of $60.8 million. The company had $135.0 million principal amount of 10% senior secured notes due 2020, carried at $129.7 million net of unamortized discounts and issuance costs. Stockholders’ deficit was $61.6 million. The company reported covenant compliance.
Material changes versus prior comparable periods
- Operating income improved in both periods, and gross margin rose, primarily reflecting lower beef costs and prior price increases. Management reported a 7.1% year-over-year reduction in branded-product hot-dog cost per pound for the quarter.
- Net income and EPS declined despite higher operating income because the new notes generated substantial interest expense. The notes were issued in March 2015 to fund a $25-per-share special dividend of approximately $116.1 million.
- Branded-product sales and licensing royalties grew, including strong growth in consumer-packaged hot dogs. Franchise restaurant sales and franchise fee income weakened, with closed locations and timing of international development deals cited as factors. Comparable domestic franchise sales were nearly flat for the half-year.
- General and administrative expense increased 10.6% for the quarter and 13.8% for the half-year, with higher compensation, professional, recruitment, and—in the half-year—severance costs cited.
- The company sold its municipal-bond marketable securities; their proceeds were included in cash and cash equivalents at quarter-end.
Outlook, risks and unusual items
- No revenue or earnings guidance was provided. Management expects available cash and operating cash flow to fund operations, debt service, and repurchases for at least the next 12 months. It estimated approximately $13.5 million annual interest expense plus approximately $1.2 million annual amortization of debt discounts and issuance costs; approximately $13.8 million of interest payments were expected in fiscal 2016.
- Management estimated a fiscal 2016 effective tax rate of approximately 40.5%–41.9%, excluding potential reductions in unrecognized tax benefits. It said such benefits could be reduced by up to $98,000 through tax settlements, while the MD&A also refers to a possible reduction of up to $183,000 including related interest and penalties.
- Beef and hot-dog costs remain volatile. There were no open hot-dog purchase commitments at quarter-end; the company was negotiating a commitment for approximately 2.6 million pounds, to be priced after production. A 10% change in food and paper costs for the half-year would have changed cost of sales by approximately $3.2 million.
- New York fast-food minimum-wage increases beginning December 2015 could pressure restaurant and franchisee margins. Other stated risks include dependence on principal supplier John Morrell & Co., labor and health-care costs, energy and distribution costs, franchisee closures, and possible franchisor joint-employer liability.
- After quarter-end, the company extended its modified Dutch Auction tender offer to November 16, 2015. It offered to buy up to 500,000 shares at $33–$36 per share, with the right to purchase up to 88,610 additional shares. The outcome was not reflected in these statements.
- The company disclosed a New York State tax-return review for April 2011–March 2014 and ordinary-course litigation; management did not expect litigation to have a material adverse effect, while noting outcomes are uncertain.
Important facts for investors to verify
- Whether branded-product and licensing growth can continue, and whether beef-cost changes can be passed through in prices.
- Franchise outlet counts, closures, comparable sales, and the explanation for differences in outlet counts stated in the filing.
- Debt-service capacity under the 10% notes, covenant restrictions, and the company’s cash needs after any tender-offer repurchases.
- The eventual tender-offer results and share count, plus the effects of New York wage legislation on company restaurants and franchisees.
- The outcome of tax reviews and uncertain-tax-position settlements; the filing gives different potential reduction figures depending on whether interest and penalties are included.