NATH

Business Context and Reporting Period

Company: Nathan's Famous, Inc.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Thirteen and twenty-six weeks ended September 24, 2006 (Fiscal 2007 Q2 and YTD).
Business Overview: The Company operates a system of 360 franchised/licensed units and six company-owned restaurants. Revenue streams include the Branded Product Program (hot dogs and proprietary items), company-owned restaurant sales, franchising fees/royalties, and licensing royalties.

Key Financial Metrics

All figures in thousands, except per share data.

Material Changes vs. Prior Period

• Revenue Growth: Total sales increased 16.5% ($1.45M) for the quarter and 14.1% ($2.39M) year-to-date compared to the prior year periods. This was driven by a 14.2% increase in the Branded Product Program and higher sales to a television retailer.
• Margin Expansion: Gross profit margin improved to 32.5% for the quarter (from 30.0% prior year) and 30.3% YTD (from 26.8% prior year). Management attributes this primarily to a 12.4% reduction in beef costs.
• Discontinued Operations: Net income was significantly impacted by discontinued operations. The prior year included a $2.82M gain from the sale of a Brooklyn property. The current period included a $400k gain from the sale of a leasehold interest and $39k in reimbursable expenses.
• Expense Increases: General and administrative expenses rose due to the adoption of SFAS 123R (share-based compensation), Sarbanes-Oxley compliance costs, and severance charges.
• Debt Reduction: The Company repaid its outstanding bank loan and capital lease obligation, resulting in zero interest expense for the quarter compared to $9k in the prior year.

Guidance, Outlook, and Risks

• Management Commentary: Management expects to incur quarterly share-based compensation expenses of approximately $87,000 for the remainder of fiscal 2007. They anticipate funding future investments and stock repurchases from operating cash flow.
• Executive Changes: Effective January 1, 2007, Howard M. Lorber will transition to Executive Chairman, and Eric Gatoff will become Chief Executive Officer. New employment agreements with significant change-in-control provisions have been executed.
• Acquisition: The Company acquired Arthur Treacher's intellectual property for $1.25M to expand co-branding efforts.
• Risks:
  • Commodity Costs: While beef costs have softened, the Company does not hedge against commodity price fluctuations. A 10% increase in food/paper costs would impact cost of sales by approximately $1.0M.
  • Licensee Performance: Earnings depend on independent licensees; their actions can harm the brand reputation.
  • Interest Rate Risk: The Company holds $21.4M in marketable securities. A 0.25% interest rate change would impact annual interest income by approximately $54,000.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by excluding the one-time $400k gain from discontinued operations in the current period and the $2.8M gain in the prior year.
• Commodity Price Sensitivity: Monitor beef and paper product prices, as the recent margin improvement is heavily reliant on lower input costs which are not guaranteed to persist.
• Share-Based Compensation: Confirm the ongoing impact of SFAS 123R adoption on future quarterly earnings, estimated at $87k per quarter.
• Franchisee Health: Review the number of non-performing franchise units (17 domestic locations deemed unrealizable in the quarter) and the collectibility of receivables.
• Liquidity Position: Note the strong liquidity position with $25.1M in cash and marketable securities and no long-term debt, but verify the utilization of the $7.5M uncommitted line of credit.