Nathan’s Famous, Inc. — Q1 FY2018 Form 10-Q
Business context and period. The filing covers the 13 weeks ended June 25, 2017, compared with the 13 weeks ended June 26, 2016. Nathan’s markets branded food products through its Branded Product Program, product licensing, and restaurant operations. At quarter-end, it had 279 franchised units and five company-operated units. Results are seasonal and the quarter is not necessarily indicative of the full year.
Financial results
Unless noted otherwise, amounts are in millions of dollars. Per-share amounts are in dollars.
| Metric | Q1 FY2018 | Prior-year quarter | Change |
|---|---|---|---|
| Total revenue | $30.918 | $29.416 | Up 5.1% |
| Sales | $22.345 | $21.262 | Up 5.1% |
| Income from operations | $8.450 | $8.824 | Down 4.2% |
| Net income | $2.922 | $3.550 | Down 17.7% |
| Diluted EPS | $0.69 | $0.85 | Down $0.16 |
| Operating cash flow | $4.388 | $4.945 | Down 11.3% |
| Adjusted EBITDA (non-GAAP) | $8.973 | $9.366 | Down 4.2% |
- Revenue mix and drivers: Branded Product Program sales rose 10.4% to $17.937 million, reflecting approximately 8.3% higher volume and 1.3% higher average selling prices. License royalties rose 8.5% to $7.401 million, including higher royalties on hot-dog sales. Restaurant operations revenue declined to $5.580 million from $6.173 million; company-owned restaurant sales fell to $4.408 million from $4.843 million, primarily due to unfavorable weather. Traditional franchise comparable domestic sales fell 3.6%.
- Margins and costs: Gross profit on sales fell to $4.820 million, or 21.6% of sales, from $5.804 million, or 27.3%. Cost of sales rose 13.4%, mainly due to a 9.3% increase in average hot-dog cost and higher volume. Company-restaurant cost of sales increased to 58.6% of restaurant sales from 54.7%, reflecting lower sales and higher labor costs. Operating income declined despite revenue growth.
- Taxes: The effective tax rate was 39.7%, versus 31.3% a year earlier. Excess stock-compensation tax benefits reduced the rates by 1.6 and 12.0 percentage points, respectively; the prior-year benefit was substantially larger.
- Cash and liquidity: Cash was $60.817 million at June 25, up $3.902 million from March 26, 2017. Net working capital was $60.059 million. Operating cash flow of $4.388 million was partly offset by $0.204 million of capital expenditures and $0.282 million of financing outflows, including dividends and share-award withholding taxes.
- Debt: The company had $135 million face value of 10% senior secured notes due in March 2020; carrying value, net of unamortized issuance costs, was $131.775 million. Quarterly interest expense was $3.663 million. The notes require approximately $13.5 million of annual cash interest; the company reported covenant compliance and no scheduled principal amortization before maturity. Debt fair value was reported as $144.113 million.
Material changes, outlook and risks
- Branded Product Program growth and licensing royalties were offset by weaker company-operated restaurant sales, lower traditional franchise royalties and pressure on product and restaurant margins. The company attributed the restaurant sales decline mainly to weather and cited higher beef and labor costs.
- Management said available cash and operating cash flow should be sufficient for operations, debt service and planned investment for at least the next 12 months. It expects to invest in restaurants and branded programs, service debt and may continue stock repurchases; no specific earnings or revenue guidance was provided.
- Management estimated a fiscal-year tax rate of approximately 40.8%–42.3%, excluding excess stock-compensation tax benefits and any reduction in uncertain tax benefits. The final rate remains subject to variables including state revenue and tax determinations.
- Key exposures include volatile beef and other commodity costs, the ability to pass cost increases through to customers, New York minimum-wage increases and scheduling rules, weather-sensitive restaurant sales, dependence on principal supplier John Morrell & Co., franchisee health, and refinancing the 2020 notes. Management warned that labor and food-cost increases could materially pressure company and franchisee margins.
- John Morrell announced a voluntary Class II recall on May 19, 2017, involving approximately 200,000 pounds of hot dogs, including Nathan’s products, after reports of visible metal flakes between product and packaging. The filing gives no clear estimate of any financial impact.
- A subsidiary recorded a $204,000 liability for a Brooklyn restaurant lease guaranty following re-franchising; additional potential costs were not reasonably determinable. Management said routine litigation was not expected to have a material adverse effect, while noting litigation uncertainty.
- The company adopted updated inventory measurement guidance without material impact. It was evaluating the future revenue standard, including possible timing changes for franchise and development fees and minimum guarantees, and the lease standard, which it expected to significantly increase other assets and liabilities.
Important facts for investors to verify
- Whether higher beef costs can be offset through pricing, purchasing arrangements or other operating efficiencies, and the resulting effect on gross margin.
- Subsequent comparable sales and unit trends for company-operated and franchised restaurants, including the impact of weather and labor regulation.
- Cash generation, dividend and repurchase activity, and the company’s capacity to service and refinance the $135 million notes due in 2020.
- Any financial, customer or reputational effects from the supplier recall, and developments related to the Brooklyn lease guaranty or other contingencies.
- Progress and eventual financial-statement effects of adopting the new revenue and lease accounting standards.