The Company is party to a License Agreement with SMG, Inc. ("SMG") dated as of February 28, 1994, as amended (the "License Agreement") pursuant to which: (i) SMG acts as the Company's exclusive licensee for the manufacture, distribution, marketing and sale of packaged Nathan's Famous frankfurter product at supermarkets, club stores and other retail outlets in the United States; and (ii) the Company has the right, but not the obligation, to require SMG to produce frankfurters for the Company's Nathan's Famous restaurant system and Branded ProductsProduct Program. On July 31, 2007, the Company provided notice to SMG that the Company has elected to terminate the License Agreement, effective July 31, 2008, (the "Termination Date"), due to SMG's breach of certain provisions of the License Agreement. SMG has disputed that a breach has occurred and has commenced, together with certain of its affiliates, an action in state court in Illinois seeking, among other things, a declaratory judgment that SMG did not breach the License Agreement. The Company filed its own action on August 2, 2007, in New York State court seeking a declaratory judgment that SMG has breached the License Agreement and that the Company has properly terminated the License Agreement. On January 23, 2008, the New York court granted SMG’s motion to dismiss the Company’s case in New York on the basis that the dispute was already the subject of a pending lawsuit in Illinois. The Company has answered SMG's complaint and asserted its own counterclaims which seek, among other things, a declaratory judgment that SMG did breach the License Agreement and that the Company has properly terminated the License Agreement. On July 31, 2008, SMG and Nathan’s entered into a Stipulationstipulation pursuant to which Nathan’s agreed that it would not effectuate the termination of the License Agreement on the grounds alleged in the present litigation until such litigation has been successfully adjudicated, and SMG agreed that in such event, Nathan’s shall have the option to require SMG to continue to perform under the License Agreement for an additional period of up to six months to ensure an orderly transition of the business to a new licensee/supplier. The agreed motion for entry of said Stipulation must be approved by the Circuit Court. The parties are currently proceeding with the discovery process.
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 adverse effect that increasing commodity costs has on our profitability and operating results; the pending litigation with the primary supplier of hot dogs to our branded product programBranded Product Program may result in a disruption in that supply or increased costs, which would adversely effect our operating results; current economic conditions could result in decreased consumer spending on discretionary products, such as fast food; as well as those risks discussed from time to timein this Form 10-Q, in the Company’s Form 10-K annual report for the year ended March 30, 2008, and in other documents which we file from time to time with the 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).
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 the Arthur Treacher’s brand, and licensing the sale of Nathan’s products within supermarkets and other retail venues. The Branded Product Program enables foodservice operators to offer Nathans’Nathan’s hot dogs and other proprietary items for sale within their facilities. In conjunction with this program, foodservice operators are granted a limited use of the Nathans’Nathan’s trademark with respect to the sale of hot dogs and certain other proprietary food items and paper goods.
During the fiscal year ended March 25, 2007, we established a new franchising program, of licensing limited menuto offer limited-menu "Nathan's Famous" ("Limited Menu Frank and Fry Franchise Operations"limited-menu franchise outlets") products to be included into new or existing food service establishments. We began to market Limited Menu Frank and Fry Franchise Operationslimited-menu franchise outlets during the fiscal year ended March 30, 2008. Pursuant to this program, operators will beare permitted to make limited use of the "Nathan's Famous" trade dress, trademarks and design for the purpose of adding "Nathan's Famous" hot dogs, crinkle-cut French fries and a limited number of other approved "Nathan's Famous" menu items to the menu of a new or existing food service establishment. The location of the new or existing food service establishment, the specific manner in which the Limited Menu Frank and Fry Franchise Operationlimited-menu franchise outlet is incorporated into the operation of the food service establishment and the specific use of our trade dress, trademarks and design willare all be subject to our prior written approval and must meet our specifications. The initial license fee underfor a Limited Menu Frank and Fry Franchise Operationlimited-menu franchise outlet is $7,500. Additionally, operatorsOperators participating in this program willare not be required to pay any royalties on thetheir sale of "Nathan's Famous" products, or make any contributions to the “Nathan’s Famous” advertising fund; however, substantially all products offered through the Limited Menu Frank and Fry Franchise Operationlimited-menu franchise outlet must be purchased from us orthrough a distributor approved by us, and we will make a profit on all such sales. In certain instances, Nathan’s may pay a fee to the sponsoring organization in exchange for their operational assistance and ongoing support of their restaurant system.or for marketing support.
On April 23, 2008, Nathan’s completed the sale of its subsidiary, NF Roasters Corp. (“Roasters”). Nathan’s previously concluded the sale of its subsidiary, Miami Subs Corporation (“Miami Subs”) on June 7, 2007. The following discussion of continuing operations excludes all of the Miami Subs and Roasters operations which were not retained by Nathan’s. us. Nathan’s has determined that it will not have any significant cash flows or continuing involvement in the ongoing operations of Roasters or Miami Subs and accordingly, has reflected such results in discontinued operations.
See Note D to the Consolidated Financial Statements contained in Item 1 for a description of the terms of such sales.
In order to help the reader better understand Nathan’s continuing operations, certain non-financial information, which was previously reported on a combined basis has also been included in this Management Discussion and Analysis. At June 29,September 28, 2008, our restaurant system consisted of 230235 Nathan’s franchised or licensed units,outlets, including 4046 limited-menu licensed units described above,franchise outlets and six Company-owned unitsoutlets (including one seasonal unit)outlet), located in 25 states and five foreign countries. At June 24,September 23, 2007, our restaurant system consisted of 200204 Nathan’s franchised or licensed units,outlets including 12 limited-menu franchise outlets and six Company-owned unitsoutlets (including one seasonal unit)outlet), located in 2021 states and four foreign countries, and thecountries. The Roasters restaurant system which included approximately 97 unitsoutlets operating in eight foreign countries and one unitoutlet operating in the United States.States at September 23, 2007.
The following summary reflects the franchise openings and closings, excluding the Roasters franchise system which was sold on April 23, 2008, for the fiscal years ended March 30, 2008, March 25, 2007, March 26, 2006, March 27, 2005 and March 28, 2004.
| | March 30, 2008 | | March 25, 2007 | | March 26, 2006 | | March 27, 2005 | | March 28, 2004 | |
Franchised restaurants operating at the beginning of the period | | | 196 | | | 192 | | | 174 | | | 147 | | | 140 | |
| | | | | | | | | | | | | | | | |
New franchised restaurants opened during the period | | | 46 | | | 21 | (A) | | 27 | | | 36 | | | 21 | |
| | | | | | | | | | | | | | | | |
Franchised restaurants closed during the period | | | (18 | ) | | (17 | ) | | ( 9 | ) | | ( 9 | ) | | (14 | ) |
| | | | | | | | | | | | | | | | |
Franchised restaurants operating at the end of the period | | | 224 | | | 196 | | | 192 | | | 174 | | | 147 | |
(A) ReflectsIncludes the opening of two test Limited Menu FrankLimited-Menu Franchise Outlets.
Impact of Economic Environment on Nathan’s Results of Operations
During the quarter ended September 28, 2008, Nathan’s experienced reduced sales in both its Company-owned restaurants and Fry Operations.at its franchised restaurants, particularly during the five-week period ended September 28, 2008, which we believe is due to the effects of the slowing economy.
Nathan’s has also experienced some slow-down in collections of accounts receivable during the second quarter ended September 28, 2008, as further described within the following results of operations. During the quarter, we were notified of four bankruptcy filings and that a certain existing franchisee and a potential new franchisee have been unable to secure funding due to the credit crisis.
Preliminary results at our Company-owned restaurants subsequent to September 28, 2008, lead us to believe that we will experience reduced sales as compared to the prior fiscal period in our Company-owned restaurants during the four-week period ending October 26, 2008. In addition, we anticipate that franchisees whose restaurants are located in malls, shopping plazas, airports, travel plazas and various destination venues, may also experience sales declines due to the current economic slow-down.
Critical Accounting Policies and Estimates
As discussed in our Form 10-K for the fiscal year ended March 30, 2008, 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. The preparation of these financial statements require us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those 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; impairment of goodwill and other intangible assets; impairment of long-lived assets; impairment of notes receivable; share-based compensation and income taxes (including uncertain tax positions). Since March 30, 2008, there have been no changes in our critical accounting policies or significant changes to the assumptions and estimates related to them, except for the accounting for fair value measurements of financial assets and liabilities and related disclosures, which is discussed in Note C to our Consolidated Financial Statements.Statements in Item 1 of this Form 10-Q.
Adoption of Accounting Pronouncements
See Note C to the Consolidated Financial Statements contained in Item I,1, for a complete discussion of the impact of SFAS No. 157, “Fair Value Measurements” (SFAS(“SFAS No. 157”) and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities -– Including an amendment of FASB Statement No. 115”, (SFAS(“SFAS No. 159”) on the Company’s financial position and results of operations.
