NATHANS FAMOUS, INC. - Quarter Report: 2018 September (Form 10-Q)

 

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		September 23, 2018				March 25, 2018
		(Unaudited)
ASSETS
CURRENT ASSETS
Cash		$	66,154			$	57,339
Accounts and other receivables, net (Note F)			10,720				10,502
Inventories			552				384
Prepaid expenses and other current assets (Note G)			523				2,873
Assets held for sale (Note H)			593				610
Total current assets			78,542				71,708
Property and equipment, net of accumulated depreciation of $8,295 and $8,264, respectively			5,202				6,642
Goodwill			95				95
Intangible asset			1,353				1,353
Deferred income taxes			406				-
Long term contractual accounts receivable			440				-
Other assets			343				293
Total assets		$	86,381			$	80,091
LIABILITIES AND STOCKHOLDERS’ (DEFICIT)
CURRENT LIABILITIES
Accounts payable		$	4,654			$	6,565
Accrued expenses and other current liabilities (Note I)			11,040				11,248
Deferred franchise fees			559				193
Total current liabilities			16,253				18,006
Long-term debt, net of unamortized debt issuance costs of $4,896 and $5,242, respectively (Note O)			145,104				144,758
Other liabilities (Note I)			1,303				1,355
Deferred franchise fees			3,044				238
Deferred income taxes			-				302
Total liabilities			165,704				164,659
COMMITMENTS AND CONTINGENCIES (Note P)
STOCKHOLDERS’ (DEFICIT)
Common stock, $.01 par value; 30,000,000 shares authorized; 9,318,942 and 9,311,922 shares issued; and 4,191,569 and 4,184,549 shares outstanding at September 23, 2018 and March 25, 2018, respectively			93				93
Additional paid-in capital			60,887				60,823
(Accumulated deficit)			(63,000	)			(68,181	)
Stockholders’ (deficit) before treasury stock			(2,020	)			(7,265	)
Treasury stock, at cost, 5,127,373 shares at September 23, 2018 and March 25, 2018			(77,303	)			(77,303	)
Total stockholders’ (deficit)			(79,323	)			(84,568	)
Total liabilities and stockholders’ (deficit)		$	86,381			$	80,091

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		Thirteen weeks ended								Twenty-six weeks ended
		September 23, 2018				September 24, 2017				September 23, 2018				September 24, 2017
REVENUES
Sales		$	21,573			$	24,392			$	42,044			$	46,622
License royalties			5,746				5,764				13,844				13,165
Franchise fees and royalties			1,239				1,315				2,343				2,487
Advertising fund revenue (Note B)			772				-				1,267				-
Total revenues			29,330				31,471				59,498				62,274
COSTS AND EXPENSES
Cost of sales			15,160				17,906				30,606				35,316
Restaurant operating expenses			1,141				1,105				2,051				2,009
Depreciation and amortization			339				367				684				735
General and administrative expenses			3,438				3,359				7,323				7,030
Advertising fund expense (Note B)			772				-				1,267				-
Total costs and expenses			20,850				22,737				41,931				45,090
Income from operations			8,480				8,734				17,567				17,184
Interest expense			(2,651	)			(3,663	)			(5,301	)			(7,326	)
Interest income			115				35				176				70
Other income, net			519				21				540				42
Income before provision for income taxes			6,463				5,127				12,982				9,970
Provision for income taxes			1,979				2,007				3,703				3,928
Net income		$	4,484			$	3,120			$	9,279			$	6,042
PER SHARE INFORMATION
Weighted average shares used in computing income per share:
Basic			4,188,000				4,179,000				4,187,000				4,178,000
Diluted			4,231,000				4,212,000				4,229,000				4,213,000
Income per share:
Basic		$	1.07			$	.75			$	2.22			$	1.45
Diluted		$	1.06			$	.74			$	2.19			$	1.43
Dividends declared per share		$	.25			$	-			$	.50			$	-

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										Additional																Total
		Common				Common				Paid-in				(Accumulated				Treasury Stock, at Cost								Stockholders’
		Shares				Stock				Capital				Deficit)				Shares				Amount				(Deficit)
Balance, March 25, 2018			9,311,922			$	93			$	60,823			$	(68,181	)			5,127,373			$	(77,303	)		$	(84,568	)
Cumulative effect of the adoption of ASC 606			-				-				-				(2,004	)			-				-				(2,004	)
Shares issued in connection with share-based compensation plans			7,020				-				134				-				-				-				134
Withholding tax on net share settlement of share-based compensation plans			-				-				(174	)			-				-				-				(174	)
Dividends on common stock			-				-				-				(2,094	)			-				-				(2,094	)
Share-based compensation			-				-				104				-				-				-				104
Net income			-				-				-				9,279				-				-				9,279
Balance, September 23, 2018			9,318,942			$	93			$	60,887			$	(63,000	)			5,127,373			$	(77,303	)		$	(79,323	)

