Nathan's Famous Inc.
Annual Report 2004

Plain-text annual report

2 0 0 4 A N N U A L R E P O R T Profile Nathan’s began as a nickel hot dog stand in Coney Island in 1916 and has become a much-loved “New York institution” now available throughout the United States and overseas. Through our innovative points-of-distribution strategies, Nathan’s products are marketed within our restaurants and throughout a wide spectrum of other foodservice and retail environments. Our Branded Product Program provides for the sale of Nathan’s signature products in over 3,300 foodservice locations. Further, Nathan’s hot dogs are now featured in over 6,000 supermarkets and club stores throughout the United States. Continued market penetration of our highly recognized and valued brands and products through a wide variety of distribution channels, continues to provide new and exciting growth opportunities for our Company. Financial Highlights (dollars in thousands, except per share amounts) Selected Consolidated Financial Data: Revenues from continuing operations Income (loss) from continuing operations Income (loss) from discontinued operations Cumulative effect of accounting change Net earnings (loss)(2) Basic earnings (loss) per share(2) Income (loss) from continuing operations Income (loss) from discontinued operations Cumulative effect of accounting change Basic earnings (loss) per share(2) Diluted earnings (loss) per share(2) Income (loss) from continuing operations Income (loss) from discontinued operations Cumulative effect of accounting change Diluted earnings (loss) per share(2) Weighted-average number of common shares outstanding Basic Diluted(3) Total assets Stockholders’ equity Fiscal Year 2004 2003 2002(1) $ 30,679 $ 1,894 $ 0 0 $ $ 1,894 $ 33,772 $ (1,506) $ (124) $ (12,338) $ (13,968) $ 39,475 $ 1,392 $ (143) 0 $ $ 1,249 $ $ $ $ $ $ $ $ 0.36 0.00 0.00 0.36 0.33 0.00 0.00 0.33 $ $ $ $ $ $ $ $ (0.25) (0.03) (2.06) (2.34) (0.25) (0.03) (2.06) (2.34) $ $ $ $ $ $ $ $ 0.20 (0.02) 0.00 0.18 0.20 (0.02) 0.00 0.18 5,306 5,678 $ 27,584 $ 17,352 5,976 5,976 $ 25,886 $ 16,383 7,048 7,083 $ 48,745 $ 36,145 (1) Our fiscal year ends on the last Sunday in March which results in a 52- or 53-week year. Fiscal 2002 was a 53-week year. (2) In Fiscal 2003, provisions, net of income taxes, of $14.2 million or $2.37 per share were recorded associated with asset impairments and vacant properties. (3) Common stock equivalents have been excluded in Fiscal 2003, due to the net loss, as the impact of their inclusion would have been anti-dilutive. President’s Letter Fiscal 2004 has been a year accentuated by both enhanced profitability and overall advancement of our business. F I N A N C I A L R E S U L T S Net income for the fifty-two weeks ended March 28, 2004 was $1,894,000 or $0.36 per basic share as compared to a net loss of $13,968,000 or $2.34 per basic share for the fifty-two weeks ended March 30, 2003. Earnings from continuing operations were $1,894,000 as compared to a loss from continuing operations of $1,506,000 for the fifty-two weeks ended March 30, 2003. As of June 27, 2004, we repurchased 851,301 shares of common stock pursuant to our share repurchase program adopted on October 7, 2002 to repurchase up to an additional one million shares of common stock. These purchases are in addition to the previously completed repurchase of one million shares of common stock pursuant to our share repurchase program adopted on September 14, 2001. R E S T A U R A N T O P E R A T I O N S During Fiscal 2004, thirty-four new restaurants opened, all of which were franchised, representing a substantial increase in restaurant development over the prior year. In total, franchise royalties increased by $483,000 or 9.0% in Fiscal 2004 compared to Fiscal 2003. At March 29, 2004, we operated five fewer Company-owned restaurants compared to the prior year as a result of our franchising or entering into management agreements for these five restaurants. The financial impact associated with our reduction in Company-owned restaurants lowered restaurant sales by $5,323,000 and improved restaurant profits by $43,000 versus Fiscal 2003. Further, the decrease in Company-owned restaurant operations enabled us to implement a manpower reduction plan, which was the primary reason for reductions in realized corporate expenses. In total, corporate general and admin- istrative expenses were reduced by $1,081,000 or 12.6% in Fiscal 2004 compared to the prior year. Internationally, in Fiscal 2004, we signed a master franchise agreement for the development of Nathan’s in Japan. On December 18, 2003, the first Nathan’s restaurant opened in Tokyo. We expect to have an additional three Nathan’s restaurants operating in Japan by the end of September, 2004. Also, during Fiscal 2004, we entered into a master franchise agreement for the development of Nathan’s in Kuwait and began to have our hot dogs sold on an American military base there. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page one Brands You Can Trust! T H E B R A N D E D - P R O D U C T P R O G R A M Fiscal 2004 marked the sixth year of our branded product program, where we feature the sale of Nathan’s hot dogs to the foodservice industry. During each year of the program, we have realized sales increases compared to the prior year. Sales increased by 20.5% to $7,651,000 in Fiscal 2004 compared to Fiscal 2003. A unique and special example of the branded-product program has been the recent introduction of a Nathan’s pretzel dog into over five hundred Auntie Anne’s outlets. R E T A I L L I C E N S I N G License royalties were $2,970,000 in Fiscal 2004 as compared to $2,585,000 in Fiscal 2003. In addi- tion to Nathan’s signature food products, last year a Nathan’s griddle was marketed through infomercials and by retailers during the 2003 holiday season. New products that have been recently or that are expected to soon be introduced at retail include Nathan’s french fries, bratwurst, and breakfast-sausage products, as well as Nathan’s corn dogs. For the first time, last year Nathan’s products were sold through our website and we began a test marketing program for the sale of Nathan’s hot dog products on QVC. Due to the success of that pro- gram, we anticipate our products will continue to be sold on QVC during Fiscal 2005. S T R A T E G I C E X P A N S I O N Long-term profitable growth continues to be the centerpiece of our objectives. We continue to suc- cessfully expand through advances in our branded-marketing approach and points-of-distribution strategy. Due to our retail licensing program, Nathan’s signature products are sold in over 6,000 supermarkets and club stores. In addition, as of March 28, 2004, 345 restaurant outlets and more than 3,300 branded- product points of sale were represented within 44 states, the District of Columbia, and 12 foreign countries featuring the Nathan’s, Miami Subs, and Kenny Rogers Roasters brands. I N C O N C L U S I O N Our focused strategies, creative approaches, ever-expanding opportunities and commitment to quality highlight Nathan’s path towards continued long-term success. We believe significant benefit will be afforded to our consumers, business partners, employees and to you—our shareholders. We are appreciative of your continued support. Howard M. Lorber Chairman and Chief Executive Officer Wayne Norbitz President and Chief Operating