Item 2. Management’s Discussion and Analysis
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Forward-Looking Statements
This Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1933, as amended, that involve risks and uncertainties. You can identify forward-looking statements because they contain words such as “believes”, “expects”, “projects”, “may”, “would”, “should”, “seeks”, “intends”, “plans”, “estimates”, “anticipates” or similar expressions that relate to our strategy, plans or intentions. All statements we make relating to our estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and financial results or to our expectations regarding future industry trends are forward-looking statements. In addition, we, through our senior management, from time to time make forward-looking public statements concerning our expected future operations and performance and other developments. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may change at any time, and, therefore, our actual results may differ materially from those that we expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and, of course, it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements contained in this Form 10-Q are based upon information available to us on the date of this Form 10-Q.
Statements in this Form 10-Q quarterly report may be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements that express our intentions, beliefs, expectations, strategies, predictions or any other statements relating to our future activities or other future events or conditions. These statements are based on current expectations, estimates and projections about our business based, in part, on assumptions made by management. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. These risks and uncertainties, many of which are not within our control, include but are not limited to: the impact of disease epidemics such as the COVID-19 pandemic; increases in the cost of food and paper products; the impact of price increases on customer visits; the status of our licensing and supply agreements, including our licensing revenue and overall profitability being substantially dependent on our agreement with Smithfield Foods, Inc.; the impact of our debt service and repayment obligations under the 2025 Notes (as defined below), including the effect on our ability to fund working capital, operations and make investments; economic (including inflationary pressures like those currently being experienced); weather (including the impact on sales at our restaurants particularly during the summer months); changes in the price of beef and beef trimmings; our ability to pass on the cost of any price increases in beef and beef trimmings; legislative and business conditions; the collectability of receivables; changes in consumer tastes; the continued viability of Coney Island as a destination location for visitors; the ability to attract franchisees; the impact of the minimum wage legislation on labor costs in New York State or other changes in labor laws, including regulations which could render a franchisor as a “joint employee” or the impact of our union contracts; our ability to attract competent restaurant and managerial personnel; the enforceability of international franchising agreements; the future effects of any food borne illness such as bovine spongiform encephalopathy, BSE or e-coli; as well as those risks discussed from time to time in this Form 10-Q and our Form 10-K annual report for the year ended March 26, 2023, and in other documents we file with the U.S. Securities and Exchange Commission. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. We generally identify forward-looking statements with the words “believe,” “intend,” “plan,” “expect,” “anticipate,” “estimate,” “will,” “should” and similar expressions. Any forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Form 10-Q.
Introduction
As used in this Report, the terms “we”, “us”, “our”, “Nathan’s” or the “Company” mean Nathan’s Famous, Inc. and its subsidiaries (unless the context indicates a different meaning).
We are engaged primarily in the marketing of the “Nathan’s Famous” brand and the sale of products bearing the “Nathan’s Famous” trademarks through several different channels of distribution. Historically, our business has been the operation and franchising of quick-service restaurants featuring Nathan’s World Famous Beef Hot Dogs, crinkle-cut French fries, and a variety of other menu offerings. Our Company-owned and franchised restaurants operate under the name “Nathan’s Famous,” the name first used at our original Coney Island restaurant opened in 1916. Nathan’s product licensing program sells packaged hot dogs, frozen crinkle-cut French fries and additional products to retail customers through supermarkets, grocery channels and club stores for off-site consumption. Our Branded Product Program enables foodservice retailers and others to sell some of Nathan’s proprietary products outside of the realm of a traditional franchise relationship. In conjunction with this program, purchasers of Nathan’s products are granted a limited use of the Nathan’s Famous trademark with respect to the sale of the purchased products, including Nathan’s World Famous Beef Hot Dogs, certain other proprietary food items and paper goods. Our Branded Menu Program is a limited franchise program, under which foodservice operators may sell a greater variety of Nathan’s Famous menu items than under the Branded Product Program.
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Our revenues are generated primarily from selling products under Nathan’s Branded Product Program, operating Company-owned restaurants, licensing agreements for the sale of Nathan’s products within supermarkets, grocery stores and club stores, the sale of Nathan’s products directly to other foodservice operators, the manufacture of certain proprietary spices by third parties and the royalties, fees and other sums we can earn from franchising the Nathan’s restaurant concept (including the Branded Menu Program and virtual kitchens).
At December 24, 2023, our restaurant system, excluding virtual kitchens, consisted of 238 locations, including 117 Branded Menu Program locations, and four Company-owned restaurants (including one seasonal unit), located in 17 states, and 13 foreign countries.
At December 25, 2022, our restaurant system, excluding virtual kitchens, consisted of 233 locations, including 120 Branded Menu Program locations, and four Company-owned restaurants (including one seasonal unit), located in 17 states, and 12 foreign countries.
Our primary focus is to expand the market penetration of the Nathan’s Famous brand by increasing the number of distribution points for our products across all of our business platforms, including our Licensing Program for distribution of Nathan’s Famous branded consumer packaged goods, our Branded Products Program for distribution of Nathan’s Famous branded bulk products to the foodservice industry, and our namesake restaurant system comprised of both Company-owned restaurants and franchised locations, including virtual kitchens. The primary drivers of our growth have been our Licensing and Branded Product Programs which have been the largest contributors to the Company’s revenues and profits.
