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NATH > SEC Filings for NATH > Form 10-K on 14-Jun-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.


On October 29, 2012, Hurricane Sandy struck the Northeastern United States, which forced the closing of all of the Company-owned restaurants. Seventy-eight franchised restaurants, including 18 Branded Menu locations, were closed for varying periods of time, one of which remain closed. Our flagship Coney Island restaurant and our Coney Island Boardwalk restaurant remained closed as a result of the storm. Our Company-owned restaurant in Oceanside, New York was closed for approximately two weeks. The Coney Island Boardwalk restaurant sustained minor damage and re-opened on March 18, 2013. The Coney Island restaurant incurred significant damage and re-opened on May 20, 2013. As a result of these damages, through March 31, 2013, the Company has incurred actual losses of approximately $1,197, inclusive of amounts written off of $449 related to destroyed or damaged property and equipment and $42 of unsalable inventories, and expects to incur approximately $100 to $200 of additional losses in future periods relating to ongoing operational and remediation costs incurred until the restaurant reopens. We believe that we maintain adequate insurance coverage between the flood and property insurance policies to cover the cost of reparations and recover lost profits and ongoing costs incurred under our business interruption insurance policy.

As of March 31, 2013, the Company received non-refundable payments of $1,026 from our insurer towards the settlement of the Company's property and casualty losses. The Company has charged these payments against the value of the assets that have been destroyed and certain repair and clean-up costs incurred. As of March 31, 2013, the remaining unutilized insurance advance of approximately $130 is included in accrued expenses and other current liabilities in the accompanying balance sheet. In addition, the Company has recorded approximately $301 for reimbursable on-going business expenses incurred while the restaurant is closed as a reduction in the related expenses and is included in accounts and other receivables in the accompanying balance sheet as the realization of the claim for loss recovery has been deemed to be probable.

During the first quarter of fiscal 2014, Nathan's settled the property claim with its insurance carriers and received approximately $3.4 million, net of fees, and used these proceeds towards the rebuilding of the restaurant.

Additionally, on November 25, 2012, we closed the Company-owned restaurant in Yonkers, New York, which was demolished as a part of a redevelopment of the property into a strip center, which will include a new Nathan's Company-owned restaurant that we anticipate opening in December 2013. As a result of the above, Nathan's Management Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K will not include a discussion of its comparable Company-owned restaurant sales. Additionally, the analysis of the comparable franchised restaurant sales will be presented based on the sales that have been reported.

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 operating and franchising 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 units operate under the name "Nathan's Famous," the name first used at our original Coney Island restaurant opened in 1916. Nathan's licensing program began in 1978 by selling packaged hot dogs and other meat products to retail customers through supermarkets or grocery-type retailers for off-site consumption. During fiscal 1998, we introduced our Branded Product Program, which enables foodservice retailers to sell some of Nathan's proprietary products outside of the realm of a traditional franchise relationship. In conjunction with this program, foodservice operators are granted a limited use of the Nathan's Famous trademark with respect to the sale of Nathan's World Famous Beef Hot Dogs and certain other proprietary food items and paper goods. During fiscal 2008, we launched our Branded Menu Program, under which foodservice operators may sell a greater variety of Nathan's Famous menu items than under the Branded Product Program.

Our revenues are generated primarily from selling products under Nathan's Branded Product Program, operating Company-owned restaurants, franchising the Nathan's restaurant concept (including under the Branded Menu Program) and licensing agreements for the sale of Nathan's products within supermarkets and club stores, the manufacture of certain proprietary spices and the sale of Nathan's products directly to other foodservice operators.

The following summary reflects the franchise openings and closings of the Nathan's franchise system for the fiscal years ended March 31, 2013, March 25, 2012, March 27, 2011, March 28, 2010 and March 29, 2009.