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		September 23, 2018				September 24, 2017
Cash flows from operating activities:
Net income		$	9,279			$	6,042
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			684				735
Gain on sale of property and equipment			(323	)			-
Amortization of debt issuance costs			346				599
Share-based compensation expense			104				199
Income tax benefit on stock option exercises			46				194
Provision for doubtful accounts			92				57
Deferred income taxes			23				40
Changes in operating assets and liabilities:
Accounts and other receivables, net			(310	)			(2,636	)
Inventories			(168	)			(25	)
Prepaid expenses and other current assets			2,350				620
Long term contractual accounts receivable			(440	)			-
Other assets			(50	)			5
Accounts payable, accrued expenses and other current liabilities			(2,015	)			(431	)
Deferred franchise fees - current			366				102
Deferred franchise fees – long term			71				-
Other liabilities			(52	)			(100	)
Net cash provided by operating activities			10,003				5,401
Cash flows from investing activities:
Proceeds from disposal of property and equipment			1,330				-
Purchase of property and equipment			(234	)			(357	)
Net cash provided by (used in) investing activities			1,096				(357	)
Cash flows from financing activities:
Proceeds from exercise of stock options			134				-
Dividends paid to stockholders			(2,244	)			(125	)
Payments of withholding tax on net share settlement of share-based compensation plans			(174	)			(157	)
Net cash (used in) financing activities			(2,284	)			(282	)
Net increase in cash			8,815				4,762
Cash, beginning of period			57,339				56,915
Cash, end of period		$	66,154			$	61,677
Cash paid during the period for:
Interest		$	4,968			$	6,750
Income taxes paid		$	1,319			$	3,400

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NOTE A - BASIS OF PRESENTATION

 

The accompanying consolidated financial statements of Nathan's Famous, Inc. and subsidiaries (collectively “Nathan’s,” the “Company,” “we,” “us” or “our”) as of and for the thirteen and twenty-six week periods ended September 23, 2018 and September 24, 2017 have been prepared in accordance with accounting principles generally accepted in the United States of America. The unaudited financial statements include all adjustments (consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of financial condition, results of operations and cash flows for the periods presented. However, our results of operations are seasonal in nature, and the results of any interim period are not necessarily indicative of results for any other interim period or the full fiscal year.

 

Certain information and footnote disclosures normally included in financial statements in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to the requirements of the Securities and Exchange Commission. We have reclassified certain prior period items in the Consolidated Balance Sheet as of March 25, 2018 and the Statement of Earnings for the thirteen and twenty-six week periods ended September 24, 2017 to be comparable with the classifications as of and for the thirteen and twenty-six week periods ended September 23, 2018. These reclassifications had no effect on previously reported total assets, total liabilities, stockholders’ deficit or net income. Management believes that the disclosures included in the accompanying consolidated interim financial statements and footnotes are adequate to make the information not misleading, but should be read in conjunction with the consolidated financial statements and notes thereto included in Nathan’s Annual Report on Form 10-K for the fiscal year ended March 25, 2018.

 

A summary of the Company’s significant accounting policies is identified in Note B of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 25, 2018.

 

Effective March 26, 2018, the Company adopted Accounting Standards Codification 606, “Revenue Recognition – Revenue from Contracts with Customers” (“ASC 606”). There have been no other significant changes to the Company’s significant accounting policies subsequent to March 25, 2018.

 

NOTE B – ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

 

Revenue recognition

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance codified in ASC 606 which amends the guidance in former ASC 605, “Revenue Recognition.” The core principle of the standard is to recognize revenue when control of the promised goods or services is transferred to customers in an amount that reflects the consideration expected to be received for those goods or services. The standard also requires additional disclosures around the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

This adoption of the new standard did not impact the Company’s recognition of sales from Company-operated restaurants as those sales are recognized on a cash basis at the time of the underlying sale and are presented net of sales tax. The standard also did not impact the recognition of sales from its Branded Product Program or its recognition of royalty income earned from its franchised restaurants or retail licenses, which are based on a percent of sales and recognized at the time the underlying sales occur.

 

The details of the significant changes in revenue recognition and quantitative impact of the changes are discussed below.

 

Franchise fees and international development fees

 

Under previous revenue recognition guidance, franchise fees were recognized as income when substantially all services to be performed by Nathan’s and conditions relating to the sale of the franchise had been performed or satisfied, which generally occurred when the franchised restaurant commenced operations.

 

Under previous revenue recognition guidance, international development fees were recognized as income, net of direct expenses, upon the opening of the first restaurant within the territory.

 

Under the new guidance, the standard requires that the transaction price received from customers be allocated to each separate and distinct performance obligation. The transaction price attributable to each separate and distinct performance obligation is then recognized as the performance obligations are satisfied. The services that we provide related to upfront fees we receive from franchisees do not contain separate and distinct performance obligations from the franchise right and as of March 26, 2018, initial restaurant franchise fees, renewal fees, transfer fees, and international development fees shall be recognized over the term of the respective agreement.

 

 

National advertising fund

 

The Company maintains a national advertising fund (the “Advertising Fund”) established to collect and administer funds contributed for use in advertising and promotional programs for Company-operated and franchised restaurants. Previously, the revenue, expenses and cash flows of the Advertising Fund were reported on the Company’s Consolidated Balance Sheets and not included in the Company’s Consolidated Statements of Earnings and Statements of Cash Flows because the contributions to the Advertising Fund were designated for specific purposes and the Company acted as an agent, in substance, with regard to these contributions as a result of industry-specific guidance.