Officer 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page two Selected Consolidated Financial Data (in thousands, except per share amounts) Fiscal Years Ended March 28, March 30, March 31, March 25, March 26, 2002(1) 2000(2) 2004 2003 2001 Statement of Operations Data: Revenues: Sales Franchise fees and royalties License royalties, investment and other income Total revenues Costs and Expenses: Cost of sales Restaurant operating expenses Depreciation and amortization Amortization of intangible assets General and administrative expenses Interest expense Impairment of long-lived assets Impairment of notes receivable Other expense (income) Total costs and expenses Income (loss) from continuing operations before income taxes Provision (benefit) for income taxes Income (loss) from continuing operations Discontinued Operations: (Loss) income from discontinued operations before income taxes (Benefit) provision for income taxes (Loss) income from discontinued operations Income (loss) before cumulative effect of accounting change Cumulative effect of change in accounting principle, net of tax benefit of $854 in 2003 Net income (loss) Basic Income (Loss) Per Share: Income (loss) from continuing operations Income (loss) from discontinued operations Cumulative effect of change in accounting principle Net income (loss) Diluted Income (Loss) Per Share: Income (loss) from continuing operations Income (loss) from discontinued operations Cumulative effect of change in accounting principle Net income (loss) Dividends Weighted-average shares used in computing net income (loss) per share Basic Diluted(3) $20,765 6,286 3,628 30,679 $ 24,762 5,977 3,033 33,772 $27,425 7,944 4,106 39,475 $29,781 8,814 3,561 42,156 $25,511 5,906 2,343 33,760 14,775 3,806 971 261 7,519 75 25 208 45 27,685 2,994 1,100 1,894 — — — 16,592 5,621 1,314 278 8,600 132 1,367 1,425 232 35,561 (1,789) (283) (1,506) (206) (82) (124) 18,269 6,559 1,395 888 9,292 256 392 185 (210) 37,026 2,449 1,057 1,392 (238) (95) (143) 19,146 7,621 1,535 839 8,978 310 127 151 462 39,169 2,987 1,402 1,585 35 14 21 16,370 7,231 1,142 716 8,222 198 465 840 427 35,611 (1,851) (382) (1,469) 331 132 199 1,894 (1,630) 1,249 1,606 (1,270) — (12,338) — — — $ 1,894 $(13,968) $ 1,249 $ 1,606 $ (1,270) $ 0.36 — — $ 0.36 $ 0.33 — — $ 0.33 $ $ $ (0.25) (0.03) (2.06) (2.34) (0.25) (0.03) (2.06) $ 0.20 (0.02) — $ 0.18 $ 0.20 (0.02) — $ (2.34) $ 0.18 $ 0.23 — — $ 0.23 $ 0.23 — — $ 0.23 — — — — 5,306 5,678 5,976 5,976 7,048 7,083 7,059 7,098 $ (0.25) 0.03 — $ (0.22) $ (0.25) 0.03 — $ (0.22) — 5,881 5,881 (Continued) 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page three Selected Consolidated Financial Data (in thousands, except per share amounts) (continued) Fiscal Years Ended March 28, March 30, March 31, March 25, March 26, 2002(1) 2000(2) 2004 2001 2003 Balance Sheet Data at End of Fiscal Year: Working capital (deficit) Total assets Long term debt, net of current maturities Stockholders’ equity Selected Restaurant Operating Data: Company-owned Restaurant Sales(4) Number of Units Open at End of Fiscal Year: Company-owned Franchised $ 9,185 27,584 866 $17,352 $ 5,935 25,886 1,053 $16,383 $ 9,565 48,745 1,220 $36,145 $ 5,210 51,826 1,789 $35,031 $ (322) 48,583 3,131 $33,347 $12,780 $21,955 $27,484 $30,946 $27,478 7 338 12 343 22 364 25 386 32 415 Notes to Selected Financial Data (1) Our fiscal year ends on the last Sunday in March which results in a 52- or 53-week year. Fiscal 2002 was a 53-week year. (2) On April 1, 1999, Nathan’s acquired the intellectual property of Roasters Corp. and Roasters Franchise Corp. On September 30, 1999, Nathan’s completed the acquisition of Miami Subs Corp. by acquiring the remaining 70% of the outstanding common stock Nathan’s did not already own. (3) Common stock equivalents have been excluded from the computation for the years ended March 30, 2003 and March 26, 2000 as, due to the net loss, the impact of their inclusion would have been anti-dilutive. (4) Company-owned restaurant sales represent sales from restaurants presented as continuing operations and discontinued operations. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page four Management’s Discussion and Analysis of Financial Condition and Results of Operations Introduction As used in this Report, the terms “we,” “us,” “our” and “Nathan’s” mean Nathan’s Famous, Inc. and its subsidiaries (unless the context indicates a different meaning). During the fiscal year ended March 26, 2000, we completed two acquisitions that provided us with two highly recognized brands. On April 1, 1999, we became the franchisor of the Kenny Rogers Roasters restaurant system by acquiring the intellectual property rights, including trademarks, recipes and franchise agreements of Roasters Corp. and Roasters Franchise Corp. On September 30, 1999, we acquired the remaining 70% of the outstanding common stock of Miami Subs Corporation we did not already own. Our rev- enues are generated primarily from operating Company-owned restaurants and franchising the Nathan’s, Miami Subs and Kenny Rogers restaurant concepts, selling products under Nathan’s Branded Product Program and licensing agreements for the sale of Nathan’s products within supermarkets. The Branded Product Program enables foodservice operators to offer 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 Nathan’s trademark with respect to the sale of hot dogs and certain other proprietary food items and paper goods. In addition to plans for expansion through franchising and our Branded Product Program, Nathan’s continues to co-brand within its existing restaurant system. Currently, the Arthur Treacher’s brand is being sold within 118 Nathan’s, Kenny Rogers Roasters and Miami Subs restaurants, the Nathan’s brand is included on the menu of 71 Miami Subs and Kenny Rogers restaurants, while the Kenny Rogers Roasters brand is being sold within 93 Miami Subs and Nathan’s restaurants. At March 31, 2002, Nathan’s owned 22 Company-operated restaurants. During the fiscal year ended March 30, 2003, Nathan’s abandoned eight Company-operated restaurants pursuant to early lease terminations which are presented as discontinued operations pursuant to SFAS No. 144 in the accompanying financial statements. Nathan’s franchised two Company-operated restaurants during the fiscal year ended March 30, 2003. During the fiscal year ended March 28, 2004, Nathan’s has franchised three Company-operated restaurants and entered into two management agreements with fran- chisees to operate two Company-operated restaurants. These seven restaurants are presented as continuing operations in the accompany- ing financial statements. At March 28, 2004, our combined system consisted of 338 fran- chised or licensed units, seven Company-owned units and over 3,300 Nathan’s Branded Product points of sale that feature Nathan’s world famous all-beef hot dogs, located in 44 states, the District of Columbia and 12 foreign countries. At March 28, 2004, our Company-owned restaurant system included seven Nathan’s units, as compared to eight Nathan’s units and four Miami Subs units at March 30, 2003. Critical Accounting Policies and Estimates Our consolidated financial statements and the notes to our con- solidated 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 liabili- ties and disclosures of contingent assets and liabilities. We believe the following