Nathan’s Famous, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended March 26, 2017 (52 weeks), with quarterly comparisons available for the fourth quarter. Unless noted, financial amounts below are in millions of dollars. The company markets Nathan’s Famous and Arthur Treacher’s brands through branded-product sales, licensing, franchising and five company-owned restaurants.
Financial performance and liquidity
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Total revenue | $96.652 | $100.890 | -4.2% |
| Operating income | $26.280 | $24.963 | +5.3% |
| Net income | $7.485 | $6.096 | +22.8% |
| Diluted EPS | $1.78 | $1.37 | +$0.41 |
| Operating cash flow | $10.412 | $12.480 | -$2.068 |
| Adjusted EBITDA | $28.348 | $27.155 | +4.4% |
- Gross profit on sales increased to $19.186 million, or 26.9% of sales, from $18.033 million, or 23.7%. Operating margin was approximately 27.2% of total revenue and net margin approximately 7.7%.
- Revenue declined mainly because Branded Product Program sales fell to $55.960 million from $58.545 million and company-owned restaurant sales fell to $15.042 million from $16.664 million. Branded Product volume rose 4.6%, but lower beef costs and the related pricing strategy reduced average selling prices by 8.2%.
- License royalties increased to $20.368 million from $19.815 million, supported by higher hot-dog volume. Franchise fees and royalties were $5.068 million versus $5.044 million.
- Lower beef costs improved gross margin and reduced total costs and expenses to $70.372 million from $75.927 million. Company-owned restaurant cost of sales nevertheless rose to 56.0% of restaurant sales from 54.9%, reflecting lower sales and higher labor costs.
- Interest expense was $14.665 million, including $13.456 million interest on the notes and $1.209 million debt-cost amortization. The 36.6% effective tax rate included a $659,000 discrete tax benefit from early adoption of share-based-payment guidance.
- Cash and cash equivalents were $56.915 million; working capital was $56.763 million. Current assets were $67.535 million against current liabilities of $10.772 million. Operating cash flow was $10.412 million, capital expenditures $1.128 million, and cash increased $6.687 million.
- Debt was $135 million principal ($131.475 million net of issuance costs), consisting of 10% senior secured notes due March 2020. The company paid $13.5 million of cash interest in FY2017 and reported compliance with note covenants. Stockholders’ deficit was $66.491 million.
Fourth-quarter and year-over-year changes
In the fourth quarter, revenue was $19.286 million versus $19.053 million a year earlier; gross profit was $2.906 million versus $3.254 million; operating income was $4.671 million versus $4.486 million; and net income was $0.729 million versus $0.507 million. Fourth-quarter diluted EPS was $0.17 versus $0.12. The filing describes the fourth quarter as typically the slowest, reflecting seasonality and Northeast weather.
For the full year, company-owned restaurant sales declined principally because of unfavorable summer, rain and cool-weather conditions at Coney Island; the prior year had record Coney Island sales. Comparable domestic franchise sales (86 outlets, excluding Branded Menu locations) were $51.288 million versus $53.027 million. Franchise locations increased to 279 from 259, despite 33 closures, after 53 openings. Adjusted EBITDA growth was attributed primarily to lower expenses, especially beef costs, rather than revenue growth.
Outlook, risks and unusual items
- Management expects beef prices could rise in FY2018 after favorable declines; beef prices had increased early in FY2018. Higher beef, labor, distribution or utility costs may pressure margins if not offset by pricing or efficiencies. New York minimum-wage increases were expected to continue raising labor costs.
- Management expects a FY2018 effective tax rate of approximately 41%–43%, excluding excess stock-compensation tax benefits and possible reductions in unrecognized tax benefits. No specific revenue or earnings guidance is provided.
- Licensing revenue and profitability are materially dependent on John Morrell & Co. The company earned approximately $17.073 million in royalties from John Morrell in FY2017; the agreement runs to 2032. Branded Product Program revenue is also concentrated: approximately 70% came from seven accounts, including one representing approximately 20% of that program’s business.
- On May 19, 2017, after fiscal year-end, John Morrell announced a voluntary Class II recall of approximately 200,000 pounds of hot dogs, including Nathan’s products, after reports of metal flakes between product and packaging film. The filing says this represented a small fraction of the manufacturer’s output; brand, supply and sales impacts remain risks.
- Other principal risks include reliance on key hot-dog and French-fry suppliers, food-safety and reputational exposure, intense price competition, franchisee performance, weather and seasonality, and the company’s substantial debt and refinancing needs. Routine litigation was not expected by management to materially affect results, though outcomes are uncertain.
- The company repurchased 30,616 shares for $1.272 million in FY2017; 260,258 shares remained authorized under its buyback plan. It does not anticipate regular cash dividends in the foreseeable future. Management stated available cash and operating cash flow should fund operations, debt service and planned needs for at least 12 months.
Investor verification priorities
- Track the financial and customer effects of the post-year-end hot-dog recall, including any follow-up disclosures.
- Verify John Morrell royalty performance, minimum guarantees, product availability and the concentration of Branded Product accounts.
- Monitor beef and labor cost trends, price pass-through, restaurant margins and the impact of New York minimum-wage increases.
- Assess cash generation and the ability to refinance or repay the $135 million notes due in 2020, including covenant restrictions and interest burden.
- Reconcile full-year and quarterly results with the audited statements and note that EBITDA and Adjusted EBITDA are non-GAAP measures.