 

Under the new guidance, which supersedes the previous industry-specific guidance, the revenue, expenses and cash flows of the Advertising Fund are fully consolidated into the Company’s Consolidated Statements of Earnings and Statements of Cash Flows.

 

While this treatment will impact the gross amount of reported advertising fund revenue and related expenses, the impact is expected to be an offsetting increase to both revenue and expense with no impact to income from operations or net income because the Company attempts to manage the Advertising Fund to breakeven over the course of the fiscal year. However, any surplus or deficit in the Advertising Fund will impact income from operations and net income.

 

The Company applied the new guidance using the modified retrospective method, whereby the cumulative effect of initially adopting the guidance was recognized as an adjustment to the opening balance of accumulated deficit at March 26, 2018 in the amount of $2,004,000, net of tax. Therefore, the results of operations from the comparative period have not been adjusted and continue to be reported under the previous revenue recognition guidance.

 

Impacts on Consolidated Financial Statements

 

The following tables summarize the impact of adopting ASC 606 on the Company’s condensed consolidated financial statements as of and for the thirteen and twenty-six weeks ended September 23, 2018 (in thousands):             

 

 

 

 

 

 

 

Contract balances

 

The following table provides information about receivables and contract liabilities (Deferred franchise fees) from contracts with customers (in thousands):

 

 

(a)	Receivables of $40 and $440 are included in Accounts and other receivables, net and Long term contractual accounts receivable, respectively.
(b)	Deferred franchise fees of $364 and $2,819 are included in Deferred franchise fees – current and long term, respectively.

 

 

Significant changes in Deferred franchise fees are as follows (in thousands):

 

 

(a)      Includes the cumulative effect of adopting ASC 606 of $2,735.

 

Anticipated Future Recognition of Deferred Franchise Fees

 

The following table reflects the estimated franchise fees to be recognized in the future related to performance obligations that are unsatisfied at the end of the period (in thousands):                    

 

 

(a) Represents franchise fees expected to be recognized for the remainder of the 2019 fiscal year, which includes international development fees expected to be recognized over the duration of one year or less. Amount does not include $242 of franchise fee revenue recognized for the twenty-six weeks ended September 23, 2018.

 

We have applied the optional exemption, as provided for under ASC 606, which allows us not to disclose the transaction price allocated to unsatisfied performance obligations when the transaction price is a sales-based royalty.

 

NOTE C – NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED

 

In February 2016, the FASB issued new guidance on leases, which outlines principles for the recognition, measurement, presentation and disclosure of leases applicable to both lessors and lessees.  The new standard is effective for annual reporting periods beginning after December 15, 2018, including interim reporting periods within those annual reporting periods.  The standard is required to take effect in Nathan’s first quarter (June 2019) of our fiscal year ending March 29, 2020.  The new guidance requires lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by finance and operating leases with lease terms of more than 12 months.  The guidance requires either a modified retrospective transition approach with application in all comparative periods presented, or an alternative transition method, which permits a company to use its effective date as the date of initial application without restating comparative period financial statements. The new guidance also provides several practical expedients and policies that companies may elect under either transition method. We currently expect to apply the alternative transition method and elect the package of practical expedients under which we will not reassess the classification of our existing leases, reevaluate whether any expired or existing contracts are or contain leases or reassess initial direct costs under the new guidance. We do not expect to elect the practical expedient that permits a reassessment of lease terms for existing leases and are continuing to evaluate other practical expedients and elections specified in the new guidance. As of September 23, 2018, there were $10,492,000 in future minimum rental payments for operating leases that are not currently recorded on our balance sheet; therefore, we expect this new guidance will have a material impact on our consolidated balance sheets and related disclosures.  We do not expect the adoption of this guidance to have a material impact on our consolidated statements of earnings and statement of cash flows.

 

In January 2017, the FASB issued an update to the accounting guidance to simplify the testing for goodwill impairment. The update removes the requirement to determine the implied fair value of goodwill to measure the amount of impairment loss, if any, under the second step of the current goodwill impairment test. A company will perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. A goodwill impairment charge will be recognized for the amount by which the reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of the goodwill. The guidance is effective prospectively for public business entities for annual reporting periods beginning after December 15, 2019. This standard is required to take effect in Nathan’s first quarter (June 2020) of our fiscal year ending March 28, 2021. Nathan’s does not expect the adoption of this new guidance to have a material impact on its results of operations or financial position.

 

 

The Company does not believe that any other recently issued, but not yet effective accounting standards, when adopted, will have a material effect on the accompanying consolidated financial statements.

 

NOTE D – INCOME PER SHARE         

 

Basic income per common share is calculated by dividing income by the weighted-average number of common shares outstanding and excludes any dilutive effect of stock options. Diluted income per common share gives effect to all potentially dilutive common shares that were outstanding during the period. Dilutive common shares used in the computation of diluted income per common share result from the assumed exercise of stock options and warrants, as determined using the treasury stock method.

 

The following chart provides a reconciliation of information used in calculating the per-share amounts for the thirteen and twenty-six week periods ended September 23, 2018 and September 24, 2017, respectively.

 

 

 

There were no options to purchase shares of common stock for the thirteen and twenty-six week periods ended September 23, 2018 and September 24, 2017 excluded from the computation of diluted earnings per share.