critical accounting policies involve additional management judgement due to the sensitivity of the methods, assumptions and esti- mates necessary in determining the related asset and liability amounts. Impairment of Goodwill and Other Intangible Assets Statement of Financial Accounting Standards No. 142, “Good- will and Other Intangible Assets,” (“SFAS No. 142”) requires that goodwill and intangible assets with indefinite lives will no longer be amortized but will be tested annually (or more frequently if impairment indicators arise) for impairment. The most significant assumptions which are used in this test are estimates of future cash f lows. We typically use the same assumptions for this test as we use in the development of our business plans. If these assumptions differ sig- nificantly from actual results, additional impairment expenses may be required. In the first quarter of fiscal 2003, Nathan’s adopted SFAS No. 142. In connection with the implementation of this new standard in fiscal 2003, Goodwill, Trademarks, Trade Names and Recipes were deemed to be impaired and their carrying value was written down by $13,192,000, or $12,338,000, net of income tax benefit of $854,000. Impairment of Long-Lived Assets Statement of Financial Accounting Standards No. 144, “Account- ing for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”) requires management judgements regarding the future operating and disposition plans for underperforming assets, and esti- mates of expected realizable values for assets to be sold. The applica- tion of SFAS No. 144 has affected the amounts and timing of charges to operating results in recent years. We evaluate possible impairment of each restaurant individually, and record an impairment charge whenever we determine that impairment factors exist. We consider a history of restaurant operating losses to be the primary indicator of potential impairment of a restaurant’s carrying value. During the fifty-two week period ended March 28, 2004, we identified one restaurant that had been impaired and recorded impairment charges of approximately $25,000. During the fifty-two weeks ended March 30, 2003, we identified seven restaurants that had been impaired and recorded impairment charges of approximately $1,367,000. Impairment of Notes Receivable Statement of Financial Accounting Standards No. 114, “Account- ing by Creditors for Impairment of a Loan,” requires management judgements regarding the future collectibility of notes receivable and the underlying fair market value of collateral. We consider the fol- lowing factors when evaluating a note for impairment: a) indications that the borrower is experiencing business problems, such as operating losses, marginal working capital, inadequate cash f low or business interruptions; b) whether the loan is secured by collateral that is not readily marketable; and/or c) whether the collateral is susceptible to deterioration in realizable value. When determining possible impair- ment, we also assess our future intention to extend certain leases 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page f ive beyond the minimum lease term and the debtor’s ability to meet its obligation over the projected term. We have identified certain notes receivable that have been impaired and recorded impairment charges of approximately $208,000 relating to two notes and $1,425,000 relating to nine notes during the fifty-two weeks ended March 28, 2004 and March 30, 2003, respectively. Revenue Recognition Sales by Company-owned restaurants, which are typically paid in cash by the customer, are recognized upon the performance of services. In connection with its franchising operations, the Company receives initial franchise fees, development fees, royalties, contribu- tions to marketing funds, 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 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 per- formed or satisfied, which generally occurs when the franchised restaurant commences operations. 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 recognized as restaurants in the develop- ment area commence operations on a pro rata basis to the minimum number of restaurants required to be open, or at the time the devel- opment agreement is effectively canceled. Nathan’s recognizes franchise royalties 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 fran- chisee. Revenue from sub-leasing properties to franchisees is recog- nized 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 accompanying consolidated statements of operations. Nathan’s recognizes revenue from the Branded Product Program when it is determined by the manufacturer that the products have been delivered via third party common carrier to Nathan’s customers. An accrual for the cost of the product to the Company is recorded simultaneously with the revenue. In the normal course of business, we extend credit to fran- chisees for the payment of ongoing royalties and to trade customers of our Branded Product Program. Notes and accounts receivable, 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 eco- nomic conditions. In the event that the collectibility of a receivable is doubtful, the associated revenue is not recorded until the facts and circumstances change in accordance with Staff Accounting Bulletin SAB No. 101, “Revenue Recognition.” Self-insurance Liabilities We are self-insured for portions of our general liability coverage. As part of our risk management strategy, our insurance programs include deductibles for each incident and in the aggregate for each policy year. As such, we accrue estimates of our ultimate self-insurance costs throughout the policy year. These estimates have been devel- oped based upon our historical trends, however, the final cost of many of these claims may not be known for five years or longer. Accordingly, our annual self-insurance costs may be subject to adjust- ment from previous estimates as facts and circumstances change. During the fifty-two weeks ended March 28, 2004, we reversed approximately $268,000 of previously recorded insurance accruals for items that have been concluded without further payment. Also, during the fifty-two weeks ended March 30, 2003, we completed an evalu- ation of the outstanding claims and reserves in conjunction with our external risk manager and reversed $196,000 of previously recorded self-insurance accruals for those claims on which our exposure had been settled. Results of Operations Fiscal Year Ended March 28, 2004 Compared to Fiscal Year Ended March 30, 2003 Revenues from Continuing Operations Total sales from continuing operations decreased by 16.1% or $3,997,000 to $20,765,000 for the fifty-two weeks ended March 28, 2004 (“fiscal 2004”) as compared to $24,762,000 for the fifty-two weeks ended March 30, 2003 (“fiscal 2003”). Company-owned restaurant sales decreased 30.1% or $5,631,000 to $12,780,000 from $18,411,000 primarily due to the operation of seven fewer Company- owned restaurants as compared to the prior fiscal year. The reduction in Company-owned restaurants is the result of our franchising or entering into management agreements for six restaurants and selling one restaurant. The financial impact associated with these seven restaurants lowered restaurant sales by $5,323,000 and improved restaurant operating profits by $43,000 versus fiscal 2003. Sales decreased 2.1% at