While we do not expect to significantly increase the number of Company-owned restaurants, we may opportunistically and strategically invest in a small number of new units as showcase locations for prospective franchisees and master developers as we seek to grow our franchise system. We continue to seek opportunities to drive sales in a variety of ways as we adapt to the ever-changing consumer and business climate.
As described in our Annual Report on Form 10-K for the year ended March 26, 2023, our future results could be materially impacted by many developments including our dependence on Smithfield Foods, Inc. as our principal supplier and the dependence of our licensing revenue and overall profitability on our agreement with Smithfield Foods, Inc. In addition, our future operating results could be impacted by supply constraints on beef or by increased costs of beef, beef trimmings and other commodities due to inflationary pressures compared to earlier periods.
On November 1, 2017, the Company issued $150,000,000 of 6.625% Senior Secured Notes due 2025 (the “2025 Notes”) and used the majority of the proceeds of this offering to redeem the Company’s 10.000% Senior Secured Notes due 2020, paid a portion of the special $5.00 cash dividend and used the remaining proceeds for general corporate purposes, including working capital.
On January 26, 2022, March 21, 2023 and December 19, 2023, the Company redeemed $40,000,000, $30,000,000 and $20,000,000, respectively, in aggregate principal amount of its 2025 Notes. $60,000,000 principal amount of the 2025 Notes were outstanding as of December 24, 2023. On May 1, 2023 and November 1, 2023, the Company paid its semi-annual interest payments for fiscal 2024. On December 19, 2023, in connection with the redemption of $20,000,000 principal amount of its 2025 Notes, the Company paid its required interest payment accrued on the redeemed 2025 Notes.
Our future results may be impacted by our interest obligations under the 2025 Notes. As a result of the $60,000,000 outstanding principal amount of the 2025 Notes as of December 24, 2023, the Company expects to incur annual interest expense of $3,975,000 and annual amortization costs of approximately $276,000.
As described below, we are also including information relating to EBITDA and Adjusted EBITDA, which are non-GAAP financial measures, in this Form 10-Q quarterly report. See “Reconciliation of GAAP and Non-GAAP Measures.”
Recent events
Inflationary Factors
Inflationary pressures negatively impacted our earnings during the first nine months of fiscal 2024, including (i) rising labor costs and (ii) higher commodity prices, including beef and beef trimmings. This trend may continue throughout the remainder of fiscal year 2024. In general, we have been able to offset cost increases resulting from inflation by increasing prices and adjusting product mix. We continue to monitor these inflationary pressures and will continue to implement mitigation measures as needed. Inherent volatility in commodity markets, including beef and beef trimmings, could have a significant impact on our results of operations. Delays in implementing price increases, competitive pressures, a decline in consumer spending levels and other factors may limit our ability to implement further price increases in the future.
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Critical Accounting Policies and Estimates
As discussed in our Form 10-K for the fiscal year ended March 26, 2023, the discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”). The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in those consolidated financial statements. These judgments can be subjective and complex, and consequently, actual results could differ from those estimates. Our most critical accounting policies and estimates relate to revenue recognition; leases; impairment of intangible assets; impairment of long-lived assets; and income taxes (including uncertain tax positions). As discussed in Note B, the Company adopted ASU 2016-13, “ Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, ” effective March 27, 2023. There have been no other significant changes to the Company’s accounting policies subsequent to March 26, 2023.
Adoption of New Accounting Standard
Please refer to Note B of the preceding consolidated financial statements for our discussion of the Adoption of the New Accounting Standard.
New Accounting Standards Not Yet Adopted
Please refer to Note C of the preceding consolidated financial statements for our discussion of New Accounting Standards Not Yet Adopted.
EBITDA and Adjusted EBITDA
The Company believes that EBITDA and Adjusted EBITDA, which are non-GAAP financial measures, are useful to investors to assist in assessing and understanding the Company's operating performance and underlying trends in the Company's business because EBITDA and Adjusted EBITDA are (i) among the measures used by management in evaluating performance and (ii) are frequently used by securities analysts, investors and other interested parties as a common performance measure.
Reconciliation of GAAP and Non-GAAP Measures
The following is provided to supplement certain Non-GAAP financial measures.
In addition to disclosing results that are determined in accordance with US GAAP, the Company has provided EBITDA, a non-GAAP financial measure, which is defined as net income excluding (i) interest expense; (ii) provision for income taxes and (iii) depreciation and amortization expense. The Company has also provided Adjusted EBITDA, a non-GAAP financial measure, which is defined as EBITDA, excluding (i) the loss on disposal of property and equipment; (ii) loss on debt extinguishment; and (iii) share-based compensation that the Company believes will impact the comparability of its results of operations.