 

NOTE E – FAIR VALUE MEASUREMENTS

 

Nathan’s follows a three-level fair value hierarchy that prioritizes the inputs to measure fair value. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels are defined as follows:

 

●     Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for an identical asset or liability in an active market

 

●     Level 2 - inputs to the valuation methodology include quoted prices for a similar asset or liability in an active market or model-derived valuations in which all significant inputs are observable for substantially the full term of the asset or liability

 

●     Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement of the asset or liability

 

The Company’s long-term debt had a face value of $150,000,000 as of September 23, 2018 and a fair value of $150,375,000 as of September 23, 2018. The Company estimates the fair value of its long-term debt based upon review of observable pricing in secondary markets as of the last trading day of the fiscal period, which we classify as Level 2.

 

The carrying amounts of cash, accounts receivable and accounts payable approximate fair value due to the short-term maturity of the instruments.

 

 

Certain non-financial assets and liabilities are measured at fair value on a non-recurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances, such as when evidence of impairment exists. At September 23, 2018, no fair value adjustment or material fair value measurements were required for non-financial assets or liabilities.

 

NOTE F – ACCOUNTS AND OTHER RECEIVABLES, NET          

 

Accounts and other receivables, net, consist of the following (in thousands):

 

 

Accounts receivable are due within 30 days and are stated at amounts due from franchisees, retail licensees and Branded Product Program customers, net of an allowance for doubtful accounts. Accounts that are outstanding longer than the contractual payment terms are generally considered past due. The Company does not recognize franchise and license royalties that are not deemed to be realizable.

 

The Company individually reviews each past due account and determines its allowance for doubtful accounts by considering a number of factors, including the length of time accounts receivable are past due, the Company’s previous loss history, the customer’s current and expected future ability to pay its obligation to the Company, the condition of the general economy and the industry as a whole. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings. After the Company has used reasonable collection efforts, it writes off accounts receivable through a charge to the allowance for doubtful accounts.

 

Changes in the Company’s allowance for doubtful accounts for the twenty-six week period ended September 23, 2018 and the fiscal year ended March 25, 2018 are as follows (in thousands):    

 

 

NOTE G – PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consist of the following (in thousands):

 

 

NOTE H – ASSETS HELD FOR SALE          

 

Prior to the end of fiscal 2018, we entered into an agreement to sell a Company-owned restaurant located in Bay Ridge, Brooklyn, NY for $12,250,000.  At September 23, 2018, we had received a $2,201,000 non-refundable deposit toward the sale of this restaurant which was included in accrued expenses and other current liabilities in the accompanying Consolidated Balance Sheet. The sale was expected to close during the second quarter of fiscal 2019.  Effective July 15, 2018, we amended the Agreement of Sale to extend the closing date until October 2018 and received an additional down-payment of $1,000,000 and a $175,000 fee to extend the closing date by three months. Property and equipment of $593,000 and $610,000 related to this sale has been classified as Assets held for sale in our Consolidated Balance Sheets at September 23, 2018 and March 25, 2018, respectively.  The sale was completed on October 23, 2018.

 

 

On August 9, 2018, the Company completed the sale of its regional office building located in Fort Lauderdale, Florida for proceeds of $1,330,000 and recorded a gain of $323,000, which represented the excess of the proceeds, less costs to sell, over the carrying value on that date. The gain was recorded in Other income, net in the Company’s Consolidated Statement of Earnings during the thirteen weeks ended September 23, 2018.

 

NOTE I – ACCRUED EXPENSES, OTHER CURRENT LIABILITIES AND OTHER LIABILITIES

 

Accrued expenses and other current liabilities consist of the following (in thousands):

 

 

Other liabilities consist of the following (in thousands):

 

 

NOTE J – REVENUES

 

The Company’s disaggregated revenues for the thirteen and twenty-six weeks ended September 23, 2018 and September 24, 2017 are as follows (in thousands):

                                                                             

 

(1) As disclosed in Note B, prior period amounts have not been adjusted under the modified retrospective method of adoption of ASC 606.

 

 

The following table disaggregates revenues by primary geographical market (in thousands):

                        

 

NOTE K – INCOME TAXES

 

On December 22, 2017, the Tax Cuts and Jobs Act, (the “Tax Act”) was enacted which among other provisions, permanently reduces the top corporate tax rate from 35 percent to a flat 21 percent beginning January 1, 2018 and eliminates the corporate Alternative Minimum Tax.  The Tax Act limits the deduction of business interest, net of interest income, to 30 percent of the adjusted taxable income of the taxpayer in any taxable year.  Any amount disallowed under the limitation is treated as business interest paid or accrued in the following year.  Disallowed interest will have an indefinite carryforward.  The Tax Act also repeals the performance-based exception to the $1.0 million deduction limitation on executive compensation and modifies the definition of “covered employees”. Additionally, the Tax Act intended to allow businesses to immediately expense the full cost of new equipment. However, the law as written does not currently permit restaurant companies to take advantage of the laws’ intention.

