Nathan’s Famous, Inc. — Form 10-Q Summary
Business context and period. Nathan’s Famous markets branded food products through its Branded Product Program, product licensing, company-operated restaurants, and franchising. This unaudited filing covers the 13 weeks ended September 24, 2017 (fiscal 2018 second quarter) and the 26 weeks ended that date; comparisons are to the corresponding 2016 periods. Results are seasonal and interim results may not indicate full-year performance. Unless indicated otherwise, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | 13 weeks ended Sep. 24, 2017 | 13 weeks ended Sep. 25, 2016 | 26 weeks ended Sep. 24, 2017 | 26 weeks ended Sep. 25, 2016 |
|---|---|---|---|---|
| Total revenue | $31.606 | $28.013 | $62.524 | $57.429 |
| Sales | $24.527 | $21.891 | $46.872 | $43.153 |
| Operating income | $8.734 | $8.031 | $17.184 | $16.855 |
| Net income | $3.120 | $2.507 | $6.042 | $6.057 |
| Diluted EPS | $0.74 | $0.60 | $1.43 | $1.44 |
| Operating cash flow | Not separately reported | Not separately reported | $5.401 | $7.561 |
- Margins: Gross profit was $6.486 million, or 26.4% of sales, in the quarter, versus $6.402 million, or 29.2%, a year earlier. For the six months, gross profit was $11.306 million, or 24.1% of sales, versus $12.206 million, or 28.3%.
- Cash and liquidity: Cash was $61.677 million at September 24, up from $56.915 million at March 26, 2017. Working capital was $63.769 million. Current assets were $74.281 million and current liabilities were $10.512 million.
- Debt: The company had $135 million face value of 10.0% senior secured notes due 2020, reported net of issuance costs at $132.074 million. Six-month interest expense was $7.326 million; cash interest paid was $6.750 million.
- Cash generation and investment: Six-month operating cash flow fell to $5.401 million from $7.561 million. Capital expenditures were $0.357 million; financing cash outflow was $0.282 million. Ending cash increased by $4.762 million.
- Balance-sheet structure: Total liabilities were $144.895 million against assets of $84.488 million; stockholders’ deficit was $60.407 million.
Changes versus the prior comparable periods
- Quarterly revenue increased 12.8%; quarterly net income rose 24.5% and diluted EPS increased from $0.60 to $0.74. Operating income increased 8.8%.
- Six-month revenue grew 8.9%, but net income was slightly lower ($6.042 million versus $6.057 million) and diluted EPS declined from $1.44 to $1.43.
- Branded Product Program sales increased 19.1% in the quarter and 14.6% for the six months. Management attributed growth to higher volume and selling prices. Beef costs increased approximately 8.4% in the quarter and 8.9% for the six months.
- License royalties increased 20.4% in the quarter and were $13.165 million for the six months, up from $11.612 million. John Morrell-related hot-dog royalties accounted for most of the increase.
- Company-operated restaurant sales declined to $6.397 million for the quarter and $10.805 million for the six months, primarily due to unfavorable weather at Coney Island locations. Comparable domestic franchise sales also declined.
- Gross margin contracted, principally because of higher beef costs and higher restaurant labor costs. Six-month operating cash flow also decreased, with increased receivables a significant use of cash.
Outlook, management commentary and risks
- Refinancing after quarter-end: On November 1, 2017, Nathan’s issued $150 million of 6.625% senior secured notes due 2025. It planned to use proceeds to redeem the $135 million 2020 notes on November 16, at an estimated payment of approximately $144 million, and to fund part of a special dividend. Management expects annual interest expense to decline by approximately $3.563 million. The refinancing is expected to include a $6.750 million call premium, approximately $2.725 million of write-off of old debt issuance costs, and approximately $0.563 million of additional interest during the overlap period.
- Dividend: On November 1, the board declared a $5.00-per-share special cash dividend, payable January 4, 2018 to holders of record December 22, 2017. The company expected to fund approximately $19.1 million of the dividend from balance-sheet cash.
- Guidance: No revenue or earnings guidance is provided. Management estimated a fiscal 2018 annual tax rate of approximately 40.8%–42.3%, excluding stock-compensation tax benefits and potential changes in uncertain tax positions. Management said available cash and operating cash flow should fund operations, debt service, the special dividend and potential repurchases for at least 12 months.
- Operating risks: Beef and other commodity-price volatility may pressure margins if pricing or purchase arrangements do not offset costs. Nathan’s identifies John Morrell & Co. as its principal supplier and notes reliance on its supply and licensing relationship. Further risks include New York minimum-wage increases, labor regulation, weather-sensitive restaurant sales, franchisee economics, and the ability to pass higher costs to customers.
- Unusual items and contingencies: A May 2017 voluntary Class II recall of certain hot dogs, including Nathan’s products, followed reports of metal flakes; management said it had no material effect on results. A Brooklyn restaurant lease guaranty resulted in a recorded liability of approximately $204,000. The company reported routine litigation, which management did not expect to have a material adverse effect, while acknowledging litigation uncertainty.
- Accounting matters: The company was evaluating new revenue-recognition guidance, including potential changes to timing of development fees and gross presentation of advertising-fund contributions and expenditures. It expects the new lease standard to significantly increase reported assets and liabilities.
Most important facts for investors to verify
- Whether refinancing and redemption were completed as planned, and the actual call premium, debt-cost write-off and resulting interest savings.
- Whether beef costs, pricing and product volumes sustain Branded Product Program growth without further gross-margin erosion.
- Trends in company-operated restaurant sales, comparable franchise sales, labor costs and the effects of minimum-wage and scheduling rules.
- Cash conversion and receivables: six-month operating cash flow declined while accounts and other receivables increased.
- The funding and cash-flow effects of the $5.00-per-share dividend, and compliance with debt covenants and restrictions on dividends or repurchases.
- Any future effects from the supplier relationship, product quality or recall issues, and adoption of new revenue and lease accounting standards.