                                   March 31,       March 25,       March 27,       March 28,       March 29,
                                     2013            2012            2011            2010            2009
Franchised restaurants
operating at the beginning of
the period                                299             264             246             249             224
Franchised restaurants opened
during the period                          40              67              40              33              46
Franchised restaurants closed
during the period                         (36 )           (32 )           (22 )           (36 )           (21 )
Franchised restaurants
operating at the end of the
period                                    303             299             264             246             249

At March 31, 2013, our franchise system consisted of 303 Nathan's Famous franchised units located in 28 states, the Cayman Islands and eight foreign countries. We also operate five Company-owned Nathan's units, including one seasonal location, within the New York metropolitan area.

As described in Risk Factors and other sections in this Annual Report on Form 10-K for the year ended March 31, 2013, our future results could be impacted by many developments. We entered into an agreement with John Morrell & Co, a subsidiary of Smithfield Foods, Inc. to become Nathan's exclusive licensee to manufacture and sell hot dogs, sausage and corned beef at retail. Our future operating results could be favorably impacted by the terms and conditions of this agreement as compared to the terms and conditions of our agreement with SMG which is scheduled to expire on March 1, 2014, although there can be no assurance thereof. There are also certain risks associated with entering into the agreement with John Morrell & Co including whether we will be able to sustain our business at the same or higher quality and consistency that is expected by our customers and whether we can successfully implement an orderly transition of the business to John Morrell & Co. In addition, our future operating results could be impacted by the record high corn prices, as a result of the drought in the Midwest, which could significantly increase the cost of beef.

Critical Accounting Policies and Estimates

Our consolidated financial statements and the notes to our consolidated financial statements contain information that is pertinent to management's discussion and analysis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities. We believe the following critical accounting policies involve additional management judgment due to the sensitivity of the methods, assumptions and estimates necessary in determining the related asset and liability amounts.

Revenue Recognition

Sales by Company-owned restaurants, which are typically paid in cash by the customer, are recognized upon the performance of services. Sales are presented net of sales tax.

In connection with its franchising operations, Nathan's receives initial franchise fees, development fees, royalties, and in certain cases, revenue from sub-leasing restaurant properties to franchisees.

Franchise and area development fees, which are typically received prior to completion of the revenue recognition process, are recorded as deferred revenue. Initial franchise fees, which are non-refundable, are recognized as income when substantially all services to be performed by Nathan's and conditions relating to the sale of the franchise have been performed or satisfied, which generally occurs when the franchised restaurant commences operations. The following services are typically provided by Nathan's prior to the opening of a franchised restaurant:

Approval of all site selections to be developed.

Provision of architectural plans suitable for restaurants to be developed.

Assistance in establishing building design specifications, reviewing construction compliance and equipping the restaurant.

Provision of appropriate menus to coordinate with the restaurant design and location to be developed.

Provision of management training for the new franchisee and selected staff.

Assistance with the initial operations and marketing of restaurants being developed.

Development fees are nonrefundable and the related agreements require the franchisee to open a specified number of restaurants in the development area within a specified time period or the agreements may be canceled by the Company. Revenue from development agreements is deferred and shall be recognized, with an appropriate provision for estimated uncollectable amounts, when all material services or conditions to the sale have been substantially performed by the franchisor. If substantial obligations under the development agreement are not dependent on the number of individual franchise locations to be opened, substantial performance shall be determined using the same criteria applicable to individual franchise, which is generally the opening of the first location pursuant to the development agreement. If substantial performance is dependent on the number of locations, then the development fee is deferred and recognized ratably over the term of the agreement, as restaurants in the development area commence operations on a pro rata basis to the minimum number of restaurants required to be open, or at the time the development agreement is effectively canceled.

Nathan's recognizes franchise royalties on a monthly basis, which are generally based upon a percentage of sales made by Nathan's franchisees, when they are earned and deemed collectible. Franchise fees and royalties that are not deemed to be collectible are not recognized as revenue until paid by the franchisee, or until collectibility is deemed to be reasonably assured.

Nathan's recognizes revenue from its Branded Menu Program either upon its sale of hot dogs or royalty income when it has been determined that other qualifying products have been sold by the manufacturer to Nathan's Branded Menu Program franchisees.