our comparable Company-owned restaurants (con- sisting of seven Nathan’s restaurants, including one seasonal restau- rant). Sales from the Branded Product Program increased by 20.5% to $7,651,000 in fiscal 2004 as compared to sales of $6,351,000 in fiscal 2003. This increase was due to higher sales volume and the impact of the price increases implemented during the second half of the fiscal year. Additionally, during fiscal 2004, Nathan’s realized sales of $334,000 in connection with a test marketing program with QVC. Franchise fees and royalties increased by $309,000 or 5.2% to $6,286,000 in fiscal 2004 compared to $5,977,000 in fiscal 2003. Franchise royalties increased by $483,000 or 9.0% to $5,835,000 in fiscal 2004 as compared to $5,352,000 in fiscal 2003. This increase is due primarily to the royalties earned from the new units that were opened or franchised during fiscal 2004 and the full year earnings from units opened during fiscal 2003, all of which have been recog- nized as income. Additionally, we realized an improvement in the 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page six amount of unrealizable royalties which were not previously recog- nized as revenues, primarily in the South Florida marketplace for the Miami Subs brand, as compared to fiscal 2003. Domestic franchise restaurant sales were virtually unchanged, decreasing by 0.3% to $161,332,000 in fiscal 2004 as compared to $161,740,000 in fiscal 2003. At March 28, 2004, 338 franchised or licensed restaurants were operating as compared to 343 franchised or licensed restaurants at March 30, 2003. At March 28, 2004, royalties from 35 domestic franchised locations have been deemed unrealizable as compared to 59 domestic franchised locations at March 30, 2003. The majority of this decline is attributable to the number of unsuccessful units that have closed. Franchise fee income derived from new openings and our co-branding activities was $428,000 in fiscal 2004 as compared to $418,000 in fiscal 2003. During fiscal 2004, 40 franchised units including the franchising of three Company-owned restaurants and the conversion of three Company-owned restaurants into manage- ment agreements were opened as compared to 24 franchise openings during fiscal 2003. During fiscal 2003, Nathan’s also earned $207,000 in connection with the termination of two Master Development Agreements due to breaches by the franchisees. License royalties were $2,970,000 in fiscal 2004 as compared to $2,585,000 in fiscal 2003. The majority of this increase is attributable to revenues from new license agreements for the sale of Nathan’s products, primarily the Nathan’s “Griddle” which was marketed via “infomercial” throughout the year and by retailers during the Christmas 2003 season. Interest income was $199,000 in fiscal 2004 versus $292,000 in fiscal 2003 due primarily to lower interest income earned on notes receivable which have been impaired during the fiscal years ended March 28, 2004 and March 30, 2003. Investment and other income increased by $303,000 to $459,000 in fiscal 2004 versus $156,000 in fiscal 2003. During fiscal 2004, Nathan’s recognized net gains of $206,000 primarily in connection with the sale of two Company-owned restaurants to franchisees and additional miscellaneous revenue of $31,000 which was partially off- set by an increased subleasing loss of $69,000. In fiscal 2003, Nathan’s realized a gain of $135,000 in connection with the early termination of a Branded Product Program sales agreement. During fiscal 2003, Nathan’s investment loss of approximately $244,000 was primarily attributable to our investment in limited partnership, which was liquidated during fiscal 2003. Costs and Expenses from Continuing Operations Cost of sales from continuing operations decreased by $1,817,000 to $14,775,000 in fiscal 2004 from $16,592,000 in fiscal 2003. During fiscal 2004, restaurant cost of sales were lower than fis- cal 2003 by approximately $3,605,000. Cost of sales were lower by approximately $3,520,000 as a result of operating fewer Company- owned restaurants during fiscal 2004. The cost of restaurant sales at our comparable units as a percentage of restaurant sales was 61.2% in fiscal 2004 as compared to 60.2% in fiscal 2003 due primarily to higher labor and related costs. Higher costs of approximately $1,480,000 were incurred primarily in connection with the growth of our Branded Product Program and higher commodity costs dur- ing fiscal 2004. Commodity costs of our beef products were higher during fiscal 2004 than fiscal 2003. This increase has been caused by reductions in the supply of beef primarily due to: 1) the prohibition since May 2003 on importing of Canadian beef livestock into the U.S., 2) the decrease in imports of Australian beef due to local drought conditions and 3) the export of U.S. beef had increased through December 23, 2003 when the first case of bovine spongi- form encephalopathy, otherwise known as BSE in the United States was reported. Although the export of beef by the United States was significantly reduced as a result of this finding, Nathan’s had not real- ized a reduction in the cost of beef during the fourth quarter of fiscal 2004. In response to these higher costs, Nathan’s had increased menu prices in its Company-operated restaurants by approximately 2.0% and increased prices within its Branded Product Program to offset some of the margin pressure. Additionally, Nathan’s also incurred cost of sales of $327,000 in fiscal 2004 in connection with the QVC test marketing program. Restaurant operating expenses decreased by $1,815,000 to $3,806,000 in fiscal 2004 from $5,621,000 in fiscal 2003. Restaurant operating costs were lower in f iscal 2004 by approximately $1,847,000, as compared to fiscal 2003 as a result of operating seven fewer restaurants. Depreciation and amortization decreased by $343,000 to $971,000 in fiscal 2004 from $1,314,000 in fiscal 2003. Depreciation expense was lower by approximately $255,000 as a result of operating fewer Company-owned restaurants and the effect of the impairment charges on long-lived assets recorded during fiscal 2003. Amortization of intangibles was $261,000 in fiscal 2004 as com- pared to $278,000 in fiscal 2003. General and administrative expenses decreased by $1,081,000 to $7,519,000 in fiscal 2004 as compared to $8,600,000 in fiscal 2003. The decrease in general and administrative expenses was due primarily to lower personnel and incentive compensation expense of approxi- mately $411,000 resulting from the implementation of an expense reduction plan (primarily in connection with the reduction in the number of Company-operated restaurants), lower professional fees of $247,000, lower bad debts expense of approximately $99,000, lower un-leased property expense of approximately $86,000 and the expense reversal from the settlement of a disputed claim of approxi- mately $50,000. Interest expense was $75,000 during fiscal 2004 as compared to $132,000 during fiscal 2003. The reduction in interest expense relates primarily to the repayment of outstanding loans between the two periods. Impairment charge on notes receivable of $208,000 during fiscal 2004 represents the write-down of two non-performing notes receiv- able and $1,425,000 during fiscal 2003 represents the write-down relating to nine notes receivable. Impairment charge on long-lived assets