Recently Issued Accounting Standards Not Yet Adopted
See Note B to the Consolidated Financial Statements contained in Item I,1 for a discussion of recently issued accounting standards not yet adopted.
Results of Operations
Thirteen weeks ended September 28, 2008 compared to thirteen weeks ended September 23, 2007
Revenues from Continuing Operations
Total sales increased by $161,000 or 1.4% to $11,418,000for the thirteen weeks ended September 28, 2008 (“second quarter fiscal 2009 period”) as compared to $11,257,000for the thirteen weeks ended September 23, 2007 ("second quarter fiscal 2008 period"). Sales from the Branded Product Program increasedby 20.8% to $6,282,000 for the second quarter fiscal 2009 period as compared to sales of $5,199,000 in the second quarter fiscal 2008 period. This increase was primarily attributable to increasedsales volume of approximately 11.8% and price increases of approximately 6.5%, beginning in July 2008. Total Company-owned restaurant sales (representing five comparable Nathan’s restaurants and one seasonal restaurant) decreased by $253,000 or 5.1% to $4,681,000 as compared to $4,934,000 during the second quarter fiscal 2008 period. The sales decline at our Company-owned restaurants during the five-week period ended September 28, 2008, was approximately $290,000 which we believe to be due to the effects of the slowing economy. During the second quarter fiscal 2009 period, sales to our television retailer were approximately $669,000 lower than the second quarter fiscal 2008 period. During the first quarter fiscal 2008 period Nathan’s participated in 15 “Try Me” airings. Under this “Try Me” format, most of the sales were shipped in our second quarter fiscal 2008. No similar promotional offerings were made during fiscal 2009. Nathan’s products were on air 13 times during the second quarter fiscal 2009 period as compared to 12 times during the second quarter fiscal 2008 period.
Franchise fees and royalties decreased by $193,000 or 13.9% to $1,191,000in the second quarter fiscal 2009 period compared to $1,384,000 in the second quarter fiscal 2008 period. Total royalties were $1,058,000 in the second quarter fiscal 2009 period as compared to $1,131,000 in the second quarter fiscal 2008 period. During the second quarter fiscal 2009 period, we did not recognize revenue of $70,000 for royalties deemed to be uncollectible as compared to the second quarter fiscal 2008 period, when we did not recognize revenue of $22,000 for royalties deemed to be uncollectible. Total royalties, excluding the adjustments for royalties deemed uncollectible as described above, were $1,128,000 in the second quarter fiscal 2009 period as compared to $1,153,000 in the second quarter fiscal 2008 period. During the second quarter fiscal 2009 period, Nathan’s earned $50,000 of higher royalties from our manufacturers and primary distributor on sales to our limited-menu franchisees. Franchise restaurant sales were $25,143,000 in the second quarter fiscal 2009 period as compared to $27,007,000 in the second quarter fiscal 2008 period. Comparable domestic franchise sales (consisting of 140 Nathan’s restaurants, excluding sales of the limited-menu franchised outlets) were $19,647,000 in the second quarter fiscal 2009 period as compared to $20,837,000 in the second quarter fiscal 2008 period. Sales at our comparable franchised restaurants declined by approximately $658,000 during the five-week period ended September 28, 2008. At September 28, 2008, 235domestic and international franchised or limited-menu franchised outlets were operating as comparedto 204domestic and international franchised or limited-menu franchised outlets at September 23, 2007. Royalty income from15franchised outlets was deemed unrealizable during the thirteen weeks ended September 28, 2008, as compared to six franchised outlets during the thirteen weeks ended September 23, 2007. Domestic franchise fee income was $79,000 in the second quarter fiscal 2009 period as compared to $137,000 in the second quarter fiscal 2008 period due to fewer openings during the second quarter fiscal 2009 period. International franchise fee income was $9,000 in the second quarter fiscal 2009 period, as compared to $31,000 during the second quarter fiscal 2008 period. During the second quarter fiscal 2009 period, ninenew franchised outlets opened, including seven limited-menu franchised outlets.During the second quarter fiscal 2008 period, 11 new franchised outlets were opened including seven limited-menu franchised outlets and one unit in Kuwait. We also recognized $45,000 and $85,000 during the second fiscal quarters 2009 and 2008, respectively, in connection with forfeited franchise and development agreements.
License royalties increased by $580,000 or 55.3% to $1,628,000 in the second quarter fiscal 2009 period as compared to $1,048,000 in the second quarter fiscal 2008 period. Total royalties earned on sales of hot dogs from our retail and foodservice license agreements of $1,085,000 increased by $267,000 or 32.6% as a result of higher licensee sales during the second quarter fiscal 2009 period. Royalties earned from our primary licensee, primarily from the retail sale of hot dogs, were $786,000 during the second quarter fiscal 2009 period as compared to $700,000 during the second quarter fiscal 2008 period. Royalties earned from another licensee, primarily from sales to Sam’s Club, were $299,000 during the second quarter fiscal 2009 period as compared to $118,000 during the second quarter fiscal 2008 period. Beginning March 2008, Nathan’s hot dogs were introduced into over 500 of the foodservice cafes operating in Sam’s Clubs throughout the United States. We earned higher revenues of $301,000 from our agreement for the manufacture of Nathan’s proprietary ingredients, including $234,000 from the settlement of a multi-year dispute under that agreement related to the unauthorized use of certain ingredients. Net royalties from all other license agreements in the second quarter fiscal 2009 period were $12,000 more than the second quarter fiscal 2008 period.
Interest income was $275,000 in the second quarter fiscal 2009 period as compared to $289,000 in the second quarter fiscal 2008 period. The decrease was primarily due to lower interest earned on our MSC Note (as defined) receivable, received in connection with the sale of Miami Subs on June 7, 2007. Interest income on the MSC Note was $38,000 in the second quarter fiscal 2009 period as compared to $48,000 during the second quarter fiscal 2008 period, resulting primarily from the ongoing repayments of the outstanding principal. Interest income on our invested cash and marketable securities was approximately $3,000 less than the second quarter fiscal 2008 period, due primarily to the reduced interest rate environment during the second quarter fiscal 2009.
Other income was $13,000 in the second quarter fiscal 2009 period as compared to $43,000 in the second quarter fiscal 2008 period. During the second quarter fiscal 2008 period, Nathan’s earned a $30,000 consent fee in connection with a licensee’s refinancing.
Costs and Expenses from Continuing Operations
Overall, our cost of sales increased by $618,000 to $8,601,000 in the second quarter fiscal 2009 period as compared to $7,983,000 in the second quarter fiscal 2008 period. Our gross profit (representing the difference between sales and cost of sales) was $2,817,000 or 24.7% of sales during the second quarter fiscal 2009 period as compared to $3,274,000 or 29.1% of sales during the second quarter fiscal 2008 period. In the Branded Product Program, our costs of sales increased by approximately $1,281,000 during the second quarter fiscal 2009 period when compared to the second quarter fiscal 2008 period, primarily as a result of product cost increases of 18.4%. However, that percentage increase in costs would have been approximately 22.2% but for the purchase commitment we entered into in January 2008, which locked in a fixed cost on approximately 1.8 million pounds of hot dogs resulting in savings of approximately $158,000 during the secondquarter fiscal 2009 period. These savings helped offset some of the effects of the substantially higher commodity costs for beef and beef trimmings, such that, our average cost per pound in the Branded Product Program was approximately 18.4% higher during the second quarter fiscal 2009 period as compared to the second quarter fiscal 2008 period. We concluded this purchase commitment during August 2008. Throughout the second quarter fiscal 2009 period, the cost of beef and beef trimmings continued to advance to the highest level since the inception of the Branded Product Program, which significantly reduced our gross profit. In response, we increased prices in our Branded Product Program during the second quarter fiscal 2009 period, although we have not been able to pass along all of the increased costs. If the cost of beef and beef trimmings do not decline and we are unable to further pass on these higher costs through price increases, our margins will continue to be significantly impacted. Beginning in mid-August 2008, we began to see a modest softening of these costs, which still remain at very high levels. With respect to our six Company-owned restaurant outlets, our cost of sales during the second quarter fiscal 2009 period was $2,523,000 or 53.9% of restaurant sales, as compared to $2,661,000 or 53.9% of restaurant sales in the second quarter fiscal 2008 period. During the second quarter fiscal 2009 period, we experienced higher food costs, which were offset by lower labor and labor-related costs as a percentage of sales. The higher food cost as a percentage of sales was primarily due to the higher cost of our hot dogs and other products such as cooking oil, bread, hamburgers and fish. Cost of sales to our television retailer decreased by $525,000 in the second quarter fiscal 2009 period primarily due to lower sales volume, which was partly offset by our higher cost of hot dogs.
