Nathan’s Famous, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the 13 and 26 weeks ended September 29, 2019 (fiscal 2020 second quarter and first half), compared with the periods ended September 23, 2018. Nathan’s markets branded food products through foodservice distribution and licensing, and operates and franchises restaurants. At quarter-end, it had 241 franchised outlets and four company-operated units, versus 265 franchised outlets and five company-operated units a year earlier. Amounts below are in millions, except per-share data.
Key financial results
| Metric | Q2 FY2020 | Q2 FY2019 | 26 weeks FY2020 | 26 weeks FY2019 |
|---|---|---|---|---|
| Total revenue | $29.73 | $29.33 | $60.24 | $59.50 |
| Operating income | $7.37 | $8.48 | $16.81 | $17.57 |
| Net income | $3.66 | $4.48 | $9.03 | $9.28 |
| Diluted EPS | $0.87 | $1.06 | $2.14 | $2.19 |
| Gross margin | 26.3% | 29.7% | 25.1% | 27.2% |
| Operating margin | 24.8% | 28.9% | 27.9% | 29.5% |
- Q2 revenue grew 1.4%; sales rose 2.5%, while license royalties fell 5.6%. Franchise fees and royalties increased, including $0.375 million of forfeited fees, primarily following termination of the Russia and Kyrgyzstan master franchise agreement.
- First-half operating cash flow was $6.10 million, down from $10.00 million. Cash increased $4.03 million to $79.47 million after $2.96 million of dividends, $0.18 million of capital expenditures, and other financing activity. The decline in operating cash flow reflected working-capital uses, including higher receivables and lower accrued liabilities.
- At September 29, cash and cash equivalents were $79.47 million; current assets were $92.85 million and current liabilities $13.97 million. Net working capital was $78.88 million. The company reported a stockholders’ deficit of $62.95 million.
- Face-value debt was $150 million: 6.625% senior secured notes due November 2025, with no scheduled principal amortization before maturity. Net of cash, debt was approximately $70.53 million. Interest expense was $2.65 million in Q2 and $5.30 million for the first half. The company reported compliance with note covenants.
- Quarterly dividends increased to $0.35 per share from $0.25; $0.70 per share was declared in the first half. A further $0.35 dividend was declared November 8, payable December 6, 2019. Future dividends remain subject to board approval and debt restrictions.
Material changes and management commentary
- Branded Product Program Q2 sales rose 5.0%, with volume up about 5.4%, but average selling prices fell about 0.5%. For the first half, sales rose 1.4%; excluding distributor-transition effects, management estimated shipments decreased about 1.0%.
- Higher beef costs pressured results: Q2 Branded Product Program cost per pound rose 5.6%, while first-half cost per pound rose 3.1%. Consolidated gross margin contracted 3.4 percentage points in Q2 and 2.1 points for the first half, principally from higher beef costs.
- Q2 license royalties declined, largely because the John Morrell & Co. hot-dog royalty average net selling price fell 5.7%, partly offset by retail volume growth of 3.3%. First-half license royalties rose 2.2%, supported by volume growth.
- Comparable company-owned restaurant sales increased 2.2% in Q2 and 6.7% for the first half, but total company-owned sales declined because a restaurant had been sold. Comparable domestic franchise sales rose 1.7% in Q2 and 2.8% for the first half; the system had fewer outlets year over year.
- Management is pursuing a restaurant-system refresh focused on menu quality, customer experience, operations, and digital and social marketing. It expects approximately $0.8–$0.9 million of incremental expenses, including $0.37 million expected to be incurred by the Advertising Fund, and may selectively invest in showcase restaurants.
- The Advertising Fund’s seasonal deficit was not expected to be fully recovered during the fiscal year; the projected deficit was reflected in Q2 results. Q2 advertising fund expense was $1.067 million versus revenue of $0.697 million.
- Management stated available cash and expected operating cash flow should fund operations, debt service, dividends, and repurchases for at least 12 months. No specific earnings or revenue guidance was provided.
Risks, contingencies, and unusual items
- Beef-price volatility and the ability to pass higher costs to customers are central margin risks. The company had no open hot-dog purchase commitments at quarter-end and said most commodity purchases remain exposed to market prices.
- Other identified risks include reliance on John Morrell & Co. for licensing revenue and supply, New York minimum-wage and other labor regulations, weather-sensitive restaurant sales, franchisee viability, receivable collectibility, and potential tariffs. A 10% change in food and paper costs would have changed first-half cost of sales by approximately $2.812 million.
- The company adopted lease accounting Topic 842 on April 1, 2019, recognizing operating lease assets and liabilities. At September 29, operating lease assets were $7.52 million and lease liabilities totaled $8.26 million; adoption was non-cash and prior-year balances were not restated.
- The company recorded a $0.217 million liability for a Brooklyn franchisee lease guaranty. Management said ordinary litigation was not expected to have a material adverse effect, while noting litigation outcomes are uncertain. No legal proceedings were listed under Part II.
- Unrecognized tax benefits were $0.280 million, with $0.267 million of accrued interest and penalties. Management said the tax benefit could decrease by up to $0.011 million during fiscal 2020.
- Cash balances substantially exceeded government-insured limits. The filing also identifies exposure to changes in returns on short-term investments and commodity, distribution, utility, and insurance costs.
Important facts for investors to verify
- Whether beef costs stabilize and Nathan’s can sustain product pricing and gross margins.
- Whether John Morrell & Co. licensing volumes and economics, especially retail hot-dog royalties, remain durable.
- Progress and actual costs of the restaurant-system initiative, including whether incremental spending produces stronger comparable sales and franchise growth.
- Cash generation and working-capital trends, alongside the $150 million note maturity in 2025 and dividend commitments.
- Impact of the Advertising Fund deficit, franchise-unit closures and openings, and the terminated Russia and Kyrgyzstan agreement.
- Lease obligations, the Brooklyn lease guaranty, tax contingencies, and compliance with note covenants and dividend restrictions.