of $25,000 during fiscal 2004 represents the write-down of one restaurant scheduled to close in September 2004 due to its lease expiration and $1,367,000 during 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page seven fiscal 2003 representing the write-down relating to seven under- performing restaurants. Other expense of $45,000 in fiscal 2004 represents lease reserves relating to two vacant properties. Other expense of $232,000 in fiscal 2003 represents lease reserves relating to four vacant properties. Provision (Benefit) for Income Taxes from Continuing Operations In fiscal 2004, the income tax provision on income from con- tinuing operations was $1,100,000 or 36.7% of income from contin- uing operations as compared to the income tax (benefit) from continuing operations of ($283,000) or 15.8% of loss from continuing operations before income taxes in fiscal 2003. The effective income tax rate was positively impacted in fiscal 2004 as a result of a tax refund received of $62,000 as a result of filing an amended fiscal 2002 tax return. The effective income tax rate was lower in the fiscal 2003 period due in part to the adoption of SFAS No. 142 which requires that goodwill no longer be amortized. Such goodwill amor- tization was not tax deductible by Nathan’s which increased the effective tax rate in prior years. Discontinued Operations No restaurants have been accounted for as discontinued opera- tions during fiscal 2004. Fiscal 2003 included the results of operations of eight Company-owned restaurants, all of which were abandoned by March 30, 2003, including seven which were abandoned in con- nection with the Home Depot early lease terminations. Revenues generated by these eight restaurants were $3,543,000 during fiscal 2003. Loss before income taxes from these restaurants was $206,000 during fiscal 2003. The fiscal 2003 loss before tax included $428,000 of additional depreciation expense due to a change in the estimated useful lives of the restaurants operating within Home Depot Improvement Centers for which Nathan’s received early lease termi- nation notifications during the second quarter of fiscal 2003. Cumulative Effect of Change in Accounting Principle In the first quarter fiscal 2003, we adopted SFAS No. 142, “Accounting for Goodwill and Other Intangibles.” In connection with the implementation of this new standard, Goodwill, Trademarks, Trade Names and Recipes were deemed to be impaired and their carrying value was written down by $13,192,000, or $12,338,000, net of tax. Fiscal Year Ended March 30, 2003 Compared to Fiscal Year Ended March 31, 2002 Revenues from Continuing Operations Total sales from continuing operations decreased by 9.7% or $2,663,000 to $24,762,000 for the fifty-two weeks ended March 30, 2003 (“fiscal 2003 period”) as compared to $27,425,000 for the fifty- three weeks ended March 31, 2002 (“fiscal 2002 period”). Sales from the Branded Product Program increased by 32.4% to $6,351,000 for the fiscal 2003 period as compared to sales of $4,797,000 in the fiscal 2002 period. Company-owned restaurant sales decreased 18.6% or $4,217,000 to $18,411,000 from $22,628,000 primarily due to the operation of five fewer Company-owned stores as compared to the prior fiscal year and an overall 5.3% sales decrease at our comparable restaurants (consisting of eight Nathan’s and four Miami Subs restau- rants). The reduction in Company-owned stores is the result of our franchising three restaurants and selling two restaurants, one of which was to the State of Florida pursuant to an order of condemnation. The financial impact associated with these five restaurants lowered restaurant sales by $3,294,000 and improved restaurant operating profits by $52,000 versus the fiscal 2002 period. During the fiscal 2002 period, approximately $341,000 in restaurant sales were gener- ated during the additional week of operations. Franchise fees and royalties decreased by 24.8% or $1,967,000 to $5,977,000 in the fiscal 2003 period compared to $7,944,000 in the fiscal 2002 period. Franchise royalties decreased by $1,409,000 or 20.8% to $5,352,000 in the fiscal 2003 period as compared to $6,761,000 in the fiscal 2002 period. The majority of this decline is due to the decrease in the amount of franchise sales, primarily within the South Florida marketplace for the Miami Subs brand, causing an increase in the amount of royalties deemed unrealizable during the fiscal 2003 period as compared to the fiscal 2002 period. Royalty income was not recorded from 59 domestic franchised locations dur- ing the fiscal 2003 period as compared to 48 domestic franchised locations during the fiscal 2002 period as a result of determining that collectibility of the royalties was not reasonably assured. Domestic franchise restaurant sales decreased by 12.8% to $161,740,000 in the fiscal 2003 period as compared to $185,389,000 in the fiscal 2002 period. At March 30, 2003, 343 franchised or licensed restaurants were operating as compared to 364 franchised or licensed restaurants at March 31, 2002. Franchise fee income derived from new open- ings, co-branding activities and forfeitures was $625,000 in the fiscal 2003 period as compared to $1,183,000 in the fiscal 2002 period. This decrease was attributable to lower franchise fees earned of $247,000, the reduction in co-branding fees earned of $210,000 and lower forfeitures of $101,000 between the two periods. Revenues from new unit openings were lower during the fiscal 2003 period as compared to the fiscal 2002 period although 24 new franchised restaurants were opened, including our first Nathan’s unit in China and nine Kenny Rogers Roasters units in foreign countries, as com- pared to 18 new franchised restaurants during the fiscal 2002 period. Franchise fees attributable to new Kenny Rogers Roasters restaurants is recognized upon payment by the franchisee, which payments have not been received. During the fiscal 2002 period, the one-time co- branding initiative was substantially concluded. During the fiscal 2003 period, we earned $207,000 in connection with the termina- tion of two Master Development Agreements in accordance with their terms due to non-compliance by the franchisees as compared to $308,000 during the fiscal 2002 period in connection with forfeited area development fees. License royalties were $2,585,000 in the fiscal 2003 period as compared to $2,038,000 in the fiscal 2002 period. This increase is attributable to higher royalties earned from sales made by SFG, Inc., Nathan’s licensee for the sale of Nathan’s frankfurters within super- markets and club stores, the manufacture of certain proprietary spices 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page eight and seasonings, the sale of condiments sold under the Nathan’s brand and royalties earned under a new license agreement in connection with the Branded Product Program. Interest income decreased by $208,000 to $292,000 in the fiscal 2003 period versus $500,000 in the fiscal 2002 period due to lower interest income on its investments in marketable securities and its notes receivable. Investment and other income decreased by $1,412,000 to $156,000 in the fiscal 2003 period versus $1,568,000 in the fiscal 2002 period. During the fiscal 2003 period, Nathan’s investment loss was approximately $206,000 greater than in the fiscal 2002 period due primarily to differences in