Nathan’s Famous, Inc. — Q1 FY2015 Form 10-Q
Reporting period: Thirteen weeks ended June 29, 2014; comparative period ended June 30, 2013. Amounts are in U.S. dollars; financial statement amounts are in thousands unless noted. Results are seasonal and interim results may not indicate full-year performance.
Business context and financial performance
Nathan’s markets its brand through branded foodservice products, company-operated restaurants, retail and foodservice licensing, and franchising. At quarter-end, its system included 311 franchised outlets and five company-owned restaurants. The quarter benefited from the new John Morrell & Co. retail hot-dog license agreement and from having the Coney Island and Yonkers restaurants open for the full period.
- Revenue: Total revenue was $27.668 million, up 18.2% from $23.401 million. Sales rose 21.6% to $20.528 million; license royalties increased to $5.568 million from $2.257 million. Franchise fees and royalties were $1.489 million, versus $1.355 million.
- Profitability: Gross profit was $4.240 million, or 20.7% of sales, compared with $3.475 million, or 20.6%. Earnings before tax were $6.862 million versus $5.527 million. Net income increased 21.4% to $4.071 million from $3.354 million; diluted EPS was $0.89 versus $0.73. The effective tax rate was 40.7%, compared with 39.3%.
- Cash flow: Operating cash flow was $3.019 million, compared with cash used of $1.296 million in the prior-year quarter. Investing activities provided $1.450 million; financing activities used $1.441 million, including $1.559 million for share repurchases. Cash and cash equivalents increased $3.028 million to $25.105 million.
- Liquidity and debt: Marketable securities were $9.415 million, and working capital was $38.298 million. Total current assets were $46.782 million against current liabilities of $8.484 million. The company reported no outstanding indebtedness.
- Other metrics: The company repurchased 31,860 shares for $1.559 million during the quarter. Capital expenditures were $220,000. Total liabilities were $10.868 million and stockholders’ equity was $46.686 million at June 29, 2014.
Material changes versus the prior-year quarter
- Retail hot-dog royalties rose substantially under the John Morrell agreement, which began March 1, 2014. Royalties from John Morrell were $4.656 million, compared with $1.466 million from the former licensee in the prior period. Management said the higher rate drove the increase and that results will depend on the new licensee’s performance.
- Company-operated restaurant sales increased to $5.291 million from $3.726 million, primarily because Coney Island and Yonkers operated for the full quarter. Management estimated the comparative sales impact from these restaurants at approximately $1.6 million.
- Branded Product and Branded Menu foodservice sales increased 14.6%, reflecting higher average selling prices and a 3.7% increase in product volume. Comparable domestic franchise sales declined 1.3%; traditional franchise royalties also edged lower.
- Hot-dog market prices were approximately 12.9% higher year over year; the company’s average cost per pound for branded-product hot dogs increased approximately 15%. Gross margin held nearly steady as higher company-restaurant sales partly offset increased beef costs.
- Prior-year results included a $2.801 million insurance gain related to Superstorm Sandy, $112,000 of interest expense associated with a legal judgment, and a $400,000 impairment charge on a long-term investment. These items did not recur in the current quarter.
Outlook, risks, contingencies and unusual items
- Management believes cash, marketable securities and operating cash flow will be sufficient to fund operations and planned share repurchases for at least 12 months. No specific earnings or revenue guidance was provided.
- Management expects the FY2015 annual tax rate to be approximately 39.5%–41.5%. It said uncertain tax benefits could decline by up to $64,000 within the next year; the filing also discusses a possible reduction of up to $124,000 during the remainder of FY2015, including related interest and penalties.
- The company warned that volatile beef costs, supply constraints, and its ability to pass higher costs on to customers could pressure margins. It had no open hot-dog purchase commitments at quarter-end. Other cost risks include utilities, insurance, labor, health care and minimum-wage changes.
- A new New York City paid-sick-leave requirement affects three company restaurants; the company was assessing the impact. Its union contract expired in June 2014, and a replacement was under negotiation. Management estimated the cited New York minimum-wage increase could add about 50 basis points to restaurant cost of sales if prices were unchanged.
- The company was considering relocating its Oceanside restaurant, subject to permits and variances, with a possible closure in November 2014 and reopening in March 2015. It estimated potential relocation capital spending of approximately $1.3 million.
- Commitments include $19.856 million of gross contractual obligations, principally operating leases and employment agreements, partly offset by $2.964 million of sublease income. A West Nyack lease guaranty liability of approximately $133,000 was recorded; payment had not been required. Ordinary-course litigation was not expected by management to have a material adverse effect, though outcomes remain uncertain.
- The filing highlighted a July 2014 NLRB general-counsel ruling concerning potential joint employer liability for franchisee labor violations. If upheld and applied to Nathan’s, it could increase liability and affect franchisee operations. The company also noted reliance on John Morrell as its principal supplier/licensee.
- In April 2014, the company settled its remaining Sandy-related business-interruption claim and received approximately $718,000, recorded in operating cash flows.
Important facts for investors to verify
- Whether the higher royalty rate and sales under the John Morrell agreement are sustainable, and the company’s dependence on that counterparty.
- Beef-cost trends, pricing actions, and resulting branded-product and restaurant margins, particularly without purchase commitments.
- Comparable franchise sales and outlet performance, alongside the effects of restaurant reopenings on comparisons.
- The actual effect of labor, sick-leave, health-care and insurance costs, and any outcome of union-contract negotiations.
- Progress, permits, timing and final cost of the proposed Oceanside relocation; any changes to liquidity, repurchases or contractual obligations.
- Developments in uncertain tax positions and the NLRB franchise-liability issue. The filing does not provide a clear quantified estimate of potential exposure from the NLRB matter.