EBITDA and Adjusted EBITDA are not recognized terms under US GAAP and should not be viewed as alternatives to net income or other measures of financial performance or liquidity in conformity with US GAAP. Additionally, our definitions of EBITDA and Adjusted EBITDA may differ from other companies. Analysis of results and outlook on a non-US GAAP basis should be used as a complement to, and in conjunction with, data presented in accordance with US GAAP.
The following is a reconciliation of net income to EBITDA and Adjusted EBITDA (in thousands):
Thirteen weeks ended
Thirty-nine weeks ended
December 24, 2023
December 25, 2022
December 24, 2023
December 25, 2022
(unaudited)
(unaudited)
Net income
$
2,607
$
3,263
$
15,706
$
16,358
Interest expense
1,392
1,944
4,219
5,831
Provision for income taxes
1,128
1,223
6,025
6,093
Depreciation and amortization
268
303
896
837
EBITDA
5,395
6,733
26,846
29,119
Loss on disposal of property and equipment
-
101
-
87
Loss on debt extinguishment
169
-
169
-
Share-based compensation
187
65
546
81
Adjusted EBITDA
$
5,751
$
6,899
$
27,561
$
29,287
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Seasonality
Our routine business pattern is affected by seasonal fluctuations, including the effects of weather and economic conditions. Historically, sales from our Company-owned restaurants, principally at Coney Island, and franchised restaurants from which franchised royalties are earned and the Company’s earnings have been highest during our first two fiscal quarters, with the fourth quarter representing the slowest period. Additionally, revenues from our Branded Product Program, Branded Menu Program and Product licensing program generally follow similar seasonal fluctuations, although not to the same degree. We expect that this seasonality will continue. Working capital requirements may vary throughout the year to support these seasonal patterns.
Due to the above seasonal factors, as well as inflationary pressures, our results of operations for the thirteen and thirty-nine weeks ended December 24, 2023 are not necessarily indicative of those for a full fiscal year.
Results of Operations
Thirteen weeks ended December 24, 2023 compared to thirteen weeks ended December 25, 2022
Revenues
Total revenues increased by approximately 10% to $28,890,000 for the thirteen weeks ended December 24, 2023 (“third quarter fiscal 2024”) as compared to $26,154,000 for the thirteen weeks ended December 25, 2022 (“third quarter fiscal 2023”).
Total sales increased by approximately 16% to $21,349,000 for the third quarter fiscal 2024 as compared to $18,340,000 for the third quarter fiscal 2023 which included foodservice sales from the Branded Product Program increasing by 18% to $19,688,000 for the third quarter fiscal 2024 as compared to sales of $16,661,000 for the third quarter fiscal 2023. During the third quarter fiscal 2024, the volume of hot dogs sold increased by approximately 8% as compared to the third quarter fiscal 2023. Our average selling prices increased by approximately 9% as compared to the third quarter fiscal 2023. Total Company-owned restaurant sales decreased by 1% to $1,661,000 during the third quarter fiscal 2024 as compared to $1,679,000 during the third quarter fiscal 2023. Restaurant sales were impacted by reduced traffic at our Coney Island locations.
License royalties decreased by approximately 4% to $6,078,000 in the third quarter fiscal 2024 as compared to $6,337,000 in the third quarter fiscal 2023. Total royalties earned on sales of hot dogs from our license agreement with Smithfield Foods, Inc. at retail and foodservice decreased 4% to $5,279,000 for the third quarter fiscal 2024 as compared to $5,489,000 in the third quarter fiscal 2023. The decrease is due to a 12% decrease in retail volume, which was offset, in part, by a 6% increase in average net selling price as compared to the second quarter fiscal 2023. The foodservice business earned higher royalties of $107,000 as compared to the third quarter fiscal 2023. Royalties earned from all other licensing agreements for the manufacture and sale of Nathan’s products decreased by $49,000 during the third quarter fiscal 2024 as compared to the third quarter fiscal 2023 primarily due to lower royalties earned on sales of franks-in-a-blanket, mozzarella sticks and other hors d’oeuvres.
Franchise fees and royalties were $955,000 in the third quarter fiscal 2024 as compared to $976,000 in the third quarter fiscal 2023. Total royalties were $868,000 in the third quarter fiscal 2024 as compared to $829,000 in the third quarter fiscal 2023. Royalties earned under the Branded Menu program were $150,000 in the third quarter fiscal 2024 as compared to $151,000 in the third quarter fiscal 2023. Royalties earned under the Branded Menu Program are not based upon a percentage of restaurant sales but are based upon product purchases. Virtual kitchen royalties were $14,000 in the third quarter fiscal 2024 as compared to $30,000 in the third quarter fiscal 2023. Traditional franchise royalties were $704,000 in the third quarter fiscal 2024 as compared to $648,000 in the third quarter fiscal 2023. Franchise restaurant sales increased to $15,635,000 in the third quarter fiscal 2024 as compared to $14,761,000 in the third quarter fiscal 2023 primarily due to higher sales at airport locations and shopping malls. Comparable domestic franchise sales (consisting of 61 Nathan’s outlets, excluding sales under the Branded Menu Program) were $12,335,000 in the third quarter fiscal 2024 as compared to $12,410,000 in the third quarter fiscal 2023.