Restaurant operating expenses increased by $51,000, to $964,000 in the second quarter fiscal 2009 period as compared to $913,000 in the second quarter fiscal 2008 period. The increaseduring the second quarter fiscal 2009 period when compared to the second quarter fiscal 2008 period resulted primarily from higherutility costs of $51,000, and various other costs of $25,000, which were partly offset by lower insurance costs of $25,000. During the second quarter fiscal 2009 period, our utility costs were approximately 23.6% higher than the second quarter fiscal 2008 period. Despite recent reductions in the cost of oil and natural gas, we remain concerned over the uncertain market conditions of these products. We may continue to incur high utility costs in the future.
Depreciationand amortization was $200,000 in the second quarter fiscal 2009 period as compared to $192,000 in the second quarter fiscal 2008 period.
General and administrative expenses were $2,249,000 in the second quarter fiscal 2009 period as compared to $2,141,000in the second quarter fiscal 2008 period. The difference in general and administrative expenses was due primarily to an increased number of bad debts of $155,000 and increased stock compensation expense of $43,000, which were partly offset by lower legal fees of $51,000 during the second quarter fiscal 2009 period, primarily associated with Nathan’s litigation against SFG (see Part II, Item 1) and loweraudit fees of $31,000 in the second quarter fiscal 2009 period. The actual amount and timing of future SFG litigation costs is not presently determinable.
Recovery of property taxes in the second quarter fiscal 2009 period, represents the settlement of a multi-year certiorari proceeding at one of Nathan’s Company-operated restaurants, net of fees.
Provision for Income Taxes from Continuing Operations
In the second quarter fiscal 2009 period, the income tax provision was $1,093,000 or 37.0% of income from continuing operations before income taxes as compared to $1,035,000 or 37.1% of income from continuing operations before income taxes in the second quarter fiscal 2008 period. For the thirteen weeks ended September 28, 2008 and September 23, 2007, Nathan’s tax provisions, excluding the effects of tax-exempt interest income, were 40.2% and 40.5%, respectively.
Twenty-six weeks ended September 28, 2008 compared to twenty-six weeks ended September 23, 2007
Revenues from Continuing Operations
Total sales increased by $1,195,000$1,356,000 or 12.2%6.4% to $11,016,000$22,434,000 for the thirteentwenty-six weeks ended June 29,September 28, 2008 (“fiscal 2009 period”) as compared to $9,821,000$21,078,000 for the thirteentwenty-six weeks ended June 24,September 23, 2007 ("fiscal 2008 period"). Sales from the Branded Product Program increased by 11.7%16.0% to $6,618,000$12,900,000 for the fiscal 2009 period as compared to sales of $5,925,000$11,124,000 in the fiscal 2008 period. This increase was primarily attributable to increased sales volume of 11.0%.approximately 11.4% and of price increases of approximately 6.5%, which took effect beginning July 2008. Total Company-owned restaurant sales (representing five comparable Nathan’s restaurants and one seasonal restaurant) increased by 6.2% to $3,859,000were $8,540,000 as compared to $3,633,000$8,567,000 during the fiscal 2008 period. During the fiscal 2009 period, sales to our television retailer were approximately $276,000 higher$393,000 lower than the fiscal 2008 period. Nathan’s products were on air 1831 times during the fiscal 2009 period as compared to 2335 times during the fiscal 2008 period. Mostperiod, which included airings of the airings in the fiscal 2008 period were15 “Try Me” specials. Under this format, most of the sales from these airings were shipped in our second quarter fiscal 2008.special promotions and two, half-hour food shows.
Franchise fees and royalties decreased by $70,000$263,000 or 5.7%10.1% to $1,152,000$2,343,000 in the fiscal 2009 period compared to $1,222,000$2,606,000 in the fiscal 2008 period. Total royalties were $1,035,000$2,093,000 in the fiscal 2009 period as compared to $1,058,000$2,189,000 in the fiscal 2008 period. During the fiscal 2009 period, we did not recognize revenue of $27,000$98,000 for royalties deemed to be uncollectible as compared to the fiscal 2008 period, when we recognized $77,000did recognize $55,000 of royalty income that was previously deemed to be uncollectible. Total royalties, excluding the adjustments for royalties deemed uncollectible as described above, were $1,062,000$2,191,000 in the fiscal 2009 period as compared to $981,000$2,134,000 in the fiscal 2008 period. During the fiscal 2009 period, Nathan’s earned $64,000$114,000 of higher royalties from our manufacturers and primary distributor on sales to our Limited Menu Frank and Frylimited-menu franchisees. Franchise restaurant sales were $23,756,000$48,900,000 in the fiscal 2009 period as compared to $23,764,000$50,771,000 in the fiscal 2008 period. Comparable domestic franchise sales (consisting of 143140 Nathan’s restaurants)outlets, excluding sales of the limited-menu franchisees) were $19,551,000$38,970,000 in the fiscal 2009 period as compared to $19,556,000$40,136,000 in the fiscal 2008 period. At June 29,September 28, 2008, 230235 domestic and international franchised or limited-menu licensed unitsfranchised outlets were operating as compared to 200204 domestic and international franchised or licensed unitslimited-menu franchised outlets at June 24,September 23, 2007. Royalty income from 1016 domestic franchised locationsoutlets was deemed unrealizable during the thirteentwenty-six weeks ended June 29,September 28, 2008, as compared to three domesticfour franchised locationsoutlets during the thirteentwenty-six weeks ended June 24,September 23, 2007. Domestic franchise fee income was $47,000$126,000 in the fiscal 2009 period as compared to $113,000$250,000 in the fiscal 2008 period. International franchise fee income was $70,000$79,000 in the fiscal 2009 period, as compared to $51,000$82,000 during the fiscal 2008 period.period due primarily to fewer openings of larger franchised restaurants. During the fiscal 2009 period, 1423 new franchised unitsoutlets opened, including nine16 limited-menu licensed units,franchised outlets, two units in Kuwait and one unit in Dubai. During the fiscal 2008 period, nine20 new franchised unitsoutlets were opened including three test Limited Menu Frankten limited-menu franchised outlets and Fry units and twothree units in Kuwait.
License royalties increased by $167,000$747,000 or 11.5%29.9% to $1,615,000$3,243,000 in the fiscal 2009 period as compared to $1,448,000$2,496,000 in the fiscal 2008 period. Total royalties earned on sales of hot dogs from our retail and foodservice license agreements of $1,358,000$2,443,000 increased by $261,000 or 23.8%27.8% from $1,911,000 as a result of higher licensee sales during the fiscal 2009 period. Royalties earned from SFG,our primary licensee, primarily from the retail sale of hot dogs, were $1,052,000$1,838,000 during the fiscal 2009 period as compared to $975,000$1,671,000 during the fiscal 2008 period. Royalties earned from John Morrell,another licensee, primarily from sales to Sam’sSam’s Club, were $306,000$605,000 during the fiscal 2009 period as compared to $122,000$240,000 during the fiscal 2008 period. Beginning March 2008, Nathan’s hot dogs were introduced into allover 500 of the foodservice cafes operating in Sam’s Clubs throughout the United States. We earned higher revenues of $274,000 from our agreement for the manufacture of Nathan’s proprietary ingredients, including $234,000 which was as a result of the settlement of a multi-year dispute under that agreement related to the unauthorized use of certain ingredients. We earned lower royalties of $101,000$56,000 from our agreement for the sale of Nathan’s pet treats. Last year, there was a sales promotion supporting the introduction of our pet treats into Wal-Mart. Net royalties from all other license agreements in the fiscal 2009 period were $5,000 more$3,000 less than the fiscal 2008 period.
Interest income was $247,000$522,000 in the fiscal 2009 period versus $235,000as compared to $524,000 in the fiscal 2008 period, primarily due to higherlower interest income on our invested cash and marketable securities of approximately $25,000 due primarily to the reduced interest rate environment and the liquidity crisis which caused Nathan’s to shift its short-term investments into secure, but low yielding, Treasury Bills. Interest earned on our MSC Note (as defined) receivable, received in connection with the sale of Miami Subs on June 7, 2007. Interest income on2007 was $80,000 in the fiscal 2009 period as compared to $59,000 in the fiscal 2008 period. This increase was primarily due to the MSC Note was $43,000being outstanding for six months during the fiscal 2009 period as compared to $12,000four months during the fiscal 2008 period. Interest income on our invested cash and marketable securities was approximately $20,000 less than the fiscal 2008 period due primarily to the reduced interest rate environment and the liquidity crisis which caused Nathan’s to shift its short term investments into secure, but low yielding, Treasury Bills.