performance of the financial markets during the time that Nathan’s maintained its investments in “trading securities,” which “trading securities” were substantially liquidated in October 2002, as compared to being held for the entire fiscal 2002 period. Nathan’s loss from sub-leasing was approximately $28,000 more than in the fiscal 2002 period. In the fiscal 2003 period, Nathan’s realized a gain of $135,000 in connection with the early ter- mination of a Branded Product Program sales agreement. During the fiscal 2003 period, Nathan’s earned approximately $126,000 less mis- cellaneous income than in the fiscal 2002 period principally in con- nection with its ice cream sales. During the fiscal 2002 period, Nathan’s recognized net gains of $1,226,000 which included $850,000 from the successful appeal of a condemnation award from the State of Florida and gains primarily in connection with the sale of two Company-owned restaurants and one non-restaurant property. Costs and Expenses from Continuing Operations Cost of sales from continuing operations decreased by $1,677,000 to $16,592,000 in the fiscal 2003 period from $18,269,000 in the fis- cal 2002 period. During the fiscal 2003 period, restaurant cost of sales were lower than the fiscal 2002 period by approximately $2,661,000. Cost of sales were lower by approximately $2,237,000 as a result of operating fewer Company-owned restaurants. The cost of restaurant sales at our comparable units as a percentage of restaurant sales was 62.6% in the fiscal 2003 period as compared to 61.5% in the fiscal 2002 period due primarily to higher labor costs. Higher prod- uct and other direct costs of approximately $984,000 were incurred in connection with the growth of our Branded Product Program which was partially offset by lower commodity costs during the fiscal 2003 period. During the fiscal 2003 period, commodity prices of our primary meat products were in line with historical norms as com- pared to being at their highest levels in recent years through most of the twenty-six weeks ended September 23, 2001. Restaurant operating expenses from continuing operations decreased by $938,000 to $5,621,000 in the fiscal 2003 period from $6,559,000 in the fiscal 2002 period. Restaurant operating costs were lower in the fiscal 2003 period by approximately $1,105,000, as compared to the fiscal 2002 period as a result of operating fewer restaurants. The reduction in restaurant operating expenses from operating fewer restaurants was partially offset by higher occupancy and current insurance costs net of lower marketing and utility costs during the fiscal 2003 period. Depreciation and amortization from continuing operations decreased by $81,000 to $1,314,000 in the fiscal 2003 period from $1,395,000 in the fiscal 2002 period due to our additional capital spending. Amortization of intangibles decreased by $610,000 to $278,000 in the fiscal 2003 period from $888,000 in the fiscal 2002 period. Amortization of intangibles decreased as a result of the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets” in the first quarter of fiscal 2003. Pursuant to SFAS No. 142, we have dis- continued the amortization of Goodwill, Trademarks, Trade Names and Recipes. General and administrative expenses decreased by $692,000 to $8,600,000 in the fiscal 2003 period as compared to $9,292,000 in the fiscal 2002 period. The decrease in general and administrative expenses was due primarily to lower litigation expense of approxi- mately $450,000, lower bad debts expense of approximately $185,000, lower compensation and related expenses of approximately $106,000 and lower travel expenses of $106,000 which were partly offset by higher insurance costs of approximately $172,000. Interest expense was $132,000 during the fiscal 2003 period as compared to $256,000 during the fiscal 2002 period. The reduction in interest expense relates primarily to the repayment of outstanding bank debt between the two periods. Impairment charge on long-lived assets of $1,367,000 during the fiscal 2003 period represents the write-down relating to seven underperforming stores, three of which are expected to continue operating. Impairment charge on notes receivable of $1,425,000 during the fiscal 2003 period relates to the write-down of nine notes receivable. Other expense in the fiscal 2003 period represents lease reserves relating to four vacant properties. Other income of $210,000 in the fiscal 2002 period represents the reversal of a previously recorded litigation provision for an award that was settled, upon appeal, in our favor. (Benefit) Provision for Income Taxes from Continuing Operations In the fiscal 2003 period, the income tax benefit from continuing operations was $283,000 or 15.8% of loss from continuing operations before income taxes as compared to a provision for income taxes of $1,057,000 or 43.2% of income from continuing operations before income taxes in the fiscal 2002 period. The effective income tax rate was lower in the fiscal 2003 period due in part to the adoption of SFAS No. 142 which requires that goodwill no longer be amortized. Such goodwill amortization was not tax deductible by Nathan’s which increased the effective tax rate in prior years. Discontinued Operations During the fiscal 2003 period, discontinued operations included eight Company-owned restaurants, all of which were abandoned, including seven which were abandoned in connection with the Home Depot early lease terminations. Revenues generated by these eight restaurants were $3,543,000 during the fiscal 2003 period as compared to $4,857,000 during the fiscal 2002 period. Losses before income taxes from these restaurants were $206,000 during the fiscal 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page nine 2003 period as compared to $238,000 during the fiscal 2002 period. The fiscal 2003 loss before tax included $428,000 of additional depreciation expense due to a change in the estimated useful lives of the restaurants operating within Home Depot Improvement Centers for which Nathan’s received early lease termination notifications dur- ing the second quarter fiscal 2003 period. Cumulative Effect of Change in Accounting Principle In the first quarter fiscal 2003 period, Nathan’s adopted SFAS No. 142, “Goodwill and Other Intangibles.” In connection with the implementation of this new standard, Goodwill, Trademarks, Trade Names and Recipes were deemed to be impaired and their carrying value was written down by $13,192,000, or $12,338,000, net of tax. Off-Balance Sheet Arrangements We are not a party to any off-balance sheet arrangements. Liquidity and Capital Resources Cash and cash equivalents at March 28, 2004 aggregated $3,449,000, increasing by $2,034,000 during fiscal 2004. At March 28, 2004, marketable securities increased by $2,854,000 from March 30, 2003 to $7,477,000 and net working capital increased to $9,185,000 from $5,935,000 at March 30, 2003. Cash provided by operations was $5,276,000 in fiscal 2004 as compared to $2,296,000 in fiscal 2003. The fiscal 2004 increase resulted primarily from higher operating prof its. Additionally, Nathan’s applied its expected Net Operating Loss from the fiscal year ended March 2003 against its estimated tax payments for its fiscal year ending March 28, 2004 reducing current year Federal tax pay- ments by approximately $668,000. During fiscal 2004, Nathan’s received