At December 24, 2023, 238 franchised locations, including domestic, international and Branded Menu Program units were operating as compared to 233 franchised locations, including domestic, international and Branded Menu Program units at December 25, 2022. Total franchise fee income was $87,000 in the third quarter fiscal 2024 as compared to $147,000 in the third quarter fiscal 2023. Domestic franchise fee income was $26,000 in the third quarter fiscal 2024 as compared to $27,000 in the third quarter fiscal 2023. International franchise fee income was $61,000 in the third quarter fiscal 2024 and the third quarter fiscal 2023.
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We did not recognize any forfeited fees in the third quarter fiscal 2024. We recognized $59,000 in forfeited fees in the third quarter fiscal 2023. During the third quarter fiscal 2024, three franchised locations opened. During the third quarter fiscal 2023, four franchise locations opened and five franchise locations closed.
Advertising fund revenue, after eliminating Company contributions, was $508,000 during the third quarter fiscal 2024 as compared to $501,000 during the third quarter fiscal 2023 period.
Costs and Expenses
Overall, our cost of sales increased by approximately 20% to $17,872,000 in the third quarter fiscal 2024 as compared to $14,925,000 in the third quarter fiscal 2023. Our gross profit (calculated as total sales less cost of sales) increased to $3,477,000 or 16% of sales during the third quarter fiscal 2024 as compared to $3,415,000 or 19% of sales during the third quarter fiscal 2023.
Cost of sales in the Branded Product Program increased by 22% to $16,688,000 in the third quarter fiscal 2024 as compared to $13,681,000 in the third quarter fiscal 2023, primarily due to the 8% increase in the volume of hot dogs sold as discussed above, as well as a 13% increase in the average cost per pound of our hot dogs. Inflationary pressures eased slightly in December 2023, yet pricing pressures on commodities, including beef and beef trimmings remain. We did not make any purchase commitments of beef during the third quarter fiscal 2024 or the third quarter fiscal 2023. If the cost of beef and beef trimmings increases and we are unable to pass on these higher costs through price increases or otherwise reduce any increase in our costs through the use of purchase commitments, our margins will be adversely impacted. With respect to Company-owned restaurants, our cost of sales during the third quarter fiscal 2024 was $1,184,000 or 71% of restaurant sales as compared to $1,244,000 or 74% of restaurant sales in the third quarter fiscal 2023. The decrease in the cost of sales during the third quarter of fiscal 2024 was primarily due to the 1% decrease in sales as discussed above. Food and paper costs as a percentage of Company-owned restaurant sales were 29%, down from 31% in the comparable period of the prior year. Labor and related expenses as a percentage of Company-owned restaurant sales were 42%, down from 43% in the comparable period in the prior year due to tighter management and staffing stabilization.
Restaurant operating expenses were $896,000 in the third quarter fiscal 2024 as compared to $932,000 in the third quarter fiscal 2023. We incurred higher occupancy expenses of $18,000, higher insurance costs of $6,000, and higher credit card and bank fees of $9,000, which were offset by lower utilities expenses of $36,000.
Depreciation and amortization, which primarily consists of the depreciation of fixed assets, including leasehold improvements and equipment, was $268,000 in the third quarter fiscal 2024 as compared to $303,000 in the third quarter fiscal 2023.
General and administrative expenses increased by $1,048,000 or 33% to $4,209,000 in the third quarter fiscal 2024 as compared to $3,161,000 in the third quarter fiscal 2023. The increase in general and administrative expenses was primarily attributable to a cash bonus payment of $500,000 to Howard M. Lorber, Executive Chairman of the Board, higher share-based compensation expense of $122,000, higher professional fees of $170,000, higher travel expenses of $66,000, and higher marketing and tradeshow expenses of $43,000.
Advertising fund expense, after eliminating Company contributions, was $508,000 during the third quarter fiscal 2024 as compared to $501,000 in the third quarter fiscal 2023.
Other Items
Interest expense of $1,392,000 in the third quarter fiscal 2024 represented interest expense of $1,300,000 on the 2025 Notes and amortization of debt issuance costs of $92,000.
Interest expense of $1,944,000 in the third quarter fiscal 2023 represented interest expense of $1,817,000 on the 2025 Notes and amortization of debt issuance costs of $127,000.
The reduction in interest expense of $552,000 is due to the reduction in the outstanding principal amount of the Company’s 2025 Notes as a result of the partial redemptions of $30,000,000 principal amount of its 2025 Notes completed in March 2023 and $20,000,000 principal amount of its 2025 Notes completed in December 2023.
On December 19, 2023, the Company completed the partial redemption, in the principal amount of $20,000,000 of the 2025 Notes. In connection with the partial redemption, the Company recorded a loss on early extinguishment of debt of $169,000 that reflected the write-off of a portion of previously recorded debt issuance costs.
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Interest income of $138,000 in the third quarter fiscal 2024 represented amounts earned by the Company on its certificates of deposit, as well as its interest bearing bank and money market accounts, as compared to $158,000 in the third quarter fiscal 2023.
