Nathan’s Famous, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2016, the 13 weeks ended June 28, 2015; comparisons are with the 13 weeks ended June 29, 2014. Amounts below are in millions unless stated otherwise. The company markets branded products, operates restaurants, and earns licensing and franchise revenue.
Financial results
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Total revenue | $30.654 | $27.585 | Up 11.1% |
| Operating income | $7.616 | $6.779 | Up 12.3% |
| Net income | $2.310 | $4.071 | Down 43.3% |
| Diluted earnings per share | $0.50 | $0.89 | Down $0.39 |
| Operating cash flow | $6.616 | $3.019 | Up $3.597 |
| Capital expenditures | $0.154 | $0.220 | Down $0.066 |
Gross profit was $4.785 million, or 20.9% of sales, versus $4.240 million, or 20.7%. Operating margin was approximately 24.8%, compared with 24.6%. Net margin was approximately 7.5%, versus 14.8%. Adjusted EBITDA, a non-GAAP measure defined by the company, was $8.257 million versus $7.447 million.
Sales rose 11.5% to $22.891 million, led by Branded Product Program sales, up 15.6% to $17.415 million. License royalties rose 17.4% to $6.536 million, including 19.7% growth in royalties from the John Morrell agreement. Franchise fees and royalties fell to $1.227 million from $1.489 million. Traditional franchise restaurant sales declined, and comparable domestic franchise sales fell 0.7%. The franchise system had 291 outlets, versus 311 a year earlier; five franchised and ten Branded Menu outlets opened during the quarter.
Cash and cash equivalents were $51.603 million and marketable securities were $7.832 million at quarter-end. Net working capital was $59.117 million, down from $61.605 million at March 29, 2015. Current liabilities were $15.617 million. The company reported $135.0 million principal amount of 10% senior secured notes due 2020, with a net carrying value of $129.437 million after discounts and issuance costs. Total liabilities were $148.307 million. The notes had a reported fair value of $144.788 million.
Material changes and notable items
- Net income was substantially lower primarily because the new notes, issued in March 2015, generated $3.709 million of quarterly interest expense, including $3.412 million accrued interest and $0.297 million amortization of debt discounts and issuance costs. The prior-year quarter had no interest expense. The first semiannual cash interest payment was due September 15, 2015.
- The notes financed a $25-per-share special dividend of approximately $116.1 million. During the quarter the company repurchased 135,987 shares for $5.360 million, at an average reported price of $39.3932 per share; 115,285 shares remained authorized for repurchase.
- General and administrative expense increased 16.6% to $3.624 million, chiefly due to higher severance, professional and recruiting costs. Branded Product Program hot-dog costs per pound rose 4.8%; pricing actions helped the overall gross margin improve slightly.
- Operating cash flow benefited from working-capital movements, including a reduction in prepaid expenses and increases in payables and accrued liabilities. Cash used in financing activities was $5.435 million, primarily for share repurchases. Cash interest paid in the quarter was zero.
Outlook, risks and contingencies
- Management stated that cash, marketable securities and operating cash flow should be sufficient for operations, debt service and repurchases for at least 12 months. It expects approximately $13.8 million of interest payments during fiscal 2016. No specific revenue or earnings guidance was provided.
- Management estimated a fiscal 2016 effective tax rate of approximately 40.4%–41.6%, excluding any benefit from reductions in uncertain tax positions. It said unrecognized tax benefits could decline by up to $98,000 within a year; a separate MD&A estimate cited a potential reduction of up to $183,000 including related interest and penalties. New York State had notified the company of a review of tax returns for April 2011 through March 2014.
- Key risks include volatile beef costs and constrained supply, reliance on John Morrell as principal supplier, and limited ability to pass cost increases through to customers. The company had no open hot-dog purchase commitments at quarter-end and did not hedge commodity exposure. A 10% short-term change in food and paper costs would have changed quarterly cost of sales by approximately $1.629 million.
- Potential wage increases in New York, including a proposed $15-per-hour fast-food minimum wage, could pressure company and franchisee economics. The filing also discusses possible joint-employer liability for franchisee labor violations, labor availability, food safety, and energy and distribution cost volatility.
- The notes impose restrictions on additional debt, dividends, repurchases and other activities; the company reported compliance with all note covenants at June 28, 2015. Litigation was described as ordinary and routine, with management not expecting a material adverse effect; the filing reports no legal proceedings under Part II.
- The company remained contingently liable for costs on two leased properties subleased to franchisees. It also reported $15.760 million of gross operating lease commitments and $2.615 million of expected sublease income.
Important facts for investors to verify
- Whether branded product and licensing growth continues to offset lower traditional franchise sales and the decline in franchise locations.
- The effect of beef-cost inflation, supplier dependence, and any price increases on sales volume and margins.
- The company’s ability to meet the 10% notes’ debt service and covenant requirements, especially after the large dividend recapitalization.
- Whether repurchases continue and how capital returns affect liquidity and share count.
- The final fiscal-year tax rate and outcome of the New York tax review and uncertain tax positions.
- The status and financial impact of proposed wage rules and potential franchise-related labor liability.