repayments on notes receivable of $797,000 and proceeds from the sale of three restaurants and other fixed assets of $489,000. We incurred capital expenditures of $449,000 during fiscal 2004. Nathan’s continued to repurchase shares of common stock pur- suant to its Stock Repurchase Program having repurchased 210,063 shares of common stock at a total cost of $928,000. We also repaid notes payable and obligations under capital leases in the amount of $187,000 during fiscal 2004. On September 14, 2001, Nathan’s was authorized to purchase up to one million shares of its common stock. Pursuant to our stock repurchase program, we repurchased one million shares of common stock in open market transactions and a private transaction at a total cost of $3,670,000 through the quarter ended September 29, 2002. On October 7, 2002, Nathan’s was authorized to purchase up to one million additional shares of its common stock. Through March 28, 2004, Nathan’s purchased 851,301 shares of common stock at a cost of approximately $3,251,000. Nathan’s has not purchased any addi- tional shares of common stock after March 28, 2004. To date, Nathan’s has purchased a total of 1,851,301 shares of common stock at a cost of approximately $6,921,000. Nathan’s expects to make additional purchases of stock from time to time, depending on market conditions, in open market or in privately negotiated transactions, at prices deemed appropriate by management. There is no set time limit on the purchases. Nathan’s expects to fund these stock repur- chases from its operating cash f low. We expect that we will make additional investments in certain existing restaurants and to support the growth of the Branded Product Program in the future and to fund those investments from our operating cash f low. We may further incur additional capital expenditures in connection with the replacement of the restaurant whose lease will expire in September 2004. In connection with our acquisition of Miami Subs, we deter- mined that up to 18 underperforming restaurants would be closed pursuant to our divestiture plan. We have terminated leases on 17 of those properties and sold the remaining property to a non-franchisee. Since acquiring Miami Subs, we have accrued approximately $1,461,000 and made payments of approximately $1,282,000 for lease obligations and termination costs, as part of the acquisition, for units having total future minimum lease obligations of $8,298,000 that had remaining lease terms of one year up to approximately 17 years. We may incur future cash payments, consisting primarily of future lease payments, including costs and expenses associated with terminating additional leases, that were not part of our divestiture plan. At June 7, 2004, there were 30 properties that we either owned or leased from third parties which we leased or sublet to franchisees, operating managers and non-franchisees. We remain contingently liable for all costs associated with these properties including: rent, property taxes and insurance. Additionally, we guaranteed financing on behalf of certain franchisees with two third-party lenders. Our maximum obligation for loans funded by the lenders as of March 28, 2004 was approximately $566,000. The following schedule represents Nathan’s cash contractual obligations by maturity (in thousands): Cash Contractual Obligations Long-term debt Capital lease obligations Employment agreements Operating leases Gross cash contractual obligations Sublease income Net cash contractual obligations Payments Due by Period 1–3 Years 3–5 Years $ 333 16 — 7,167 7,516 3,885 $ 333 19 — 4,759 5,111 2,682 Less than 1 Year $ 167 6 494 3,871 4,538 2,075 After 5 Years $ 153 12 — 3,643 3,808 2,512 $ Total 986 53 494 19,440 20,973 11,154 $ 9,819 $2,463 $3,631 $2,429 $1,296 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page ten The following schedule represents the expiration of Nathan’s other contractual commitments by maturity (in thousands): Other Contractual Commitments Loan guarantees Total commercial commitments Total Amounts Committed $566 $566 Amount of Commitment Expiration Per Period Less than 1 Year $213 $213 1–3 Years 3–5 Years $347 $347 $6 $6 After 5 Years $— $— Management believes that available cash, marketable investment securities, and internally generated funds should provide sufficient capital to finance our operations for at least the next twelve months. We currently maintain a $5,000,000 uncommitted bank line of credit and have never borrowed any funds under any lines of credit. Seasonality Our business is affected by seasonal f luctuations, the effects of weather and economic conditions. Historically, restaurant sales from Company-owned restaurants, franchised restaurants from which roy- alties are earned and earnings have been highest during our first two fiscal quarters with the fourth fiscal quarter representing the slowest period. This seasonality is primarily attributable to weather condi- tions in our marketplace for our Company-owned Nathan’s stores, which is principally the New York metropolitan area. Miami Subs’ restaurant sales have historically been strongest during the period March through August, which approximates our first and second quarters, as a result of a heavy concentration of restaurants being located in Florida. Notwithstanding the continued growth of our Branded Product Program and the changing composition of our restaurants, we believe that future revenues and profits will continue to be highest during our first two fiscal quarters with the fourth fiscal quarter representing the slowest period. Inf lationary Impact During the past three years, our commodity costs for beef have f luctuated significantly while other costs have remained relatively stable. As such, we believe that general inf lation has not materially impacted earnings during that period of time. However, during the first half of the fiscal 2002 period, commodity prices of our primary beef products reached their highest levels in many years. Throughout fiscal 2003, these costs were in line with historical norms. During fiscal 2004, the price of our beef products has risen dramatically over historical norms and particularly as compared to fiscal 2003. We also experienced increased costs for utilities and insurance during the fiscal 2002, 2003 and 2004 periods. In 2002, various Federal and New York State legislators proposed changes to the minimum wage requirements, however, none of the proposals were enacted. Although we only operate seven Company-owned restaurants, we believe that signifi- cant increases in the minimum wage could have a significant finan- cial impact on our financial results. Prolonged increases in labor, food and other operating expenses could adversely affect our operations and those of the restaurant industry and we might have to reconsider our pricing strategy as a means to offset reduced operating margins. 