Other income, net was $21,000 in the third quarter fiscal 2024, which primarily relates to sublease income from a franchised restaurant. Other expense, net was $60,000 in the third quarter fiscal 2023, which primarily relates to a loss on disposal of assets for capitalized software no longer in use of $101,000 offset by sublease income from a franchised restaurant.
Provision for Income Taxes
The effective income tax rate for the third quarter fiscal 2024 was 30.2% as compared to 27.3% in the third quarter fiscal 2023. The effective income tax rate for the third quarter fiscal 2024 reflected income tax expense of $1,128,000 recorded on $3,735,000 of pre-tax income. The effective income tax rate for the third quarter fiscal 2023 reflected income tax expense of $1,223,000 recorded on $4,486,000 of pre-tax income. The effective tax rates are higher than the U.S. Federal statutory rates primarily due to state and local taxes, as well as non-deductible executive compensation under the Internal Revenue Code Section 162(m).
The amount of unrecognized tax benefits at December 24, 2023 was $465,000 all of which would impact the Company’s effective tax rate, if recognized. As of December 24, 2023, the Company had approximately $343,000 accrued for the payment of interest and penalties in connection with unrecognized tax benefits.
Nathan’s estimates that its unrecognized tax benefit excluding accrued interest and penalties could be further reduced by up to $19,000 during the fiscal year ending March 31, 2024 due primarily to the lapse of statutes of limitations which would favorably impact the Company’s effective tax rate, although no assurances can be given in this regard.
Results of Operations
Thirty-nine weeks ended December 24, 2023 compared to thirty-nine weeks ended December 25, 2022
Revenues
Total revenues increased by 6% to $109,619,000 for the thirty-nine weeks ended December 24, 2023 (“fiscal 2024 period”) as compared to $103,371,000 for the thirty-nine weeks ended December 25, 2022 (“fiscal 2023 period”).
Total sales increased by approximately 9% to $78,722,000 for the fiscal 2024 period as compared to $72,535,000 for the fiscal 2023 period which included foodservice sales from the Branded Product Program increasing by 10% to $68,210,000 for the fiscal 2024 period as compared to sales of $61,862,000 for the fiscal 2023 period. During the fiscal 2024 period, the volume of hot dogs sold in the Branded Product Program increased by approximately 2% as compared to the fiscal 2023 period. Our average selling prices, which are partially correlated to the beef markets, increased by approximately 8% as compared to the fiscal 2023 period. Total Company-owned restaurant sales decreased by approximately 2% to $10,512,000 during the fiscal 2024 period as compared to $10,673,000 during the fiscal 2023 period. Restaurant sales were impacted by reduced traffic at our Coney Island locations as a result of unfavorable weather conditions during the summer season.
License royalties increased to $26,075,000 in the fiscal 2024 period as compared to $26,064,000 in the fiscal 2023 period. Total royalties earned on sales of hot dogs from our license agreement with Smithfield Foods, Inc. at retail and foodservice, were $23,582,000 for the fiscal 2024 period as compared to $23,594,000 in the fiscal 2023 period. The nominal decline is due to a 4% decrease in retail volume as compared to the fiscal 2023 period which was offset, in part, by a 3% increase in average net selling price. The foodservice business earned higher royalties of $217,000 as compared to the fiscal 2023 period. Royalties earned from all other licensing agreements for the manufacture and sale of Nathan’s products increased by $23,000 during the fiscal 2024 period as compared to the fiscal 2023 period primarily due to higher royalties earned on sales of french fries and onion rings, offset, in part, by lower royalties on the sales of franks-in-a-blanket, mozzarella sticks, and other hors d’oeuvres.
Franchise fees and royalties were $3,321,000 in the fiscal 2024 period as compared to $3,268,000 in the fiscal 2023 period. Total royalties were $2,996,000 in the fiscal 2024 period as compared to $2,785,000 in the fiscal 2023 period. Royalties earned under the Branded Menu program were $603,000 in the fiscal 2024 period as compared to $468,000 in the fiscal 2023 period. Royalties earned under the Branded Menu Program are not based upon a percentage of restaurant sales but are based upon product purchases. Virtual kitchen royalties were $64,000 in the fiscal 2024 period as compared to $112,000 in the fiscal 2023 period. Traditional franchise royalties were $2,329,000 in the fiscal 2024 period as compared to $2,205,000 in the fiscal 2023 period. Franchise restaurant sales increased to $52,068,000 in the fiscal 2024 period as compared to $49,302,000 in the fiscal 2023 period primarily due to higher sales at airport locations, shopping malls and movie theaters. Comparable domestic franchise sales (consisting of 64 Nathan’s units, excluding sales under the Branded Menu Program) were $42,456,000 in the fiscal 2024 period as compared to $40,847,000 in the fiscal 2023 period.