Nathan's recognizes revenue from the Branded Product Program when it is determined that the products have been delivered via third party common carrier to Nathan's customers. Rebates to customers are recorded as a reduction to sales.

Revenue from sub-leasing properties is recognized as income as the revenue is earned and becomes receivable and deemed collectible. Sub-lease rental income is presented net of associated lease costs in the consolidated statements of earnings.

Nathan's recognizes revenue from royalties on the licensing of the use of its intellectual property in connection with certain products produced and sold by outside vendors. The use of the Nathan's intellectual property must be approved by Nathan's prior to each specific application to ensure proper quality and project a consistent image. Revenue from license royalties is recognized on a monthly basis when it is earned and deemed collectible.

In the normal course of business, we extend credit to franchisees and licensees for the payment of ongoing royalties and to trade customers of our Branded Product Program. Accounts and other receivables, net, as shown on our consolidated balance sheets are net of allowances for doubtful accounts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessment of collectibility based upon historical trends and an evaluation of the impact of current and projected economic conditions. In the event that the collectibility of a receivable at the date of the transaction is doubtful, the associated revenue is not recorded until the facts and circumstances change in accordance with the applicable accounting standards. The Company writes off accounts receivable when they are deemed uncollectible.

Impairment of Goodwill and Other Intangible Assets

Goodwill and intangible assets are deemed to have indefinite lives, and accordingly, are not amortized, but are evaluated annually (or more frequently if events or changes in circumstances indicate the carrying value may not be recoverable) for impairment. The most significant assumptions, which are used in this test, are estimates of future cash flows. We typically use the same assumptions for this test as we use in the development of our business plans. If these assumptions differ significantly from actual results, impairment charges may be required in the future. We conducted our annual impairment tests and no goodwill or other intangible assets were determined to be impaired during the fiscal years ended March 31, 2013, March 25, 2012 or March 27, 2011.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstance indicate that the carrying value may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from use of the assets and their ultimate disposition. In instances where impairment is determined to exist, the Company writes down the asset to its fair value based on the present value of estimated future cash flows.

Impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment factors are determined to be present. The Company considers a history of restaurant operating losses to be its primary indicator of potential impairment for individual restaurant locations. As result of Hurricane Sandy, our Coney Island restaurant sustained significant damage and was considered temporarily impaired for purpose of this analysis. The restaurant was fully repaired and re-opened on May 20, 2013. No impairment charges on long-lived assets were recorded during the fiscal years ended March 31, 2013, March 25, 2012 or March 27, 2011.

Impairment of Long-Term Investment

We make judgments regarding the future realizability of this investment based upon the financial information provided to us by the investment's management. We typically rely on management's assumptions, of future revenues and cash flows based upon the annual business plans presented. If these assumptions differ significantly from actual results, we consider whether indicators of impairment exist. If an impairment indicator exists, management evaluates the fair value of its investment to determine if an, other than temporary impairment in value has occurred. If determined that an, other than temporary impairment in value has occurred, impairment charges may be required in the future. We have not recognized any impairment on this investment during the fifty-three week period ended March 31, 2013.

Stock-Based Compensation

As discussed in Note K of the Notes to Consolidated Financial Statements, we have one active share-based compensation plan that provides stock options and restricted stock awards for certain employees and non-employee directors to acquire shares of our common stock. We consider the following factors in determining the value of stock-based compensation:

(a) expected option term based upon expected termination behavior;

(b) volatility based upon historical price changes of the Company's common stock over a period equal to the expected life of the option;

(c) expected dividend yield; and

(d) risk free interest rate on date of grant.

Income Taxes

The Company's current provision for income taxes is based upon its estimated taxable income in each of the jurisdictions in which it operates, after considering the impact on taxable income of temporary differences resulting from different treatment of items for tax and financial reporting purposes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and any operating loss or tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in those periods in which temporary differences become deductible. Should management determine that it is more likely than not that some portion of the deferred tax assets will not be realized, a valuation allowance against the deferred tax assets would be established in the period such determination was made.