 

The income tax provisions for the twenty-six week periods ended September 23, 2018 and September 24, 2017 reflect effective tax rates of 28.5% and 39.4%, respectively. The majority of the decline in the Company’s tax rate is due to the reduction in our Federal income tax rate from 34% to 21% pursuant to the Tax Act. Nathan’s effective tax rates for the twenty-six week periods ended September 23, 2018 and September 24, 2017 were reduced by 0.4% and 1.9%, respectively, as a result of the tax benefits associated with stock compensation. For the twenty-six week periods ended September 23, 2018 and September 24, 2017, excess tax benefits of $46,000 and $194,000, respectively, were reflected in the Consolidated Statements of Earnings as a reduction in determining the provision for income taxes.

 

The amount of unrecognized tax benefits at September 23, 2018 was $250,000, all of which would impact Nathan’s effective tax rate, if recognized. As of September 23, 2018, Nathan’s had $238,000 of accrued interest and penalties in connection with unrecognized tax benefits.

 

In January 2018, Nathan’s received notification from the State of Virginia that it was seeking to review Nathan’s tax returns for the period April 2014 through March 2017. The review has been completed; Nathan’s has accepted the findings and settled the matter in the second quarter fiscal 2019. The effects of the review have been factored into the Company’s effective tax rate for fiscal 2019.

 

Nathan’s estimates that its annual tax rate for the fiscal year ending March 31, 2019 will be in the range of approximately 27.0% to 30.0% excluding the impact of any discrete items recorded and excess tax benefit associated with stock compensation. The final annual tax rate is subject to many variables, including the ultimate determination of revenue and income tax by state, among other factors, and therefore cannot be determined until the end of the fiscal year; therefore, the actual tax rate could differ from our current estimates. In addition, the ultimate benefit of the Tax Act on Nathan’s is unclear as the lower annual tax rate could be outweighed by deduction limitations and other provisions included in further guidance and regulations.

 

NOTE L – SEGMENT INFORMATION

 

Nathan’s considers itself to be a brand marketer of the Nathan’s Famous signature products to the foodservice industry pursuant to its various business structures. Nathan’s sells its products directly to consumers through its restaurant operations segment consisting of Company-operated and franchised restaurants, to distributors that resell our products to the foodservice industry through the Branded Product Program (“BPP”) and by third party manufacturers pursuant to license agreements that sell our products to club stores and grocery stores nationwide. The Company’s Chief Executive Officer has been identified as the Chief Operating Decision Maker (“CODM”) who evaluates performance and allocates resources for the Branded Product Program, Product Licensing and Restaurant Operations segments based upon a number of factors, the primary profit measure being income from operations. Certain administrative expenses are not allocated to the segments and are reported within Corporate.

 

Branded Product Program – This segment derives revenue principally from the sale of hot dog products either directly to foodservice operators or to various foodservice distributors who resell the products to foodservice operators.

 

Product licensing – This segment derives revenue, primarily in the form of royalties, from licensing a broad variety of Nathan’s Famous branded products, including our hotdogs, sausage and corned beef products, frozen French fries and additional products through retail grocery channels and club stores throughout the United States.

 

 

Restaurant operations – This segment derives revenue from sale of our products at Company-owned restaurants and earns fees and royalties from its franchised restaurants.

 

Revenues from operating segments are from transactions with unaffiliated third parties and do not include any intersegment revenues.

 

Income from operations attributable to Corporate consists principally of administrative expenses not allocated to the operating segments such as executive management, finance, information technology, legal, insurance, corporate office costs, corporate incentive compensation and compliance costs.

 

Interest expense, interest income and other income, net are managed centrally at the corporate level, and, accordingly, such items are not presented by segment since they are excluded from the measure of profitability reviewed by the CODM.

 

Operating segment information is as follows (in thousands):

 

 

(1)

Represents advertising fund revenue

 

NOTE M– SHARE-BASED COMPENSATION

 

Total share-based compensation during the thirteen-week periods ended September 23, 2018 and September 24, 2017 was $23,000 and $100,000, respectively. Total share-based compensation during the twenty-six week periods ended September 23, 2018 and September 24, 2017 was $104,000 and $199,000, respectively. Total share-based compensation is included in general and administrative expenses in our accompanying Consolidated Statements of Earnings. As of September 23, 2018, there was $342,000 of unamortized compensation expense related to share-based incentive awards. We expect to recognize this expense over approximately thirty-six months, which represents the weighted average remaining requisite service periods for such awards.

 

The Company recognizes compensation cost for unvested stock-based incentive awards on a straight-line basis over the requisite service period. Compensation cost charged to expense under all stock-based incentive awards is as follows (in thousands):

           

 

 

Stock options outstanding: 

 

During the fiscal year ended March 29, 2015, the Company granted options to purchase 50,000 shares at an exercise price of $53.89 per share, all of which expire five years from the date of grant. All such stock options vest ratably over a four-year period which commenced August 6, 2015 and contained anti-dilution rights that were structured to equalize the award’s fair value before and after the modification.

 

In connection with the Company’s special cash dividend, paid on January 4, 2018, to stockholders of record as of December 22, 2017, the Company performed an analysis, pursuant to the anti-dilution provisions of the 2010 Stock Incentive Plan, as amended (the “2010 Plan”), and issued replacement options to purchase 68,498 shares at an exercise price of $33.438 for the unvested stock options outstanding as of the record date of December 22, 2017, canceling 64,384 shares at an exercise price of $35.58 per share. Nathan’s performed its evaluation based on the closing price of its common stock on December 20, 2017, the day before the stock went ex-dividend, of $83.20 per share, or $78.20 per share excluding the dividend of $5.00 per share. No other terms or conditions of the outstanding options were modified.