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At December 24, 2023, 238 franchised locations, including domestic, international and Branded Menu Program units were operating as compared to 233 franchised locations, including domestic, international and Branded Menu Program franchise units at December 25, 2022. Total franchise fee income was $325,000 in the fiscal 2024 period as compared to $483,000 in the fiscal 2023 period. Domestic franchise fee income was $81,000 in the fiscal 2024 period as compared to $84,000 in the fiscal 2023 period. International franchise fee income was $181,000 in the fiscal 2024 period as compared to $191,000 during the fiscal 2023 period.
We recognized $63,000 and $208,000 in forfeited fees in the fiscal 2024 period and fiscal 2023 period, respectively. During the fiscal 2024 period, seventeen franchise locations opened and eleven franchise locations closed. During the fiscal 2023 period, eight franchise locations opened and fourteen franchise locations closed.
Advertising fund revenue, after eliminating Company contributions, was $1,501,000 in the fiscal 2024 period, as compared to $1,504,000 during the fiscal 2023 period.
Costs and Expenses
Overall, our cost of sales increased by 12% to $66,743,000 in the fiscal 2024 period as compared to $59,490,000 in the fiscal 2023 period. Our gross profit (calculated as total sales less cost of sales) decreased to $11,979,000 or 15% of sales during the fiscal 2024 period as compared to $13,045,000 or 18% of sales during the fiscal 2023 period.
Cost of sales in the Branded Product Program increased by 14% to $60,698,000 during the fiscal 2024 period as compared to $53,056,000 during the fiscal 2023 period, primarily due to the 2% increase in the volume of hot dogs sold as discussed above, as well as a 12% increase in the average cost per pound of our hot dogs. Inflationary pressures eased slightly in December 2023, yet pricing pressures on commodities, including beef and beef trimmings remain. We did not make any purchase commitments of beef during the fiscal 2024 and 2023 periods. If the cost of beef and beef trimmings increases and we are unable to pass on these higher costs through price increases or otherwise reduce any increase in our costs through the use of purchase commitments, our margins will be adversely impacted. With respect to Company-owned restaurants, our cost of sales during the fiscal 2024 period was $6,045,000 or 58% of restaurant sales as compared to $6,434,000 or 60% of restaurant sales in the fiscal 2023 period. The decrease in cost of sales during the fiscal 2024 period was primarily due to the 2% decrease in sales discussed above. Food and paper costs as a percentage of Company-owned restaurant sales were 28%, down from 29% in the comparable period of the prior year. Labor and related expenses as a percentage of Company-owned restaurant sales were 29%, down from 31% in the comparable period in the prior year due to tighter management and staffing stabilization.
Restaurant operating expenses were $3,279,000 in the fiscal 2024 period as compared to $3,217,000 in the fiscal 2023 period. We incurred higher occupancy expenses of $43,000, higher credit card and bank fees of $73,000, which were offset, in part, by lower utilities expenses of $38,000.
Depreciation and amortization, which primarily consists of the depreciation of fixed assets, including leasehold improvements and equipment, was $896,000 in the fiscal 2024 period as compared to $837,000 in the fiscal 2023 period.
General and administrative expenses increased by $1,374,000 or 14% to $11,496,000 in the fiscal 2024 period as compared to $10,122,000 in the fiscal 2023 period. The increase in general and administrative expenses was primarily attributable to a cash bonus payment of $500,000 to Howard M. Lorber, Executive Chairman of the Board, higher share-based compensation expenses of $466,000 and higher professional fees of $272,000.
Advertising fund expense, after eliminating Company contributions, was $1,501,000 in the fiscal 2024 period, as compared to $1,679,000 in the fiscal 2023 period.
Other Items
Interest expense of $4,219,000 in the fiscal 2024 period represented interest expense of $3,943,000 on the 2025 Notes and amortization of debt issuance costs of $276,000.
Interest expense of $5,831,000 in the fiscal 2023 period represented interest expense of $5,450,000 on the 2025 Notes and amortization of debt issuance costs of $381,000.
The reduction in interest expense of $1,612,000 is due to the reduction in the outstanding principal amount of the Company’s 2025 Notes as a result of the partial redemptions of $30,000,000 principal amount of its 2025 Notes completed in March 2023 and $20,000,000 principal amount of its 2025 Notes completed in December 2023.
On December 19, 2023, the Company completed the partial redemption, in the principal amount of $20,000,000 of the 2025 Notes. In connection with the partial redemption, the Company recorded a loss on early extinguishment of debt of $169,000 that reflected the write-off of a portion of previously recorded debt issuance costs.
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Interest income of $350,000 in the fiscal 2024 period represented amounts earned by the Company on its certificates of deposit, as well as interest bearing bank and money market accounts, as compared to $260,000 in the fiscal 2023 period.
Other income, net was $65,000 in the fiscal 2024 period, which primarily relates to sublease income from a franchised restaurant. Other expense, net was $4,000 in the fiscal 2023 period, which primarily relates to a net loss on disposal of assets for capitalized software no longer in use of $87,000, offset by sublease income from a franchised restaurant.