Uncertain Tax Positions

Financial Accounting Standards establish guidance for the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. Financial Accounting Standards also provide guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure requirements. (See Note J of the Notes to Consolidated Financial Statements.)

Adoption of New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board, ("FASB") issued final guidance for new presentation requirements for reclassifications out of accumulated other comprehensive income and to resolve certain cost/benefit concerns related to reporting reclassification adjustments. This update provides entities with two basic options for reporting the effect of significant reclassifications - either 1) on the face of the statement where net income is presented or 2) as a separate footnote disclosure. Public entities will report reclassifications in both annual and interim periods, while private entities are only required to report them in annual financial statements. For public entities, the new guidance is effective prospectively for annual and interim for reporting periods beginning after December 15, 2012 which for Nathan's was the fourth quarter of its fiscal year ended March 31, 2013. The adoption of this new guidance did not have a material impact on the results of operations or financial position.

In July 2012, the FASB issued new accounting guidance on testing indefinite-lived intangible assets for impairment. The new guidance provides the entity with the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of an indefinite-lived asset is less than its carrying value. If it is not, then no further analysis is required otherwise then the previously required quantitative testing is required. The new guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, which for Nathan's will be the first quarter of its fiscal 2014. Early adoption is permitted. We do not expect the adoption of this new guidance to have a material impact on the results of operations or financial position.

We do not believe that any other recently issued, but not yet effective accounting standards, if adopted, would have a material effect on the accompanying financial statements.

Results of Operations

Fiscal year ended March 31, 2013 compared to fiscal year ended March 25, 2012


Total sales increased by 8.2% to $56,656,000 for the fifty-three weeks ended March 31, 2013 ("fiscal 2013") as compared to $52,369,000 for the fifty-two weeks ended March 25, 2012 ("fiscal 2012"). Foodservice sales from the Branded Product and Branded Menu Programs increased by 12.2% to $43,214,000 for fiscal 2013 as compared to sales of $38,506,000 in fiscal 2012. This increase was primarily attributable to a 10.4% increase in the volume of products ordered and the impact of price increases that took effect during the fiscal 2013 and fiscal 2012 periods. We estimate that the additional week of operations during fiscal 2013 represented approximately $828,000 of the sales increase. Total Company-owned restaurant sales, comprised of five Nathan's restaurants in both periods (including one seasonal restaurant), increased by $195,000 to $13,403,000 during fiscal 2013 compared to $13,209,000 during fiscal 2012. This increase was primarily attributed to the increased sales at our relocated and expanded seasonal Boardwalk restaurant in Coney Island that opened in April 2012. Weather conditions had generally been favorable throughout the first twenty-six weeks of fiscal 2013 as compared to the first twenty-six weeks of the fiscal 2012 period. Sales since the third quarter fiscal 2013 were negatively affected due to the closures of our flagship Coney Island and Oceanside locations caused by Hurricane Sandy and the closure of our Yonkers, New York, restaurant for redevelopment. Based on our fiscal 2012 results, we estimate that, compared to fiscal 2012, the closures of our Coney Island and Oceanside restaurants due to the storm reduced sales by approximately $1,095,000 and $66,000, respectively. Additionally, we estimate that the closing of our Yonkers restaurant for redevelopment in November 2012, further reduced sales by approximately $632,000 as compared to fiscal 2012. During fiscal 2012, we were forced to temporarily close all of our restaurants during tropical storm Irene for the weekend of August 27, 2011 and experienced much more rain than usual, particularly during weekends, and a cold Labor Day weekend which we believe further decreased sales particularly at our Coney Island locations. During fiscal 2013, other sales were approximately $615,000 lower than fiscal 2012 primarily because Nathan's terminated our agreement with the QVC television network in March 2012.