Other income was $12,000$25,000 in the fiscal 2009 period versus $13,000as compared to $56,000 in the fiscal 2008 period. During the second quarter fiscal 2008 period, Nathan’s earned a $30,000 consent fee in connection with a licensee’s refinancing.
Costs and Expenses from Continuing Operations
Overall, our cost of sales increased by $904,000$1,522,000 to $8,332,000$16,933,000 in the fiscal 2009 period from $7,428,000as compared to $15,411,000 in the fiscal 2008 period. Our gross profit (representing the difference between sales and cost of sales) was $2,684,000$5,501,000 or 24.4%24.5% of sales during the fiscal 2009 period as compared to $2,393,000$5,667,000 or 24.4%26.9% of sales during the fiscal 2008 period. In the Branded ProductsProduct Program, our costscost of sales increased by approximately $511,000$1,792,000 during the fiscal 2009 period when compared to the fiscal 2008 period, primarily as a result of increased sales volume.volume and also to the higher cost of our hot dogs of approximately 7.7%. However, that percentage increase in costs would have been significantly largerapproximately 12.6% but for the purchase commitment we entered into in January 2008, which locked in a fixed cost on approximately 1.8 million pounds of hot dogs and resulted in a savings of approximately $304,000$462,000 during the quarter. Thisfiscal 2009 period. These savings more than counteractedoffset some of the effects of the substantially higher commodity costs for beef and beef trimmings such that our average cost (and average margin) per pound in the Branded ProductsProduct Program was slightly improvedapproximately 7.7% higher during the fiscal 2009 period as compared to the fiscal 2008 period. While some inventory remained available under the purchase commitment at the commencement of the second quarter of fiscal 2009, we expect to deplete it during July and August. Accordingly, although we expect the purchase commitment to continue to provide some benefit to the Branded Products Program during the second quarter, we do not believe that the benefit will be as extensive as the benefit achieved during the first quarter. Furthermore, the underlying cost of beef and beef trimmings markets havehas continued to advance and now are at all time highs.throughout the fiscal period, reaching the highest level since the inception of the Branded Product Program. In response, we have initiated price increases in our Branded Product Program during the second quarter. However, ifquarter fiscal 2009 period. Beginning in mid-August 2008, we have seen a modest softening of these costs, which still remain at very high levels. If the cost of beef and beef trimmings markets dodoes not recededecline and we are unable to pass on these higher costs through price increases, our margins maywill continue to be significantly impaired.impacted. With respect to our six Company-owned restaurant units,outlets, our cost of sales during the fiscal 2009 period was $2,237,000$4,760,000 or 58.0%55.7% of restaurant sales, as compared to $2,076,000$4,737,000 or 57.1%55.3% of restaurant sales in the fiscal 2008 period. During the fiscal 2009 period, we experienced higher food and direct labor costs, which were partly offset by slightly lower foodlabor-related costs as a percentage of sales. The slightly lowerhigher food cost as a percentage of sales was achieveddue primarily to the higher commodity cost of our hot dogs, hamburgers, cooking oil, bread and fish, which were partly as a result ofmitigated by our sales price increases for select menu items of between 3.0% and 7.3%. Cost of sales also increasedto our television retailer declined by $232,000$293,000 in the fiscal 2009 period, primarily due to higherlower sales volume towhich was partly offset by our television retailer.higher cost of hot dogs.
Restaurant operating expenses increased by $74,000,$125,000 to $912,000$1,876,000 in the fiscal 2009 period, from $838,000as compared to $1,751,000 in the fiscal 2008 period. The increase during the fiscal 2009 period when compared to the fiscal 2008 period resulted primarily from higher utility costs of $18,000,$69,000, occupancy costs of $17,000, marketing costs of $8,000,$24,000 and various other costs of $38,000,$39,000, which were partly offset by lower insurance costs of $8,000.$33,000. During the fiscal 2009 period our utility costs were approximately 5.2%18.0% higher than the fiscal 2008 period. Based uponDespite recent reductions in the cost of oil and natural gas, we remain concerned over the uncertain market conditions for oil and natural gas, wegas. We may continue to incur higher utility costs in the future.
Depreciation and amortization was $198,000$398,000 in the fiscal 2009 period as compared to $182,000$374,000 in the fiscal 2008 period.
General and administrative expenses increased by $373,000$481,000 to $2,445,000$4,694,000 in the fiscal 2009 period as compared to $2,072,000$4,213,000 in the fiscal 2008 period. The difference in general and administrative expenses was due to an increase in the number of bad debts of $154,000, higher legal fees of $147,000$97,000 during the fiscal 2009 period primarily associated with Nathan’s litigation against SFG (see Part II, Item 1), higher audit fees of $95,000$48,000 in the fiscal 2009 period related to Nathan’s first audit under Section 404 of the Sarbanes-Oxley Act of 2002, requiring Nathan’s auditor to audit Nathan’s internal controls over financial reporting, a $27,000$70,000 increase in Nathan’s stock-based compensation expense, higher compensation costs of $23,000, higher business development costs of $19,000 in connection with Franchising and the Branded Product Program$80,000 and higher occupancy costs of $15,000.$14,000. The actual amount and timing of future SFG litigation costs is not presently determinable.
Recovery of property taxes in the second quarter fiscal 2009 period, represents the settlement of a multi-year certiorari proceeding at one of Nathan’s Company-operated restaurants, net of fees.
Provision for Income Taxes from Continuing Operations
In the fiscal 2009 period, the income tax provision was $800,000$1,893,000 or 37.1% of income from continuing operations before income taxes as compared to $811,000$1,846,000 or 36.5%36.8% of income from continuing operations before income taxes in the fiscal 2008 period. For each of the thirteen-weektwenty-six-week periods ended June 29,September 28, 2008 and June 24,September 23, 2007, Nathan’s tax provision, excluding the effects of tax-exempt interest income, was 40.4% and 40.6%., respectively.
Discontinued Operations
On April 23, 2008, Nathan’s completed the sale of its wholly-owned subsidiary, NF Roasters Corp, to Roasters Asia Pacific (Cayman) Limited. Pursuant to the Stock PurchaseNFR Agreement, (“NFR Agreement”), Nathan’s sold all of the stock of NF Roasters for $4,000,000 in cash. In connection with the NFR Agreement, Nathan’s and Miami Subs may continue to sell Kenny Rogers products within the existing restaurant systems without payment of royalties.
Nathan’s has realized a gain on the sale of Roasters of $3,656,000 net of professional fees of $39,000 and recorded income taxes of $1,352,000 on the gain during the thirteentwenty-six weeks ended June 29,September 28, 2008. Nathan’s has determined that it will not have any significant cash flows or continuing involvement in the ongoing operations of NF Roasters. Therefore, the results of operations for NF Roasters, including the gaingains on disposal, have been presented as discontinued operations for all periods presented. The accompanying balance sheet for the fiscal year ended March 30, 2008, has been revised to reflect the assets and liabilities of Roasters that were subsequently sold, as held for sale as of that date.
On June 7, 2007, Nathan’s completed the sale of Miami Subs to Miami Subs Capital Partners I, Inc. (“Purchaser”). Pursuant to the Stock Purchase Agreement (“MSC Agreement”), Nathan’s sold all of the stock of Miami Subs in exchange for $3,250,000, consisting of $850,000 in cash and the Purchaser’s promissory note in the principal amount of $2,400,000 (the “MSC Note”). The MSC Note bears interest at 8% per annum, is payable over a four-year term and is secured by a lien on all of the assets of Miami Substhe Purchaser and by the personal guarantees of two principals of the Purchaser. The Purchaser may also prepay the MSC Note at any time. In the event the MSC Note was fully repaid within one year of the sale, Nathan’s had agreed to reduce the amount due by $250,000. Due to the ability to prepay the loan and reduce the amount due, the recognition of the additional $250,000 was initially deferred. The MSC Note was not prepaid within the requisite timeframe and Nathan’s recognized the deferred revenue of $250,000 as additional gain and recorded income taxes of $92,000 during the first quarter ended June 29, 2008. Effective August 31, 2008, Nathan’s and the Purchaser agreed to extend the due date of the MSC Note until April 2014, to reduce the monthly payments and to settle certain claims under the MSC Agreement. In accordance with the MSC Agreement, Nathan’s retained ownership of Miami Subs’ then corporate office in Fort Lauderdale, Florida (the “Corporate Office”).Florida.
Nathan’s initially realized a gain on the sale of Miami Subs of $983,000, net of professional fees of $37,000 and recorded income taxes of $334,000 on the gain during the thirteentwenty-six weeks ended June 24,September 23, 2007. Nathan’s also recognized an additional gain of $250,000 or $158,000, net of tax during the thirteentwenty-six weeks ended June 29,September 28, 2008, resulting from the contingent consideration which was deferred at the time of sale. Nathan’s has determined that it will not have any significant cash flows or continuing involvement in the ongoing operations of Miami Subs. Therefore, the results of operations for Miami Subs, including the gains on disposal, have been presented as discontinued operations for all periods presented.