 

In connection with the Company’s special cash dividend, paid on March 27, 2015, to stockholders of record as of March 20, 2015, the Company performed an analysis, pursuant to the anti-dilution provisions of the 2010 Plan, and issued replacement options to purchase 75,745 shares at an exercise price of $35.58 for the unvested stock options outstanding as of March 29, 2015, canceling 50,000 shares at an exercise price of $53.89. Nathan’s performed its evaluation based on the closing price of its common stock on March 27, 2015 of $73.56 per share, or $48.56 per share excluding the dividend of $25.00 per share. No other terms or conditions of the outstanding options were modified.

 

During the twenty-six week period ended September 23, 2018, the Company granted options to purchase 10,000 shares at an exercise price of $89.90 per share, all of which expire five years from the date of grant. All such stock options vest ratably over a three year period commencing September 12, 2018.

 

The weighted-average option fair values, as determined using the Black-Scholes option valuation model, and the assumptions used to estimate these values for stock options granted during the thirteen weeks and twenty-six weeks ended September 23, 2018, are as follows:

 

 

The expected dividend yield is based on historical and projected dividend yields. The Company expects volatility based primarily on historical monthly price changes of the Company’s stock equal to the expected life of the option. The risk free interest rate is based on the U.S. Treasury yield in effect at the time of the grant. The expected option term is the number of years the Company estimates the options will be outstanding prior to exercise based on expected employment termination behavior.

 

Transactions with respect to stock options for the twenty-six weeks ended September 23, 2018 are as follows:

 

 

A-

Represents outstanding options after giving effect to the replacement options issued in connection with the Company’s 2015 and 2017 special dividends.

 

 

Restricted stock: 

 

Transactions with respect to restricted stock for the twenty-six weeks ended September 23, 2018 are as follows:

 

 

During the twenty-six week period ended September 23, 2018, the Company granted 1,000 shares of restricted stock at a fair value of $89.90 per share representing the closing price on the date of the grant, which will be fully vested three years from the date of grant. The restrictions on the shares lapse ratably over a three-year period on the annual anniversary of the date of grant. The compensation expense related to this restricted stock award is expected to be $89,900 and will be recognized, commencing on the grant date, over three years.

 

NOTE N– STOCKHOLDERS’ EQUITY

 

1. Dividends

 

On May 31, 2018, Nathan’s Board of Directors authorized the commencement of a regular dividend of $1.00 per share per annum, payable at the rate of $0.25 per quarter. The initial $0.25 per share dividend was declared on June 8, 2018 and paid on June 22, 2018 to stockholders of record at the close of business on June 18, 2018. Effective August 3, 2018, the Board declared its quarterly cash dividend of $0.25 per share which was paid on September 21, 2018 to stockholders of record at the close of business on September 10, 2018. Through September 23, 2018, we have paid $2,094,000 of regular dividends.

 

Effective November 2, 2018, the Board of Directors declared its quarterly cash dividend of $0.25 per share payable on December 14, 2018 to stockholders of record at the close of business on December 3, 2018. Our ability to pay future dividends is limited by the terms of the Indenture, dated November 1, 2017, between the Company, certain of its wholly-owned subsidiaries, as guarantors and U.S. Bank National Association, as trustee and collateral trustee (the “Indenture”). In addition, the declaration and payment of any cash dividends in the future are subject to final determination of the Board and will be dependent upon our earnings and financial requirements.

 

On November 1, 2017, the Company’s Board of Directors declared a special cash dividend of $5.00 per share payable to stockholders of record as of December 22, 2017 of which approximately $20,923,000 was paid on January 4, 2018 to the stockholders. The Company also accrued $25,000 for the expected dividends payable on unvested restricted shares pursuant to the terms of the restricted stock agreement. As unvested restricted stock vests, the declared dividend is paid. The Company paid this $25,000 during the thirteen weeks ended June 24, 2018.

 

On March 10, 2015, the Company’s Board of Directors declared a special cash dividend of $25.00 per share payable to stockholders of record as of March 20, 2015 of which approximately $115,100,000 was paid on March 27, 2015 to the stockholders. The Company accrued $1,000,000 for the expected dividends payable on unvested shares pursuant to the terms of the restricted stock agreements. As unvested restricted stock vests, the declared dividend is paid. As of March 25, 2018 we had paid $875,000 of the accrued dividend and the remaining $125,000 was paid during the thirteen weeks ended June 24, 2018.

 

2. Common Stock Purchase Rights

 

On June 5, 2013, Nathan’s adopted a stockholder rights plan (the “2013 Rights Plan”) under which all stockholders of record as of June 17, 2013 received rights to purchase shares of common stock (the “2013 Rights”).

