NATH

Business Context and Reporting Period

Company: Nathan's Famous, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 27, 2010 (Thirteen weeks)
Business Overview: The Company operates and franchises quick-service restaurants and markets the "Nathan's Famous" brand through a Branded Product Program, licensing agreements, and the sale of proprietary spices. As of June 27, 2010, the system included 252 franchised units and 5 Company-owned units.

Key Financial Metrics

Margins: Gross profit margin on sales decreased to 23.2% in Q2 2010 from 26.4% in Q2 2009, primarily due to higher hot dog costs. The effective tax rate was 34.0% in Q2 2010 compared to 36.8% in Q2 2009.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 9.8% year-over-year. Sales from the Branded Product and Branded Menu Programs rose 14.7% to $7.85 million, driven by higher volume. Company-owned restaurant sales increased 15.2% to $4.03 million, attributed to higher customer counts and favorable weather at the Coney Island location.
• Cost Pressures: Cost of sales increased 17.0% to $9.49 million. The market price of hot dogs was approximately 9.6% higher than the prior year, though purchase commitments mitigated the impact, keeping the cost increase to 7.9%.
• Franchise Performance: Comparable domestic franchise sales decreased 1.7%. International franchise sales declined 26.2%, primarily in the Middle East. However, franchise fee income increased 50.4% due to new openings and re-franchising.
• Cash Flow Improvement: Net cash provided by operating activities surged to $1.20 million from $15,000 in the prior year, driven by net income and non-cash adjustments, despite a $1.46 million increase in accounts receivable.

Outlook, Risks, and Contingencies

• Guidance: Management estimates the annual effective tax rate for the fiscal year ending March 27, 2011, will be between 36.0% and 39.0%. No specific revenue or earnings guidance was provided for the full year.
• Legal Proceedings:
  • SMG, Inc. Litigation: Ongoing dispute regarding the termination of a License Agreement for retail hot dog distribution. Summary judgment motions were denied in February 2010; a trial is expected before the end of calendar 2010.
  • Painted Pieces LTD: Copyright infringement lawsuit settled in May 2010 for $140,000.
• Risk Factors:
  • Commodity Costs: Volatility in beef prices remains a significant risk. Management expects continued price volatility for beef products in fiscal 2011.
  • Healthcare Reform: New federal legislation may force the Company to expand healthcare coverage for part-time workers or incur penalties, potentially increasing costs.
  • Franchisee Performance: Earnings depend heavily on franchisee success; operational shortcomings by franchisees could damage the brand reputation.
• Subsequent Event: On August 3, 2010, the Company established an uncommitted $10 million line of credit expiring June 30, 2011.

Investor Verification Checklist

• Commodity Hedging: Verify the extent of future purchase commitments for hot dogs to mitigate rising beef costs, as the current commitments have concluded.
• SMG Litigation Outcome: Monitor the trial scheduled for late 2010 regarding the SMG, Inc. license agreement, as a loss could disrupt the primary retail supply chain.
• Receivables Management: Review the $1.46 million increase in accounts receivable to ensure collectability, particularly from licensees and the television retailer.
• Healthcare Costs: Assess the potential financial impact of the 2010 healthcare reform legislation on the Company's part-time workforce.
• Stock Repurchases: Note that 821,207 shares remain available for repurchase under existing plans, though no shares were bought in Q2 2010.