Provision for Income Taxes
The effective income tax rate for the fiscal 2024 period was 27.7% compared to 27.1% in the fiscal 2023 period. The effective income tax rate for the fiscal 2024 period reflected income tax expense of $6,025,000 recorded on $21,731,000 of pre-tax income. The effective income tax rate for the fiscal 2023 period reflected income tax expense of $6,093,000 recorded on $22,451,000 of pre-tax income. The effective tax rates are higher than the U.S. Federal statutory rates primarily due to state and local taxes, as well as non-deductible executive compensation under the Internal Revenue Code Section 162(m).
The amount of unrecognized tax benefits at December 24, 2023 was $465,000 all of which would impact the Company’s effective tax rate, if recognized. As of December 24, 2023, the Company had approximately $343,000 accrued for the payment of interest and penalties in connection with unrecognized tax benefits.
Nathan’s estimates that its unrecognized tax benefit excluding accrued interest and penalties could be further reduced by up to $19,000 during the fiscal year ending March 31, 2024 due primarily to the lapse of statutes of limitations which would favorably impact the Company’s effective tax rate, although no assurances can be given in this regard.
Off-Balance Sheet Arrangements
At December 24, 2023 and December 25, 2022, Nathan’s did not have any open purchase commitments for hot dogs. Nathan’s may enter into purchase commitments in the future as favorable market conditions become available.
Liquidity and Capital Resources
Cash at December 24, 2023 aggregated $16,732,000, a $13,129,000 decrease during the fiscal 2024 period as compared to cash of $29,861,000 at March 26, 2023. Net working capital decreased to $21,050,000 from $30,652,000 at March 26, 2023, primarily due to the redemption of $20,000,000 of the Company’s 2025 Notes. We paid our semi-annual interest payments for fiscal 2024 of $2,650,000 on May 1, 2023 and November 1, 2023, as well as our required interest payment of $177,000 on December 19, 2023 in connection with the partial redemption of $20,000,000 principal amount of our 2025 Notes. We paid our first, second and third quarter fiscal 2024 dividend payments of $2,040,000 each on June 28, 2023, September 1, 2023 and December 1, 2023, respectively. We expect to pay our fourth quarter dividend on March 1, 2024.
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 2025 Notes have no scheduled principal amortization payments prior to its final maturity on November 1, 2025.
Cash provided by operations of $13,596,000 in the fiscal 2024 period is primarily attributable to net income of $15,706,000 in addition to other non-cash operating items of $2,023,000, offset by changes in other operating assets and liabilities of $4,133,000. Non-cash operating expenses consist principally of depreciation and amortization of $896,000, amortization of debt issuance costs of $276,000, share-based compensation expense of $546,000, a loss on debt extinguishment of $169,000 and a provision for uncollectible accounts of $75,000. In the fiscal 2024 period, accounts and other receivables decreased by $1,147,000 due primarily to lower Branded Product Program receivables of $895,000 and lower franchise and license royalty receivables of $792,000 . Prepaid expenses and other current assets decreased by $308,000 due principally to a decrease in prepaid marketing and other expenses of $596,000 which were offset, in part, by an increase in prepaid income taxes of $353,000. Accounts payable, accrued expenses and other current liabilities decreased by $5,394,000 due to lower accrued interest expense of $1,535,000 as a result of the partial redemption of our 2025 Notes; a decline in accrued payroll and other benefits of $1,053,000 resulting primarily from the payment of year-end fiscal 2023 incentive compensation; earned deferred revenue of $1,156,000; and a decline in accounts payable of $1,780,000 due to the timing of product purchases for our Branded Product Program and Company-owned restaurants.
Cash used in investing activities was $243,000 in the fiscal 2024 period primarily in connection with capital expenditures incurred for our Branded Product Program and our Coney Island restaurants.
Cash used in financing activities of $26,482,000 in the fiscal 2024 period relates primarily to the payment of $20,000,000 in connection with the partial redemption of the 2025 Notes and the payments of the Company’s quarterly $0.50 per share cash dividends totaling $6,120,000. The Company also paid $362,000 for withholding taxes on the net share vesting of 10,000 restricted stock units.
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In 2016, the Board 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 December 24, 2023, Nathan’s has repurchased 1,101,884 shares at a cost of $39,000,000 under the sixth stock repurchase plan. At December 24, 2023, there were 98,116 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. There were no stock repurchases during the fiscal 2024 period.
As discussed above, we had cash at December 24, 2023 aggregating $16,732,000. Our Board routinely monitors and assesses its cash position and our current and potential capital requirements. The Company paid its first quarter fiscal 2024 dividend of $2,040,000 on June 28, 2023, its second quarter fiscal 2024 dividend of $2,040,000 on September 1, 2023 and its third quarter fiscal 2024 dividend of $2,040,000 on December 1, 2023.
Effective February 1, 2024, the Company declared its fourth quarter dividend of $0.50 per common share to stockholders of record as of the close of business on February 20, 2024, which is payable on March 1, 2024.
The Company’s total cash requirement for dividends for all of fiscal 2024 would be approximately $8,162,000 based on the number of shares of common stock outstanding at January 26, 2024. The Company intends to declare and pay quarterly cash dividends; however, there can be no assurance that any additional quarterly dividends will be declared or paid or of the amount or timing of such dividends, if any.