Franchise fees and royalties were $5,782,000 in fiscal 2013 as compared to $5,586,000 in fiscal 2012. Total royalties were $4,930,000 in fiscal 2013 as compared to $4,666,000 in fiscal 2012. Royalties earned under the Branded Menu program were $883,000 in fiscal 2013 as compared to $708,000 in fiscal 2012 due principally to the additional units in operation. Royalties earned under the Branded Menu Program are not based upon a percentage of restaurant sales but are based upon product purchases. Traditional franchise royalties were $4,047,000 in fiscal 2013 as compared to $3,958,000 in fiscal 2012. Franchise restaurant sales were $90,401,000 in fiscal 2013 as compared to $90,022,000 in fiscal 2012. We estimate that the additional week of operations during fiscal 2013 resulted in $939,000 of additional total franchise sales or royalties of approximately $48,000. We believe that fiscal 2013 sales were negatively impacted by approximately $510,000 attributable to the franchised restaurants in the Northeast that were closed due to Hurricane Sandy. One of these restaurants affected remains closed. Comparable domestic franchise sales (consisting of 117 Nathan's outlets, operating for 15 months prior to the beginning of the fiscal year, excluding sales under the Branded Menu Program) were $58,092,000 in fiscal 2013 as compared to $59,180,000 in fiscal 2012, a decrease of 1.8%. Excluding the effect of the additional week of operations, franchise sales within our entertainment venues declined by approximately 4.8% compared to the prior period, including significant sales declines at two franchised locations that have been negatively affected by adjacent long term construction projects. During the second quarter fiscal 2012, most of our franchised locations in the Northeast were also negatively affected by tropical storm Irene.

At March 31, 2013, 303 domestic and international franchised or Branded Menu Program franchise outlets were operating as compared to 299 domestic and international franchised or Branded Menu Program franchise outlets at March 25, 2012.Total franchise fee income was $852,000 in fiscal 2013, including cancellation fees of $190,000, compared to $920,000 in fiscal 2012, including cancellation fees of $74,000. Domestic franchise fee income was $324,000 in fiscal 2013 compared to $547,000 in fiscal 2012, primarily due to opening fewer Branded Menu Program outlets within K-marts. International franchise fee income was $338,000 in fiscal 2013, compared to $299,000 during fiscal 2012. During fiscal 2013, 40 new franchised outlets opened, including our first two mobile trucks, our first location in Turkey, our first location in Mexico City, our sixth restaurant in the Dominican Republic and twenty Branded Menu Program outlets, including ten units operated by K-mart. During fiscal 2012, 67 new franchised outlets opened, including two locations in Canada, China, Jamaica, Kuwait and the Dominican Republic and 43 Branded Menu Program outlets, including 28 units operated by Kmart.

License royalties were $8,631,000 in fiscal 2013 as compared to $7,586,000 in fiscal 2012. We do not believe that the additional week of operations had a significant impact on royalties as our licensees continued to report based upon their fiscal reporting periods. Total royalties earned on sales of hot dogs from our retail and foodservice license agreements increased 15.1% to $6,948,000 from $6,037,000 primarily due to higher sales by SMG and higher royalties from a change in packaging on certain products sold by SMG in fiscal 2013. Royalties earned from SMG, primarily from the retail sale of hot dogs, were $5,506,000 during fiscal 2013 as compared to $4,503,000 during fiscal 2012. Royalties earned from our foodservice licensee, substantially from sales of hot dogs to Sam's Club and Kroger's, were $1,442,000 during fiscal 2013 as compared to $1,534,000 during fiscal 2012. This decrease is due primarily to a temporary royalty concession for the period April 2012 through July 2012, on sales to Sam's Club and lower sales volume to Kroger's. During fiscal 2013, we earned incremental royalties of $114,000 from a new agreement for the sale of salty snacks. Royalties earned from all other licensing agreements for the manufacture and sale of Nathan's products were $1,553,000, during fiscal 2013, as compared to $1,533,000 during fiscal 2012.

Interest income was $392,000 in fiscal 2013 as compared to $573,000 in fiscal . . .

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