During the thirteentwenty-six weeks ended June 24,September 23, 2007, Nathan’s completed a Lease Termination Agreement with respect to three leased properties in Fort Lauderdale, Florida, with its landlord, and CVS 3285 FL, L.L.C., (“CVS”) to sell our leasehold interests to CVS for $2,000,000. As the properties were subject to certain sublease and management agreements between Nathan’s and the then-current occupants, Nathan’s made payments to, or forgave indebtedness of, the then-current occupants of the properties and paid brokerage commissions of $494,000 in the aggregate. Nathan’s made the property available to the buyer by May 29, 2007, and Nathan’s received the proceeds of the sale on June 5, 2007. Nathan’s recognized a gain of $1,506,000 and recorded income taxes of $557,000 during the thirteen-weektwenty-six-week period ended June 24,September 23, 2007. The results of operations for these properties, including the gain on disposal, have been included as discontinued operations for all periods presented.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements, other than a guarantee of a severance agreement andof which $31,000 has been recorded on the remainingaccompanying balance sheet. We have concluded our purchase commitment to acquire approximately 385,000 lbs.a total of 1,785,000 lbs of hot dogs during July andthrough August 2008. Refer to Note J to the Consolidated Financial Statements for further information on these transactions.
Liquidity and Capital Resources
Cash and cash equivalents at June 29,September 28, 2008 aggregated $17,369,000,$14,693,000, increasing by $2,988,000$312,000 during the fiscal 2009 period. At June 29,September 28, 2008, marketable securities were $20,150,000$22,581,000 and net working capital increased to $38,172,000$37,123,000 from $35,650,000 at March 30, 2008.
Cash used inprovided by operations of $1,000$2,595,000 in the fiscal 2009 period is primarily attributable to net income of $3,822,000$5,681,000 less gains of $3,906,000 from the sales of Roasters and Miami Subs, plus other non-cash items of $340,000.836,000. Changes in Nathan’s operating assets and liabilities decreased cash by $257,000,$16,000, resulting principally from increased accounts receivableand other receivables of $1,698,000, and increased inventories of $168,000,$1,354,000, which were partly offset by an increase in accounts payable of $880,000 and$318,000, decreased prepaid expenses of $624,000.$831,000 and decreased inventory of $156,000. The net increase in accounts receivable is dueand other receivables relates primarily fromto sales from the Branded Product Program of approximately $800,000, higher royalties from$676,000, receivable for a property tax recovery of $516,000 and advances made to the Nathan’s licensees from the growthFamous Advertising Fund of their business of approximately $721,000 and higher sales to our television retailer of approximately $67,000.$320,000. The net increase in accounts payable, other current liabilitiesaccrued expenses and other long termcurrent liabilities is primarily due to the increase in accrued income taxes payable, resulting primarily from the gain on the sale of NF Roasters Corp. which was partly offset by a reduction in accounts payable and the annual payment of accrued compensation.
Cash was provided from investing activities of $4,439,000$1,780,000 in the fiscal 2009 period, primarily from cash proceeds from the sale of Roasters in the amount of $3,961,000, and the redemption of $500,000 of maturing available-for-sale securities.securities and receipt of all scheduled payments of $297,000 on the MSC Note receivable. We invested $2,699,000 in available-for-sale securities and incurred capital expenditures of $169,000 and received all scheduled payments of $147,000 on the MSC Note receivable.$279,000.
Cash was used in financing activities of $1,450,000$4,063,000 in the fiscal 2009 period, primarily for the purchase of 103,858300,961 treasury shares of Company Common Stock at a cost of $1,460,000$4,411,000 pursuant to the stock repurchase plan as authorized by the Board of Directors on November 5, 2007. Cash was received from the proceeds of employee stock option exercises of $10,000.$145,000 and the expected realization of the associated tax benefit of $203,000.
From the commencement of its stock repurchase program in September 2001 through March 30, 2008, Nathan’s purchased a total of 2,000,000 shares of common stock at a cost of approximately $9,086,000, concluding the second stock repurchase plan previously authorized by the Board of Directors.
On November 5, 2007, Nathan’s Board of Directors authorized the purchase of up to an additional 500,000 shares of its common stock on behalf of the Company. On June 11, 2008, Nathan’s and Mutual Securities, Inc. (“MSI”) entered into an agreement (the “10b5-1 Agreement”) pursuant to which MSI has been authorized to purchase shares of the Company’s common stock, par value $.01 per share (“Common Stock”) having a value of up to an aggregate $6 million. The 10b5-1 Agreement was adopted under the safe harbor provided by Rule 10b5-1 of the Securities Exchange Act of 1934 in order to assist the Company in implementing its previously announced stock purchase plan for the purchase of up to 500,000 shares. There is no set time limit on the repurchases. Future purchases may be made from time to time, depending on market conditions, in open market or privately negotiatedprivately-negotiated transactions, at prices deemed appropriate by management. Through June 29,September 28, 2008, the Company had repurchased an additional 103,858221,706 shares of its common stockCommon Stock at a total cost of $1,460,000$3,309,000 pursuant to the 10b5-1 Agreement. Subsequent to June 29,September 28, 2008, Nathan’s has continued to repurchase its common stockCommon Stock in the open market pursuant to the 10b5-1 Agreement, repurchasinghaving repurchased an additional 85,830182,923 shares at a total cost of approximately $1,261,000$2,691,000 through JulyOctober 31, 2008. For the period commencing March 31, 2008 and ending JulyOctober 31, 2008, Nathan’s repurchased 79,255 shares at a cost of approximately $1,102,000 before the adoption of the 10b5-1 Agreement and purchased 110,433404,629 shares at a cost of approximately $1,619,000$6,000,000 pursuant to the 10b5-1 Agreement through October 31, 2008, thereby completing the purchases authorized under the 10b5-1 Agreement. There are 16,116 remaining shares authorized to be repurchased under Nathan’s third stock repurchase plan.
Management believes that available cash, marketable securities and cash generated from operations should provide sufficient capital to finance our operations and stock repurchases for at least the next twelve months. We currently maintain aEffective October 2008, Nathan’s decided that it would not extend its $7,500,000 uncommitted bank line of credit, and havehaving never borrowed any funds under thisthat line of credit.
Nathan’s philosophy with respect to maintaining a balance sheet with a significant amount of cash and marketable securities reflects our views of maintaining readily available capital to expand our existing business and pursue any new business opportunities which might present themselves to expand our business. Nathan’s believes in the value of returning its cash to its shareholders through the repurchase of its outstanding common stock and continuously evaluates this opportunity. Nathan’s routinely assesses its investment management approach with respect to our current and potential capital requirements.
We expect that we will continue the stock repurchase program, and make additional investments in certain existing restaurants and support the growth of the Branded Product Program in the future and fund those investments from our operating cash flow. We may also incur capital expenditures in connection with opportunistic investments on a case-by-case basis.
At June 29,September 28, 2008, there were three properties that we lease from third parties which we sublease to franchisees and a non-franchisee. We remain contingently liable for all costs associated with these properties including: rent, property taxes and insurance. We may incur future cash payments with respect to such properties, consisting primarily of future lease payments, including costs and expenses associated with terminating any of such leases.
