NATH

Business Context and Reporting Period

Company: Nathan's Famous, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 28, 2008 (Thirteen and Twenty-six weeks)
Business Overview: The Company operates and franchises Nathan's Famous restaurants, licenses its brand for retail products (Branded Product Program), and sells hot dogs and other proprietary items. As of September 28, 2008, the system included 235 franchised/licensed outlets and six Company-owned outlets.

Key Financial Metrics

Note: Net income for the 26-week period includes significant gains from discontinued operations ($2,467k).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 3.6% for the quarter and 6.8% for the year-to-date period. Sales from the Branded Product Program grew 20.8% (quarter) and 16.0% (YTD) due to volume increases and price hikes.
• Margin Compression: Gross profit margin for continuing operations declined to 24.7% (quarter) and 24.5% (YTD) from 29.1% and 26.9% respectively. This was driven by an 18.4% increase in beef costs for the Branded Product Program, partially mitigated by a fixed-price purchase commitment entered in January 2008.
• Discontinued Operations: The Company sold its subsidiary, NF Roasters Corp., in April 2008, realizing a gain of $3.66 million. This transaction, along with prior gains from the sale of Miami Subs, significantly boosted YTD net income.
• Franchise Performance: Comparable domestic franchise sales declined approximately 3.1% for the quarter and 2.9% YTD, attributed to the slowing economy and credit crisis affecting franchisee funding.
• Stock Repurchases: The Company repurchased 300,961 shares for $4.41 million during the 26-week period. Subsequent to the period end, the Company completed a $6 million 10b5-1 repurchase plan.

Guidance, Outlook, and Risks

• Economic Outlook: Management anticipates reduced sales in Company-owned and franchised restaurants due to the slowing economy and credit crisis. Preliminary results post-period indicate continued sales declines.
• Commodity Costs: Beef costs remain volatile and at historic highs. While a purchase commitment provided temporary savings, the Company expects continued price volatility and may need to implement further price increases to protect margins.
• Legal Proceedings: The Company is engaged in litigation with its primary frankfurter supplier, SMG, Inc., regarding the termination of a license agreement. The outcome could impact supply chains and royalty revenues. A stipulation was reached to delay termination until litigation is adjudicated.
• Liquidity: The Company maintains a strong balance sheet with no long-term debt. It decided not to extend its $7.5 million uncommitted bank line of credit, relying on cash, marketable securities, and operating cash flow for capital needs.
• Operational Risks: Risks include the closure of the Astroland Amusement Park in Coney Island (impacting the flagship store), reliance on single suppliers for frankfurters and fries, and potential increases in minimum wage.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by excluding the $3.66 million gain from the sale of NF Roasters Corp. and the $250,000 contingent gain from Miami Subs.
• Beef Cost Hedging: Confirm the status of future commodity purchase commitments, as the January 2008 commitment expired in August 2008.
• Supplier Litigation: Monitor the status of the lawsuit against SMG, Inc., as a loss could disrupt the primary supply of frankfurters for both restaurants and retail.
• Franchisee Solvency: Review the increase in bad debts ($155k increase in G&A) and the number of franchisees deemed uncollectible (15 outlets in the quarter) as a leading indicator of franchisee financial health.
• Stock Repurchase Completion: Note that the $6 million 10b5-1 repurchase plan was completed shortly after the period end, leaving only 16,116 shares remaining under the broader third repurchase plan.