NATH

Business Context and Reporting Period

Company: Nathan's Famous, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 24, 2001 (Thirteen weeks)
Business Overview: The company operates and franchises Nathan's, Kenny Rogers Roasters, and Miami Subs restaurant concepts. It also generates revenue through licensing agreements and a Branded Product Program. As of the reporting date, the system included 24 company-owned units and 384 franchised or licensed units.

Key Financial Metrics

Margins: Net income margin was approximately 8.1% for the quarter. The effective income tax rate was 43.8% compared to 40.4% in the prior year.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 7.9% to $11.876 million. Company-owned restaurant sales dropped 15.7% primarily due to the operation of seven fewer company-owned stores. However, sales from the Branded Product Program increased 35.3%.
• Profitability Increase: Despite lower revenues, Net Income increased 29.1% to $962,000. This was driven by a $210,000 reversal of a litigation provision, a $96,000 gain on the sale of a restaurant, and reduced operating expenses from closing underperforming units.
• Cash Flow Shift: Operating cash flow turned negative at $(2.232) million, a significant decline from the $5.313 million positive flow in the prior year. This was due to decreases in accounts payable and accrued expenses, and increased investment in marketable securities.
• Asset Reduction: The company sold two company-owned restaurants during the quarter, generating $1.875 million in proceeds. One sale was a condemnation by the State of Florida.

Guidance, Outlook, Risks, and Contingencies

Management Commentary and Outlook

Management expects to fund future investments in existing restaurants from operating cash flow and does not anticipate significant capital expenditures for new company-owned restaurants. The company maintains a $7.5 million uncommitted bank line of credit with no current borrowings. Management believes available cash and securities are sufficient to finance operations for the next twelve months.

Risks and Contingencies

• Legal Proceedings:
  • Sexual Harassment Lawsuit: Named as a defendant in a $17 million lawsuit in New York regarding alleged failure to supervise a former employee who harassed a minor. The company intends to defend vigorously.
  • Franchise Dispute: Miami Subs is defending a lawsuit in Florida regarding a franchise sale involving fraud and breach of contract claims. Damages sought are unspecified.
• Tax Audit: A tentative settlement with the IRS regarding Miami Subs tax audits (1991-1996) is pending. If approved, the liability will be approximately $101,520 plus interest (total under $300,000). The company has accrued $345,000 for this matter.
• Divestiture Plan: The company is closing underperforming Miami Subs restaurants. Approximately $1.461 million has been accrued for lease reserves and termination costs. Future cash payments for lease terminations may be required.
• Commodity Prices: Primary meat product prices rose to recent highs. While retail prices were raised in select situations, sustained high costs could impact margins.

Investor Verification Checklist

• Verify the status of the $17 million sexual harassment lawsuit and the potential for additional legal costs.
• Confirm the final approval of the IRS tax audit settlement and the impact on future tax liabilities.
• Monitor the execution of the Miami Subs divestiture plan and the actual cash outflows for lease terminations versus the $1.461 million accrual.
• Assess the sustainability of the Branded Product Program's 35.3% growth rate as a counterbalance to declining company-owned restaurant sales.
• Review the impact of rising commodity costs on future gross margins, given the company's limited hedging strategy.