The following schedule represents Nathan’s cash contractual obligations and commitments by maturity (in thousands):
| | Payments Due by Period | | | | | |
| | Less than | | | | More than | |
Cash Contractual Obligations | | Total | | 1 Year | | 1 - 3 Years | | 3-5 Years | | 5 Years | |
| | | | | | | | | | | | | | | | |
Employment Agreements (a) | | $ | 3,602 | | $ | 1,236 | | $ | 1,166 | | $ | 600 | | $ | 600 | |
Operating Leases | | | 12,056 | | | 1,556 | | | 1,928 | | | 1,110 | | | 7,462 | |
Gross Cash Contractual Obligations | | | 15,658 | | | 2,792 | | | 3,094 | | | 1,710 | | | 8,062 | |
| | | | | | | | | | | | | | | | |
Sublease Income | | | 1,263 | | | 304 | | | 582 | | | 332 | | | 45 | |
Net Cash Contractual Obligations | | $ | 14,395 | | $ | 2,488 | | $ | 2,512 | | $ | 1,378 | | $ | 8,017 | |
| | Amount of Commitment Expiration by Period | |
| | | | | | | | | | | |
| | Total | | | | | | | | | |
| | Amounts | | Less than | | | | | | More than | |
Other Contractual Commitment | | Committed | | 1 Year | | 1 - 3 Years | | 3-5 Years | | 5 Years | |
| | | | | | | | | | | | | | | | |
Commitment to purchase | | $ | 591 | | $ | 591 | | $ | - | | $ | - | | $ | - | |
Total Other Contractual Commitment | | $ | 591 | | $ | 591 | | $ | - | | $ | - | | $ | - | |
(a) Includes the extension of Messrs. Gatoff's and Norbitz’ employment agreements for which no non-renewal notices were provided within the required 180 days of December 31, 2008. | | Payments Due by Period | |
| | | | Less than | | | | | | More than | |
Cash Contractual Obligations | | Total | | 1 Year | | 1 - 3 Years | | 3 - 5 Years | | 5 Years | |
| | | | | | | | | | | |
Employment Agreements | | $ | 3,293 | | $ | 1,236 | | $ | 957 | | $ | 500 | | $ | 600 | |
Operating Leases | | | 11,719 | | | 1,520 | | | 1,771 | | | 1,102 | | | 7,326 | |
Gross Cash Contractual Obligations | | | 15,012 | | | 2,756 | | | 2,728 | | | 1,602 | | | 7,926 | |
| | | | | | | | | | | | | | | | |
Sublease Income | | | 1,195 | | | 344 | | | 541 | | | 292 | | | 18 | |
Net Cash Contractual Obligations | | $ | 13,817 | | $ | 2,412 | | $ | 2,187 | | $ | 1,310 | | $ | 7,908 | |
Inflationary Impact
We do not believe that general inflation has materially impacted earnings during fiscal 2008, 2007 and 2006. However, during the fiscal 2009 period, we have experienced significant cost increases for certain food products, distribution costs and utilities. Our commodity costs for beef have been very volatile since fiscal 2004 and the cost of beef is currently at a historic high,has continued to set new highs during the quarter, having increased significantly during the fiscal 2009 period. Nathan’s was able to partly mitigate some of the increase by entering into a purchase commitment in January 2008 for approximately 35% of its projected hot dog purchases during the period from April through August 2008. As a result of the purchase commitment, Nathan’s actual cost of hot dogs for its Branded Product Program were approximately 1.2% less7.7% higher than its first quarter last yeartwenty-six weeks ended September 23, 2007, instead of being approximately 4.7%12.6% higher. In addition, the cost of beef for our last fiscal year ended March 30, 2008 was approximately 8.2% higher than our prior fiscal year. We are unable to predict the future cost of our hot dogs, however, we expect to experience continued price volatility for our beef products during the rest of fiscal 2009. Since January 2008, we have experienced cost increases for a number of our other food products. We expect to incur higher commodity costs for cooking oil, fish, potatoes and paper products during fiscal 2009. As previously discussed, Nathan’s increased prices in response to the increased commodity costs. In addition, for the past four years we have continued to experience the impact of higher oil prices in the form of higher distribution costs for our food products and higher utility costs in our Company-owned restaurants.
From time to time, various Federal and New York State legislators have proposed changes to the minimum wage requirements. On May 25, 2007, President Bush signed legislation which increased the Federal minimum wage to $5.85 per hour, effective July 24, 2007, with increases to $6.55 per hour effective July 24, 2008 and to $7.25 per hour effective July 24, 2009. The New York State minimum wage, where our Company-owned restaurants are located, was increased to $7.15 per hour on January 1, 2007 and will increase to $7.25 per hour on July 24, 2009. These wage increases have not had a material impact on our results of operations or financial position as the vast majority of our employees are paid at a rate higher than the minimum wage. Although we only operate six Company-owned restaurants, we believe that significant increases in the minimum wage could have a significant financial impact on our financial results and the results of our franchisees. Continued increases in labor, food and other operating expenses could adversely affect our operations and those of the restaurant industry and we might have to further reconsider our pricing strategy as a means to offset reduced operating margins.
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,” “Risk Factors” and “Notes to Consolidated Financial Statements” in this Form 10-Q and “Risk Factors” in this Form 10-Q and in our Form 10-K for our fiscal year ended March 30, 2008.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Cash and Cash Equivalents
We have historically invested our cash and cash equivalents in short term, fixed rate, highly rated and highly liquid instruments which are reinvested when they mature throughout the year. Although our existing investments are not considered at risk with respect to changes in interest rates or markets for these instruments, our rate of return on short-term investments could be affected at the time of reinvestment as a result of intervening events. As of June 29,September 28, 2008, Nathans’Nathan’s cash and cash equivalents aggregated $17,369,000.$14,693,000. Earnings on these cash and cash equivalents would increase or decrease by approximately $43,000$37,000 per annum for each 0.25% change in interest rates.
Marketable Securities
We have invested our marketable securities in intermediate term, fixed rate, highly rated and highly liquid instruments. These investments are subject to fluctuations in interest rates. As of June 29,September 28, 2008, the market value of Nathans’Nathan’s marketable securities aggregated $20,150,000.$22,581,000. Interest income on these marketable securities would increase or decrease by approximately $50,000$56,000 per annum for each 0.25% change in interest rates. The following chart presents the hypothetical changes in the fair value of the marketable investment securities held at June 29,September 28, 2008 that are sensitive to interest rate fluctuations (in thousands):
| | Valuation of securities | | | | Valuation of securities | |
| | Given an interest rate | | | | Given an interest rate | |
| | Decrease of X Basis points | | Fair | | Increase of X Basis points | |
| | (150BPS) | | (100BPS) | | (50BPS) | | Value | | +50BPS | | +100BPS | | +150BPS | |
| | | | | | | | | | | | | | | | | | | | | | |
Municipal notes and bonds | | $ | 21,211 | | $ | 20,850 | | $ | 20,498 | | $ | 20,150 | | $ | 19,805 | | $ | 19,463 | | $ | 19,131 | |
| | Valuation of securities | | | | Valuation of securities | |
| | Given an interest rate | | | | Given an interest rate | |
| | Decrease of X Basis points | | Fair | | Increase of X Basis points | |
| | (150BPS) | | (100BPS) | | (50BPS) | | Value | | +50BPS | | +100BPS | | +150BPS | |
| | | | | | | | | | | | | | | |
Municipal notes and bonds | | $ | 23,794 | | $ | 23,388 | | $ | 22,984 | | $ | 22,581 | | $ | 22,183 | | $ | 21,792 | | $ | 21,408 | |
Borrowings
The interest rate on our prior borrowings was generally determined based upon the prime rate and was subject to market fluctuation as the prime rate changed, as determined within each specific agreement. At June 29,September 28, 2008, we had no outstanding indebtedness. If we were to borrow money in the future, such borrowings would be based upon the then prevailing interest rates. We do not anticipate entering into interest rate swaps or other financial instruments to hedge our borrowings. We maintainmaintained a $7,500,000 credit line at the prime rate (5.0% as of June 29,September 28, 2008), which expires inwe decided to let expire as of October 1, 2008. We have never borrowed any funds under this credit line. Accordingly, we do not believe that fluctuations in interest rates would have a material impact on our financial results.
Commodity Costs
The cost of commodities is subject to market fluctuation. Historically,In January 2008, we entered into a purchase commitment to acquire approximately 1,785,000 lbs of hot dogs at $1.535 per lb through August 2008. We may attempt to enter into similar arrangements in the future. With the exception of that commitment, we have not attempted to hedge against fluctuations in the prices of the commodities we purchase using future, forward, option or other instruments. However, in January 2008, we entered into a purchase commitment to acquire approximately 1,785,000 lbs of hot dogs at $1.535 per lb. We may attempt to enter into similar arrangements in the future. As a result, we expect that the majority of our future commodities purchases will be subject to changes in the prices of such commodities. Generally, we have attempted to pass through permanent increases in our commodity prices to our customers, thereby reducing the impact of long-term increases on our financial results. A short termshort-term increase or decrease of 10.0% in the cost of our food and paper products for the thirteentwenty-six weeks ended June 29,September 28, 2008 would have increased or decreased our cost of sales by approximately $666,000.$1,357,000.
Foreign Currencies
Foreign franchisees generally conduct business with us and make payments in United States dollars, reducing the risks inherent with changes in the values of foreign currencies. As a result, we have not purchased future contracts, options or other instruments to hedge against changes in values of foreign currencies and we do not believe fluctuations in the value of foreign currencies would have a material impact on our financial results.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as required by Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Controls
There were no changes in our internal controls over financial reporting that occurred during the thirteentwenty-six weeks ended June 29,September 28, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls
We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer have concluded that such controls and procedures are effective at the reasonable assurance level.
PART II.II - OTHER INFORMATION
ItemItem 1. Legal Proceedings
We and our subsidiaries are from time to time involved in ordinary and routine litigation. Management presently believes that the ultimate outcome of such ordinary and routine litigation individually or in the aggregate, will not have a material adverse effect on our 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 our results of operations for the period in which the ruling occurs.