 

The 2013 Rights were distributed as a dividend. Initially, the 2013 Rights will attach to, and trade with, the Company’s common stock. Subject to the terms, conditions and limitations of the 2013 Rights Plan, the 2013 Rights will become exercisable if (among other things) a person or group acquires 15% or more of the Company’s common stock. Upon such an event and payment of the purchase price of $100.00 (the “2013 Right Purchase Price”), each 2013 Right (except those held by the acquiring person or group) will entitle the holder to acquire one share of the Company’s common stock (or the economic equivalent thereof) or, if the then-current market price is less than the then current 2013 Right Purchase Price, a number of shares of the Company’s common stock which at the time of the transaction has a market value equal to the then current 2013 Right Purchase Price at a purchase price per share equal to the then current market price of the Company’s Common Stock.

 

On June 14, 2018, the Company and American Stock Transfer and Trust Company, LLC, the Rights Agent, amended the 2013 Rights Plan. The Amendment postponed the expiration date to September 30, 2018, at which time it terminated.

 

 

At September 23, 2018, the Company had reserved 5,165,171 shares of common stock for issuance upon exercise of the 2013 Rights.  On September 30, 2018, the Rights Plan terminated.

 

3. Stock Repurchase Programs

 

During the period from October 2001 through September 23, 2018, Nathan’s purchased 5,127,373 shares of common stock at a cost of approximately $77,303,000 pursuant to various stock repurchase plans previously authorized by the Board of Directors. During the twenty-six week period ended September 23, 2018, we did not repurchase any shares of common stock.

 

In 2016, the Company’s Board of Directors authorized increases to the sixth stock repurchase plan for the purchase of up to 1,200,000 shares of its common stock on behalf of the Company. As of September 23, 2018, Nathan’s had repurchased 939,742 shares at a cost of $29,641,000 under the sixth stock repurchase plan. At September 23, 2018, there were 260,258 shares remaining to be repurchased pursuant to the sixth stock repurchase plan. The plan does not have a set expiration date. Purchases under the Company’s stock repurchase program may be made from time to time, depending on market conditions, in open market or privately-negotiated transactions, at prices deemed appropriate by management. There is no set time limit on the repurchases.

 

NOTE O – LONG-TERM DEBT

 

Long-term debt consists of the following (in thousands):

 

 

On November 1, 2017, the Company issued $150,000,000 of 6.625% Senior Secured Notes due 2025 (the "2025 Notes") in a private offering in accordance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). The 2025 Notes were issued pursuant to the Indenture. The Company used the net proceeds of the 2025 Notes offering to satisfy and discharge the Indenture relating to the 10.000% Senior Secured Notes due 2020 and redeem the 2020 Notes (the "Redemption"), paid a portion of a special $5.00 per share cash dividend to Nathan's stockholders of record, with the remaining net proceeds for general corporate purposes, including working capital. The Company also funded the majority of the special dividend of $5.00 per share through its existing cash. The Redemption occurred on November 16, 2017.

 

The 2025 Notes bear interest at 6.625% per annum, payable semi-annually on May 1^st and November 1^st of each year. The Company made its required semi-annual interest payments of $4,968,750 on May 1, 2018 and November 1, 2018.

 

The 2025 Notes have no scheduled principal amortization payments prior to its final maturity on November 1, 2025.

 

The terms and conditions of the 2025 Notes are as follows:

 

There are no financial maintenance covenants associated with the 2025 Notes. As of September 23, 2018, Nathan’s was in compliance with all covenants associated with the 2025 Notes.

 

The Indenture contains certain covenants limiting the Company’s ability and the ability of its restricted subsidiaries (as defined in the Indenture) to, subject to certain exceptions and qualifications: (i) incur additional indebtedness; (ii) pay dividends or make other distributions on, redeem or repurchase, capital stock; (iii) make investments or other restricted payments; (iv) create or incur certain liens; (v) incur restrictions on the payment of dividends or other distributions from its restricted subsidiaries; (vi) enter into certain transactions with affiliates; (vii) sell assets; or (viii) effect a consolidation or merger. Certain Restricted Payments which may be made or indebtedness incurred by Nathan’s or its Restricted Subsidiaries may require compliance with the following financial ratios:

 

Fixed Charge Coverage Ratio: the ratio of the Consolidated Cash Flow to the Fixed Charges for the relevant period, currently set at 2.0 to 1.0 in the Indenture. The Fixed Charge Coverage Ratio applies to determining whether additional Restricted Payments may be made, certain additional debt may be incurred and acquisitions may be made.

 

Priority Secured Leverage Ratio: the ratio of (a) Consolidated Net Debt outstanding as of such date that is secured by a Priority Lien to (b) Consolidated Cash Flow of Nathan’s for the Test Period then most recently ended, in each case with such pro forma adjustments as are appropriate; currently set at 0.40 to 1.00 in the Indenture.

 

Secured Leverage Ratio: the ratio of (a) Consolidated Net Debt outstanding as of such date that is secured by a Lien on any property of Nathan’s or any Guarantor to (b) Consolidated Cash Flow of Nathan’s for the Test Period then most recently ended, in each case with such pro forma adjustments as are appropriate. The Secured Leverage Ratio under the Indenture is 3.75 to 1.00 and applies if Nathan’s wants to incur additional debt on the same terms as the 2025 Notes.

 

 

The Indenture also contains customary events of default, including, among other things, failure to pay interest, failure to comply with agreements related to the indenture, failure to pay at maturity or acceleration of other indebtedness, failure to pay certain judgments, and certain events of insolvency or bankruptcy. Generally, if any event of default occurs, the Trustee or the holders of at least 25% in principal amount of the 2025 Notes may declare the 2025 Notes due and payable by providing notice to the Company. In case of default arising from certain events of bankruptcy or insolvency, the 2025 Notes will become immediately due and payable.