Our ability to pay future dividends is limited by the terms of the Indenture for the 2025 Notes. In addition, the 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. We may also return capital to our stockholders through stock repurchases, subject to any restrictions in the Indenture, although there is no assurance that the Company will make any repurchases under its existing stock repurchase plan.
We may from time to time seek to redeem additional portions of our 2025 Notes, through open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on market conditions, our liquidity requirements, and other factors.
We expect that in the future we will make investments in certain existing restaurants, support the growth of the Branded Product and Branded Menu Programs, service the outstanding debt, fund our dividend program and may continue our stock repurchase programs, funding those investments from our operating cash flow. We may also incur capital and other expenditures or engage in investing activities in connection with opportunistic situations that may arise on a case-by-case basis. During the fiscal year ending March 31, 2024, we will be required to make interest payments of $5,477,000, inclusive of the interest payment in connection with the partial redemption of its 2025 Notes, of which all have been made as of December 19, 2023.
Management believes that available cash and cash generated from operations should provide sufficient capital to finance our operations, satisfy our debt service requirements, fund dividend distributions and stock repurchases for at least the next 12 months.
At December 24, 2023, we sublet one property to a franchisee that we lease from a third party. We remain contingently liable for all costs associated with this property including: rent, property taxes and insurance. We may incur future cash payments with respect to such property, consisting primarily of future lease payments, including costs and expenses associated with terminating such lease.
Our contractual obligations primarily consist of the 2025 Notes and the related interest payments, operating leases, and employment agreements with certain executive officers. These contractual obligations impact our short-term and long-term liquidity and capital resource needs. There have been no material changes in our contractual obligations since March 26, 2023 except for the partial redemption of the 2025 Notes on December 19, 2023 discussed above.
Inflationary Pressures
Inflationary pressures on labor and rising commodity prices, most notably for beef and beef trimmings, have impacted our consolidated results of operations during the fiscal 2024 period, and this trend may continue through the remainder of fiscal year 2024. From April 2023 through September 2023, we experienced significant increases in the cost of beef and beef trimmings. From October 2023 through December 2023, we began to experience slight declines in beef and beef trimming costs.
Our average cost of hot dogs during the fiscal 2024 period was approximately 12% higher than during the fiscal 2023 period. Inherent volatility experienced in certain commodity markets, such as those for beef and beef trimmings due to seasonal shifts, climate conditions, industry demand, inflationary pressures and other macroeconomic factors could have an adverse effect on our results of operations. This impact will depend on our ability to manage such volatility through price increases and product mix.
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We have experienced competitive pressure on labor rates as a result of the increase in the minimum hourly wage for fast food workers which increased to $15.00 in New York state during fiscal 2022 where our Company-owned restaurants are located. On January 1, 2024, the minimum wage increased to $16.00 in New York City, Long Island and Westchester which will be followed by $0.50 annual increases in 2025 and 2026. Further, beginning in 2027, the minimum wage across New York State will increase annually according to the Consumer Price Index. There has also been an increased demand for labor at all levels which has resulted in greater challenges retaining adequate staffing levels at our Company-owned restaurants; our franchised restaurants and Branded Menu Program locations; as well as for certain vendors in our supply chain that we depend on for our commodities. We remain in contact with our major suppliers and to date we have not experienced significant disruptions in our supply chain.
We are unable to predict the future cost of our hot dogs and expect to experience price volatility for our beef products during the remainder of fiscal 2024. To the extent that beef prices increase as compared to earlier periods, it could impact our results of operations. In the past, we entered into purchase commitments for a portion of our hot dogs to reduce the impact of increasing market prices. We may attempt to enter into similar purchase arrangements for hot dogs and other products in the future. Additionally, we expect to continue experiencing volatility in oil and gas prices on our distribution costs for our food products and utility costs in the Company-owned restaurants and volatile insurance costs resulting from the uncertainty of the insurance markets.
We believe that these increases in the minimum wage and other changes in employment laws have had a significant financial impact on our financial results and the results of our franchisees that operate in New York State. Our business could be negatively impacted if the decrease in margins for our franchisees results in the potential loss of new franchisees or the closing of a significant number of franchised restaurants.
Continued increases in labor costs, commodity prices and other operating expenses, including health care, could adversely affect our operations. We attempt to manage inflationary pressure, and rising commodity costs, at least in part, through raising prices. Delays in implementing price increases, competitive pressures, a decline in consumer spending levels and other factors may limit our ability to offset these rising costs. Volatility in commodity prices, including beef and beef trimmings could have a significant adverse effect on our results of operations.
The Company’s business, financial condition, operating results and cash flows can be impacted by a number of factors, including but not limited to those set forth above in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” any one of which could cause our actual results to vary materially from recent results or from our anticipated future results. For a discussion identifying additional risk factors and important factors that could cause actual results to differ materially from those anticipated, also see the discussions in “Forward-Looking Statements” and “Notes to Consolidated Financial Statements” in this Form 10-Q and “Risk Factors” in our Form 10-K for our fiscal year ended March 26, 2023.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.