On March 20, 2007, a personal injury lawsuit was initiated seeking unspecified damages against the Company's subtenant and the Company's master landlord at a leased property in Huntington, New York. The claim relates to damages suffered by an individual as a result of an alleged "trip and fall" on the sidewalk in front of the leased property, maintenance of which is the subtenant's responsibility. Although the Company was not named as a defendant in the lawsuit, under its master lease agreement the Company may have an obligation to indemnify the master landlord in connection with this claim. The Company did not maintain its own insurance on the property concerned at the time of the incident; however, the Company is named as an additional insured under its subtenant's liability policy. Accordingly, if the master landlord is found liable for damages and seeks indemnity from the Company, the Company believes that it would be entitled to coverage under the subtenant's insurance policy. Additionally, under the terms of the sublease, the subtenant is required to indemnify the Company, regardless of insurance coverage.
The Company is party to a License Agreement with SMG, Inc. ("SMG") dated as of February 28, 1994, as amended (the "License Agreement") pursuant to which: (i) SMG acts as the Company's exclusive licensee for the manufacture, distribution, marketing and sale of packaged Nathan's Famous frankfurter product at supermarkets, club stores and other retail outlets in the United States; and (ii) the Company has the right, but not the obligation, to require SMG to produce frankfurters for the Nathan's Famous restaurant system and Branded ProductsProduct Program. On July 31, 2007, the Company provided notice to SMG that the Company has elected to terminate the License Agreement, effective July 31, 2008, (the "Termination Date"), due to SMG's breach of certain provisions of the License Agreement. SMG has disputed that a breach has occurred and has commenced, together with certain of its affiliates, an action in state court in Illinois seeking, among other things, a declaratory judgment that SMG did not breach the License Agreement. The Company's filed its own action on August 2, 2007, in New York State court seeking a declaratory judgment that SMG has breached the License Agreement and that the Company has properly terminated the License Agreement. On January 23, 2008, the New York court granted SMG’s motion to dismiss the Company’s case in New York on the basis that the dispute was already the subject of a pending lawsuit in Illinois. The Company has answered SMG's complaint and asserted its own counterclaims which seek, among other things, a declaratory judgment that SMG did breach the License Agreement and that the Company has properly terminated the License Agreement. On July 31, 2008, SMG and Nathan’s entered into a Stipulationstipulation pursuant to which Nathan’s agreed that it would not effectuate the termination of the License Agreement on the grounds alleged in the present litigation until such litigation has been successfully adjudicated, and SMG agreed that in such event, Nathan’s shall have the option to require SMG to continue to perform under the License Agreement for an additional period of up to six months to ensure an orderly transition of the business to a new licensee/supplier. The agreed motion for entry of said Stipulation must be approved by the Circuit Court. The parties are currently proceeding with the discovery process.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors described below, as well as those discussed in Part I, “Item 1A. Risk Factors” in the Annual Report on Form 10-K for the fiscal year ended March 30, 2008, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing Nathan's. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Increases in the cost of food and paper products could harm our profitability and operating results.
The cost of the food and paper products we use depends on a variety of factors, many of which are beyond our control. We purchase large quantities of beef and our beef costs in the United States represent approximately 80% to 85% of our food costs. The market for beef is particularly volatile and is subject to significant price fluctuations due to seasonal shifts, climate conditions, industry demand and other factors beyond our control. For example, in the past, reduced supply and increased demand in beef resulted in shortages, which required us to pay significantly higher prices for the beef we purchased. We were unable to pass all of the price increases to our customers. As the price of beef or other food products that we use in our operations increaseincreases significantly, particularly in the Branded Product Program, and we choose not to pass, or cannot pass, thesesuch increases on to our customers, our operating margins would decrease. Food and paper products typically represent approximately 25% to 30% of our cost of restaurant sales.
Fluctuations in weather, supply and demand and economic conditions could adversely affect the cost, availability and quality of some of our critical products, including beef. Our inability to obtain requisite quantities of high-quality ingredients would adversely affect our ability to provide the menu items that are central to our business, and the highly competitive nature of our industry may limit our ability to pass through increased costs to our customers. Continuing increases in the cost of fuel would increase the distribution costs of our prime products thereby increasing the food and paper costcosts to us and to our franchisees, thusthereby negatively affecting our profitability.
Nathan’s does not have the ability to effectively hedge all of its beef purchases using futures or forward contracts without incurring undue financial risk, although Nathan’s hashad entered into a commitment to purchase 1,785,000 pounds of hot dogs for the period April through August 2008. Nathan’s may seek to enter into similar commitments to purchase in the future.
The loss of one or more of our key suppliers could lead to supply disruptions, increased costs and lower operating results.
The Company relies on one supplier for the majority of its frankfurters and another supplier for its supply of frozen French fries. An interruption in the supply of product from either one of these suppliers without the Company obtaining an alternative source of supply on comparable terms could lead to supply disruptions, increased costs and lower operating results.
The Company is currently engaged in litigation with its primary supplier of frankfurters for each of the Company’s major lines of business seeking a judicial declaration that the Company is entitled to terminate its License Agreement with such supplier. In anticipation of such termination, the Company is seeking one or more alternative sources of supply to commence immediately following the termination of the License Agreement (or sooner if necessary); however, the termination of the License Agreement presents a number of risks to the Company and its operations.
Although the Company believes that its frankfurter supplier is contractually obligated to perform its obligations under the License Agreement until its termination and the Company expects its frankfurter supplier to continue to discharge those obligations, there is no assurance that the supplier will do so. In addition, the Company and the frankfurter supplier have entered into a commitment to purchase pursuant to which the supplier has agreed to sell to the Company 1,785,000 pounds of frankfurters between April and August 2008. In the event that the frankfurter supplier breaches its contractual obligations under the License Agreement and/or the commitment to purchase by failing or refusing to manufacture and supply frankfurters for the Company’s restaurant and Branded Product Program operations or to manufacture, distribute, market and sell Nathan’s Famous frankfurters to the retail trade, there is no assurance that the Company could secure an alternate source of supply in a timely manner.
Additionally, all of the frozen French fries sold through its franchised restaurants are obtained from one supplier. In the event that the French fry supplier is unable to fulfill Nathan’s requirements for any reasons, including due to a significant interruption in its manufacturing operations, whether as a result of a natural disaster or for other reasons, such interruption could significantly impair the Company’s ability to operate its business on a day-to-day basis.
In the event that the Company is unable to find one or more alternative suppliers of frankfurters or French fries on a timely basis, there could be a disruption in the supply of product to Company’s owned andCompany-owned restaurants, franchised restaurants and Branded Product accounts, which would damage the Company, its franchisees and Branded Product customers and, in turn, negatively impact the Company’s financial results. In addition, any gap in supply to retail customers would result in lost royalty payments to the Company, which could have a significant adverse financial impact on the Company’s results from operations. Furthermore, any gap in supply to retail customers may damage the Nathan’s Famous trademarks in the eyes of consumers and the retail trade, which damage might negatively impact the Company’s overall business in general and impair the Company’s ability to continue its retail licensing program.
Additionally, once secured, there is no assurance that any alternate sources of supply would be capable of meeting the Company’s specifications and quality standards on a timely and consistent basis or that the financial terms of such supply arrangement will be as favorable as the Company’s present terms with its frankfurter or French fry supplier, as the case may be.
Any of the foregoing occurrences may cause disruptions in supply of the Company’s frankfurter or French fry products, as the case may be, damage the Company’s franchisees and Branded Product customers, adversely impact the Company’s financial results and/or damage the Nathan’s Famous trademarks.
The closure of a Coney Island amusement park, and the redevelopment of the Coney Island amusement district, may have a material adverse effect on Nathan's financial results.
The original, flagship Nathan's Famous restaurant is located in the Coney Island amusement district in Coney Island, New York. We believe that customer traffic at this location depends, in part, on the operation of the various area amusements and attractions. One such attraction, the Astroland Amusement Park, has reportedly been closed permanently as of September 2008. Additionally, the City of New York and a private real estate developer have proposed competing plans to redevelop the entire Coney Island amusement district. We are unable to determine the impact of the closing of Astroland and/or the redevelopment of the Coney Island amusement district; however, any substantial decrease in the number of visitors to Coney Island would likely have a material adverse effect on our financial results.
Recent turmoil in the credit markets and the financial services industry may negatively impact the Company’s profitability and operating results.
Recently, the credit markets and the financial services industry have been experiencing a period of unprecedented turmoil and upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the United States federal government. While the ultimate outcome of these events cannot be predicted, they may have a material adverse effect on the Company’s liquidity and financial condition if the recent economic crisis results in reduced sales at our Company-owned and franchised restaurants or of licensed products for which we receive royalties or if it adversely impacts franchisees’ ability to finance purchases or restructurings of restaurant franchises, any of which may negatively impact the Company’s business and operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds:.
