Nathan’s Famous, Inc. — Form 10-Q Summary
Reporting period: Thirteen and thirty-nine weeks ended December 27, 2015, compared with periods ended December 28, 2014. The quarter is the company’s third quarter of fiscal 2016. Unaudited results are seasonal and interim performance may not indicate full-year results.
Business context
Nathan’s earns revenue from branded food sales, product licensing, company-operated restaurants, and franchising. At period-end, its system had 267 units, including 262 franchised and five company-operated, versus 310 units a year earlier. The company identifies John Morrell & Co. as its principal hot-dog supplier.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | 13 weeks 2015 | 13 weeks 2014 | 39 weeks 2015 | 39 weeks 2014 |
|---|---|---|---|---|
| Total revenue | $20.6 | $22.3 | $81.8 | $78.8 |
| Operating income | $4.4 | $3.8 | $20.5 | $17.0 |
| Net income | $0.4 | $2.2 | $5.6 | $10.2 |
| Diluted EPS | $0.10 | $0.49 | $1.24 | $2.21 |
| Adjusted EBITDA (non-GAAP) | $4.9 | $4.4 | $22.2 | $18.9 |
- Quarterly revenue declined 7.8%, while year-to-date revenue rose 3.9%. Lower quarterly Branded Product Program sales and franchise fees more than offset increased licensing royalties. Year-to-date licensing royalties grew to $15.4 million from $13.7 million, primarily from growth in the consumer packaged hot-dog business.
- Gross margin on sales improved to 23.4% from 15.0% for the quarter and to 23.6% from 19.0% year to date, reflecting lower beef costs and company-restaurant price increases. Operating income rose despite higher general and administrative expenses.
- Net income fell sharply because the company issued $135 million of 10% secured notes in March 2015. Interest expense was $3.7 million for the quarter and $11.1 million year to date; the comparable 2014 periods had no interest expense. Management expects about $13.5 million annual interest expense plus approximately $1.2 million annual amortization of debt discounts and issuance costs.
- Operating cash flow was $13.3 million year to date, compared with $10.5 million. Investing activities provided $6.4 million; financing activities used $11.4 million, largely for share repurchases. Cash and cash equivalents were $59.7 million at December 27, 2015, versus $51.4 million at March 29, 2015. Working capital was $57.4 million; current assets were $70.5 million and current liabilities $13.1 million. Marketable securities had been sold and converted to cash.
Debt, capital allocation and outlook
- The notes have $135 million principal outstanding, mature in March 2020, and carry a 10% coupon. The balance sheet reports $130.0 million net of unamortized discount and issuance costs. The company reported compliance with note covenants and no financial maintenance covenants.
- The company repurchased 273,870 shares for $11.3 million year to date, including 88,672 shares accepted at $44 per share in a modified Dutch auction. On February 1, 2016, the board authorized up to 200,000 additional repurchases. The March 2015 special dividend returned approximately $116.1 million to shareholders and was funded principally by the notes offering.
- Management believes cash and operating cash flow will be sufficient for operations, debt service, and potential repurchases for at least 12 months. It expects to invest in restaurants and branded programs and service debt from operating cash flow. No specific revenue or earnings guidance is provided. Management estimates a fiscal 2016 tax rate of approximately 40.5%–41.9%, excluding possible benefits from reductions in uncertain tax positions.
Management commentary, risks and contingencies
- Beef costs had declined substantially, supporting margins, but management expects commodity price volatility and warns that failure to pass on future cost increases could pressure margins. A hot-dog purchase commitment of approximately 2.6 million pounds, valued at about $5.2 million, was scheduled to begin being purchased in February 2016.
- New York minimum-wage legislation took effect beginning December 31, 2015. The company estimated its restaurant labor costs had increased approximately 12.2% and warned that it may not fully offset further increases through pricing or efficiencies. Rising health-care, labor, food, utility and distribution costs are additional risks.
- Other stated risks include dependence on John Morrell, franchise closures and recruitment, the collectibility of receivables, consumer demand, and a potential change in franchisor “joint employer” liability. The company also remains contingently liable for costs on a property it subleases to a franchisee.
- Management reported ordinary-course litigation that it did not believe would materially affect the company; the filing’s legal proceedings item lists none. A New York tax review was awaiting final conclusion. Unrecognized tax benefits were $0.3 million, with $0.3 million accrued for related interest and penalties.
Important facts for investors to verify
- Whether lower beef costs and pricing actions can sustain improved gross margins as commodity prices change.
- The effect of the 10% notes’ interest burden, refinancing needs at 2020 maturity, and the notes’ restrictions on dividends, repurchases and additional debt.
- Whether licensing growth and new franchise openings can offset the decline in system outlets and franchise royalties.
- The realized impact of New York wage increases, future labor legislation, and the company’s ability to pass higher costs through to customers.
- The cash and earnings effects of share repurchases, the pending hot-dog purchase commitment, and tax-review outcomes. Adjusted EBITDA is a non-GAAP measure and should be considered alongside GAAP results.