NATH

Business Context and Reporting Period

Company: Nathan's Famous, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: March 29, 1998 (52-week fiscal year)
Business Overview: The Company operates and franchises fast food units featuring all-beef frankfurters and crinkle-cut french fries. As of March 29, 1998, the system included 27 Company-owned units, 156 franchised/licensed units, and 308 branded product outlets. The Company is expanding through non-traditional captive markets (e.g., Home Depot locations) and international master franchising.

Key Financial Metrics

Margins: Cost of sales as a percentage of restaurant sales was 60.5% in 1998 (up from 60.0% in 1997). Restaurant operating expenses were 28.8% of sales in 1998 (down from 30.4% in 1997).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 8.7% to $28.877 million. Company-owned restaurant sales rose 2.8% to $22.332 million, with comparable unit sales increasing 3.8%.
• Franchise Decline: Franchise fees and royalties decreased 5.4% to $3.062 million. This was primarily due to the closure of 53 Caldor units in the prior year, which had generated significant royalties.
• License Royalties: Increased 27.0% to $1.495 million, driven by the SMG, Inc. license agreement for packaged hot dogs and the amortization of a deferred fee.
• Profitability: Net earnings more than doubled to $1.528 million. This was aided by a $523,000 reduction in the valuation allowance for deferred tax assets and the disposal of three underperforming restaurants.
• Expansion: The Company opened 4 new Company-owned units and 28 franchised units. The Branded Product Program grew significantly, adding 251 outlets.

Guidance, Outlook, and Risks

Outlook: Management expects franchisees to open approximately 25-30 new units in fiscal 1999. The Company plans to continue opening Company-owned units within Home Depot Improvement Centers and expanding the Branded Product Program. International expansion is ongoing, with the first unit in Israel opening in April 1998 and negotiations for Russia, Egypt, and Poland.

Risks and Contingencies:

• Legal Proceedings: The Company is defending against a lawsuit by Textron Financial Corporation seeking at least $1.5 million regarding a lease dispute. A franchisee counterclaim seeking over $5 million was largely dismissed, though a statutory relief claim remains. A $13 million RICO-related lawsuit was dismissed in May 1998.
• Competition: The fast food industry is highly competitive, with competitors utilizing "value pricing" and deep discount strategies that could negatively impact margins.
• Seasonality: Sales and earnings are historically highest in the first two fiscal quarters due to weather conditions in the New York metropolitan area.
• Year 2000: The Company is replacing its accounting systems to ensure Year 2000 compliance, though it believes costs will not be material.

Investor Verification Checklist

• Franchise Dependency: Verify the impact of the Caldor unit closures on future royalty streams and the success of new franchise openings in offsetting this loss.
• Tax Provision: Confirm the sustainability of the reduced effective tax rate (16.0%) resulting from the $523,000 reduction in the deferred tax valuation allowance.
• Legal Exposure: Monitor the status of the Textron Financial Corporation lawsuit ($1.5M claim) and the remaining statutory claim from the Phylli Foods franchisee dispute.
• Margin Pressure: Assess the ability to maintain operating margins given the 60.5% cost of sales ratio and competitive pricing pressures in the fast food sector.
• Liquidity: Review the utilization of the $5 million uncommitted bank line of credit and the reliance on marketable securities ($8.5M) for capital needs.