ISSUER PURCHASES OF EQUITY SECURITIES
Period | | (a) Total Number of Shares Purchased | | (b) Average Price Paid per Share | | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans | | (d) Maximum Number of Shares that May Yet Be Purchased Under the Plan | |
| | | �� | | | | | | | | | | |
March 31, 2008 April 27, 2008 | | | -0- | | $ | 0.0000 | | | 2,000,000 | | | 500,000 | |
| | | | | | | | | | | | | |
April 28, 2008 May 25, 2008 | | | -0- | | $ | 0.0000 | | | 2,000,000 | | | 500,000 | |
| | | | | | | | | | | | | |
May 26, 2008 June 29, 2008 | | | 103,858 | | $ | 14.0293 | | | 2,103,858 | | | 396,142 | |
| | | | | | | | | | | | | |
Total | | | 103,858 | | $ | 14.0293 | | | 2,103,858 | | | 396,142 | |
Period | | (a) Total Number of Shares Purchased | | (b) Average Price Paid per Share | | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans | | (d) Maximum Number of Shares that May Yet Be Purchased Under the Plan | |
| | | | | | | | | |
June 30, 2008 July 27, 2008 | | | 73,957 | | $ | 14.6612 | | | 73,957 | | | 322,185 | |
| | | | | | | | | | | | | |
July 28, 2008 August 24, 2008 | | | 90,865 | | $ | 14.9635 | | | 90,865 | | | 231,320 | |
| | | | | | | | | | | | | |
August 25, 2008 September 28, 2008 | | | 32,281 | | $ | 15.5358 | | | 32,281 | | | 199,039 | |
| | | | | | | | | | | | | |
Total | | | 197,103 | | $ | 14.9744 | | | 197,103 | | | 199,039 | |
On September 14, 2001, Nathan’s was authorized to purchase up to 1,000,000 shares of its common stock. Pursuant to itsthis first stock repurchase program, we repurchased 1,000,000 shares of common stock in open marketopen-market transactions and a private transaction at a total cost of $3,670,000. On October 7, 2002, Nathan’s was authorized to purchase up to 1,000,000 additional shares of its common stock. Nathan’s concluded the second authorized stock repurchase program of 1,000,000 shares of common stock at a cost of approximately $5,416,000. On November 5, 2007, Nathan’s Board of Directors authorized the purchase of up to an additional 500,000 shares of its common stock on behalf of the Company. On June 11, 2008, Nathan’s and Mutual Securities, Inc. (“MSI”)MSI entered into an agreement (the “10b5-1 Agreement”)the 10b5-1 Agreement pursuant to which MSI has been authorized to purchase shares of the Company’s common stock having a value of up to an aggregate $6 million. The 10b5-1 Agreement was adopted under the safe harbor provided by Rule 10b5-1 of the Securities Exchange Act of 1934 in order to assist the Company in implementing its previously announced stock purchase plan for the purchase of up to 500,000 shares. Through June 29,September 28, 2008, Nathan’s purchased a total of 2,103,8582,300,961 shares of common stock at a cost of approximately $10,546,000$13,497,000 pursuant to the current and previous stock repurchase plans previously authorized by the Board of Directors. Of these repurchased shares, 103,858300,961 shares at a cost of $1,460,000$4,411,000 were repurchased during the thirteentwenty-six weeks ended June 29,September 28, 2008. Subsequent to June 29,September 28, 2008, Nathan’s has continued to repurchase its common stock in the open market pursuant to the 10b5-1 Agreement, repurchasing an additional 85,830182,923 shares at a total cost of approximately $1,261,000$2,691,000 through JulyOctober 31, 2008. For the period commencing March 31, 2008 and ending JulyOctober 31, 2008, Nathan’s repurchased 79,255 shares at a cost of approximately $1,102,000 before the adoption of the 10b5-1 Agreement and purchased 110,433404,629 shares at a cost of approximately $1,619,000$6,000,000 pursuant to the 10b5-1 Agreement through October 31, 2008, thereby completing the purchases authorized under the 10b5-1 Agreement. There are 16,116 remaining shares to be repurchased in order to complete Nathan’s third stock repurchase plan. Future purchases may be made from time to time, depending on market conditions, in open market or privately- negotiatedprivately-negotiated transactions, at prices deemed appropriate by management. There is no set time limit on the repurchases.
Item 4. Submission of Matters to a Vote of Security Holders.
(a) | The Company held its Annual Meeting of Stockholders on September 9, 2008. |
(b) | Nine Directors were elected at the Annual Meeting to serve until the Annual Meeting of Stockholders in 2009. The names of these Directors and votes cast in favor of their election and shares withheld are as follows: |
| | FOR | | WITHHELD | |
HOWARD M. LORBER | | | 4,496,557 | | | 222,301 | |
WAYNE NORBITZ | | | 4,605,789 | | | 113,069 | |
ROBERT J. EIDE | | | 4,513,364 | | | 205,494 | |
ERIC GATOFF | | | 4,605,914 | | | 112,944 | |
BRIAN S. GENSON | | | 4,622,271 | | | 96,587 | |
BARRY LEISTNER | | | 4,630,897 | | | 87,961 | |
DONALD L. PERLYN | | | 4,494,798 | | | 224,060 | |
A.F. PETROCELLI | | | 4,571,526 | | | 147,332 | |
CHARLES RAICH | | | 4,514,220 | | | 204,638 | |
ItemItem 6. ExhibitsExhibits.
3.1 | | Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-1 No. 33- 56976.33-56976.) |
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3.2 | | Amendment to the Certificate of Incorporation, filed December 15, 1992. (Incorporated by reference to Exhibit 3.2 to Registration Statement on Form S-1 No. 33-56976.) |
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3.3 | | By-Laws, as amended. (Incorporated by reference to Exhibit 3.3 to Form 10-K for the fiscal year ended March 27, 2005.) |
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4.1 | | Specimen Stock Certificate. (Incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-1 No. 33-56976.) |
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4.2 | | Form of Rights Certificate. (Incorporated by reference to Exhibit A to Exhibit 4.2 to Form 8-K dated June 6, 2008.) |
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4.3 | | Rights Agreement dated as of June 4, 2008 between Nathan’s Famous, Inc. and American Stock Transfer and Trust Company. (Incorporated by reference to Exhibit 4.2 to Form 8-K dated June 6, 2008.) |
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10.1 | | *Settlement Agreement and Release between Miami Subs Capital Partners I, Inc. and Nathan’s Famous, Inc. |
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10.2 | | *Amended and Restated Promissory Note of Miami Subs Capital Partners I, Inc. |
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31.1 | | *Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 | | *Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 | | *Certification by Eric Gatoff, CEO, Nathan’s Famous, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 | | *Certification by Ronald G. DeVos, CFO, Nathan’s Famous, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
| | *Filed herewith. |
*Filed herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | NATHAN'S FAMOUS, INC. |
| | |
Date: August 8,November 7, 2008 | By: | /s/Eric Gatoff |
| | Eric Gatoff |
| | Chief Executive Officer |
| | (Principal (Principal Executive Officer) |
| | |
Date: August 8,November 7, 2008 | By: | /s/Ronald G. DeVos |
| | Ronald G. DeVos |
| | Vice President - Finance |
| | and Chief Financial Officer |
| | (Principal (Principal Financial and Accounting Officer) |
Exhibit Index
3.1 | | Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-1 No. 33- 56976.33-56976.) |
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3.2 | | Amendment to the Certificate of Incorporation, filed December 15, 1992. (Incorporated by reference to Exhibit 3.2 to Registration Statement on Form S-1 No. 33-56976.) |
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3.3 | | By-Laws, as amended. (Incorporated by reference to Exhibit 3.3 to Form 10-K for the fiscal year ended March 27, 2005.) |
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4.1 | | Specimen Stock Certificate. (Incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-1 No. 33-56976.) |
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4.2 | | Form of Rights Certificate. (Incorporated by reference to Exhibit A to Exhibit 4.2 to Form 8-K dated June 6, 2008.) |
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4.3 | | Rights Agreement dated as of June 4, 2008 between Nathan’s Famous, Inc. and American Stock Transfer and Trust Company. (Incorporated by reference to Exhibit 4.2 to Form 8-K dated June 6, 2008.) |
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10.1 | | *Settlement Agreement and Release between Miami Subs Capital Partners I, Inc. and Nathan’s Famous, Inc. |
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10.2 | | *Amended and Restated Promissory Note of Miami Subs Capital Partners I, Inc. |
| | |
31.1 | | *Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 | | *Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 | | *Certification by Eric Gatoff, CEO, Nathan’s Famous, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 | | *Certification by Ronald G. DeVos, CFO, Nathan’s Famous, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
| | *Filed herewith. |
*Filed herewith.