 

The 2025 Notes are general senior secured obligations, are fully and unconditionally guaranteed by substantially all of the Company’s wholly-owned subsidiaries and rank pari passu in right of payment with all of the Company’s existing and future indebtedness that is not subordinated, are senior in right of payment to any of the Company’s existing and future subordinated indebtedness, are structurally subordinated to any existing and future indebtedness and other liabilities of the Company’s subsidiaries that do not guarantee the 2025 Notes, and are effectively junior to all existing and future indebtedness that is secured by assets other than the collateral securing the 2025 Notes.

 

Pursuant to the terms of a collateral trust agreement, the liens securing the 2025 Notes and the guarantees will be contractually subordinated to the liens securing any future credit facility.

 

The 2025 Notes and the guarantees are the Company and the guarantors’ senior secured obligations and will rank:

 

	●	senior in right of payment to all of the Company and the guarantors’ future subordinated indebtedness;
	●	effectively senior to all unsecured senior indebtedness to the extent of the value of the collateral securing the 2025 Notes and the guarantees;
	●	pari passu with all of the Company and the guarantors’ other senior indebtedness;
	●	effectively junior to any future credit facility to the extent of the value of the collateral securing any future credit facility and the 2025 Notes and the guarantees and certain other assets;
	●	effectively junior to any of the Company and the guarantors’ existing and future indebtedness that is secured by assets other than the collateral securing the 2025 Notes and the guarantees to the extent of the value of any such assets; and
	●	structurally subordinated to the indebtedness of any of the Company’s current and future subsidiaries that do not guarantee the 2025 Notes.

 

The Company may redeem the 2025 Notes in whole or in part prior to November 1, 2020, at a redemption price of 100% of the principal amount of the 2025 Notes redeemed plus the Applicable Premium, plus accrued and unpaid interest. An Applicable Premium is the greater of 1% of the principal amount of the 2025 Notes; or the excess of the present value at such redemption date of (i) the redemption price of the 2025 Notes at November 1, 2020 plus (ii) all required interest payments due on the 2025 Notes through November 1, 2020 (excluding accrued but unpaid interest to the redemption date), computed using a discount rate equal to the Treasury Rate as of such redemption date plus 50 basis points; over the then outstanding principal amount of the 2025 Notes.

 

Prior to November 1, 2020, if using the net cash proceeds of certain equity offerings, the Company has the option to redeem up to 35% of the aggregate principal amount of the 2025 Notes at a redemption price equal to 106.625% of the principal amount of the 2025 Notes redeemed, plus accrued and unpaid interest and any additional interest.

 

On or after November 1, 2020, the Company may redeem some or all of the 2025 Notes at a decreasing premium over time, plus accrued and unpaid interest as follows:

 

 

In certain circumstances involving a change of control, the Company will be required to make an offer to repurchase all or, at the holder’s option, any part, of each holder’s 2025 Notes pursuant to the offer described below (the “Change of Control Offer”). In the Change of Control Offer, the Company will be required to offer payment in cash equal to 101% of the aggregate principal amount of 2025 Notes repurchased plus accrued and unpaid interest, to the date of purchase.

 

 

If the Company sells certain assets and does not use the net proceeds as required, the Company will be required to use such net proceeds to repurchase the 2025 Notes at 100% of the principal amount thereof, plus accrued and unpaid interest and additional interest penalty, if any, to the date of repurchase.

 

The 2025 Notes may be traded between qualified institutional buyers pursuant to Rule 144A of the Securities Act. We have recorded the 2025 Notes at cost.

 

NOTE P – COMMITMENTS AND CONTINGENCIES

 

1. Commitments 

 

On February 27, 2017, a wholly-owned subsidiary of the Company executed a Guaranty of Lease (the “Brooklyn Guaranty”) in connection with its re-franchising of a restaurant located in Brooklyn, New York. The Company is obligated to make payments under the Brooklyn Guaranty in the event of a default by the tenant/franchisee. The Brooklyn Guaranty has an initial term of 10 years and one 5-year option and is limited to 24 months of rent for the first three years of the term. Nathan’s has recorded a liability of $204,000 as a component of Other liabilities on the accompanying Consolidated Balance Sheets, in connection with the Brooklyn Guaranty which does not include potential percentage rent, real estate tax increases, attorney’s fees and other costs as these amounts are not reasonably determinable at this time. Nathan’s has received a personal guaranty from the franchisee for all obligations under the Brooklyn Guaranty. For the remainder of the term, the Brooklyn Guaranty is limited to 12 months of rent plus reasonable costs of collection and attorney’s fees.                 

 

2. Contingencies

 

The Company and its subsidiaries are from time to time involved in ordinary and routine litigation. Management presently believes that the ultimate outcome of these proceedings, individually or in the aggregate, will not have a material adverse effect on the Company’s financial position, cash flows or results of operations. Nevertheless, litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling could include money damages and, in such event, could result in a material adverse impact on the Company’s results of operations for the period in which the ruling occurs. 

 

 

 

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