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 March 28, 2004, Nathan’s cash and cash equivalents aggregated $3,369,000. Earnings on these cash and cash equivalents would increase or decrease by approxi- mately $8,400 per annum for each .25% change in interest rates. Marketable Investment Securities We have invested our marketable investment securities in intermediate term, fixed rate, highly rated and highly liquid instruments. These investments are subject to f luctuations in interest rates. As of March 28, 2004, the market value of Nathan’s marketable investment securities aggregated $7,477,000. Interest income on these marketable investment securities would increase or decrease by approximately $18,700 per annum for each .25% change in interest rates. The following chart presents the hypothetical changes in the fair value of the marketable investment securities held at March 28, 2004 that are sensitive to interest rate f luctuations (in thousands): Municipal notes and bonds Valuation of Securities Given an Interest Rate Decrease of X Basis Points (150BPS) (100BPS) (50BPS) $7,845 $7,716 $7,596 Fair Value $7,477 Valuation of Securities Given an Interest Rate Increase of X Basis Points +50BPS +100BPS +150BPS $7,361 $7,248 $7,138 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page eleven Borrowings The interest rate on our borrowings is generally determined based upon the prime rate and may be subject to market f luctuation as the prime rate changes as determined within each specific agree- ment. We do not anticipate entering into interest rate swaps or other financial instruments to hedge our borrowings. At March 28, 2004, total outstanding debt, including capital leases, aggregated $1,039,000 of which $986,000 is at risk due to changes in interest rates. The cur- rent interest rate is 4.50% per annum and will adjust in January 2006 and 2009 to prime plus .25%. Nathan’s also maintains a $5,000,000 credit line which bears interest at the prime rate plus 1.00% (5.00% at May 7, 2004). Nathan’s has never borrowed any funds under its line of credit. Accordingly, Nathan’s does not believe that f luctuations in interest rates would have a material impact on its financial results. Commodity Costs The cost of commodities are subject to market f luctuation. We have not attempted to hedge against f luctuations in the prices of the commodities we purchase using future, forward, option or other instruments. As a result, our future commodities purchases are subject to changes in the prices of such commodities. Generally, we attempt to pass through permanent increases in our commodity prices to our customers, thereby reducing the impact of long-term increases on our financial results. During the fifty-two week period ended March 28, 2004, the price of our beef products has risen dramatically over historical norms and particularly as compared to last year. This increase has been caused by reductions in the supply of beef primarily due to: 1) the prohibition since May 2003 on importing of Canadian beef livestock into the U.S. 2) the decrease in imports of Australian beef due to local drought conditions and 3) the export of U.S. beef had increased through December 23, 2003 when the first case of bovine spongiform encephalopathy, otherwise known as BSE in the United States was reported. Nathan’s has not experienced a softening in the price of beef since December 23, 2003. Although the export of beef by the United States was significantly reduced as a result of this finding, Nathan’s had not realized a reduction in the cost of beef during the fourth quarter of fiscal 2004. As a result, Nathan’s cost of its hot dogs was approximately 14.6% higher during the fifty-two weeks ended March 28, 2004 than the fifty-two weeks ended March 30, 2003. Nathan’s had already increased menu prices in its Company- operated restaurants by approximately 2.0% and had increased prices within its Branded Product Program to offset some of the margin pressure. A short term increase or decrease of 10% in the cost of our food and paper products for the entire fifty-two weeks ended March 28, 2004 would have increased or decreased cost of sales by approxi- mately $983,000. On December 23, 2003, the United States Department of Agriculture (“USDA”) announced that the first case of bovine spongiform encephalopathy, otherwise known as BSE, or mad-cow disease was discovered in the United States in a single cow in the State of Washington. Nathan’s has obtained written assurances from its beef processors that Nathan’s products have not come from the meat processing plants associated with the production of products having to do with this incident. To date, Nathan’s demand for its products continues to be strong. Nathan’s has not experienced any material financial impact in connection with this incident. 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 f luctuations in the value of foreign currencies would have a material impact on our financial results. Forward-Looking Statement Certain statements contained in this report are forward-looking statements. Forward-looking statements represent our current judg- ment regarding future events. Although we would not make forward- looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy and actual results may differ materially from those we anticipated due to a number of uncertainties, many of which we are not aware. These risks and uncertainties, many of which are not within our control, include, but are not limited to: the future effects of the first case of bovine spongiform encephalopathy, BSE, identified in the United States on December 23, 2003; economic, weather, legislative and business conditions; the collectibility of receivables; the availability of suitable restaurant sites on reasonable rental terms; changes in consumer tastes; the ability to continue to attract franchisees; the ability to pur- chase our primary food and paper products at reasonable prices; no material increases in the minimum wage; and our ability to attract competent restaurant and managerial personnel. We generally iden- tify forward-looking statements with the words “believe,” “intend,” “plan,” “expect,” “anticipate,” “estimate,” “will,” “should” and simi- lar expressions. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twelve Consolidated Balance Sheets (in thousands, except share and per share amounts) Assets Current Assets Cash and cash equivalents Marketable securities Notes and accounts receivable, net Inventories Assets available for sale Prepaid expenses and other current assets Deferred income taxes Total current assets Notes receivable, net Property and equipment, net Goodwill Intangible assets, net Deferred income taxes Other assets, net Liabilities and Stockholders’ Equity Current Liabilities Current maturities of notes payable and capital lease obligations Accounts payable Accrued expenses and other current liabilities Deferred franchise fees Total current liabilities Notes payable and capital lease obligations, less current maturities Other liabilities Total liabilities Commitments and Contingencies (Note L) Stockholders’ Equity Common stock, $.01 par value; 30,000,000 shares authorized; 7,065,202 and 7,065,202 shares issued; and 5,213,901 and 5,423,964 shares outstanding at March 28, 2004 and March 30, 2003, respectively Additional paid-in capital Accumulated deficit Accumulated other comprehensive income Treasury stock, at cost, 1,851,301 and 1,641,238 shares at March 28, 2004 and March 30, 2003, respectively Total stockholders’ equity The accompanying notes are an integral part of these statements. March 28, 2004 March 30, 2003 $ 3,449 7,477 2,352 743 507 463 1,326 16,317 313 5,094 95 3,063 2,452 250 $ 1,415 4,623 2,607 389 799 642 2,079 12,554 740 6,263 95 3,319 2,647 268 $ 27,584 $ 25,886 $ 173 1,950 4,836 173 7,132 866 2,234 10,232 71 40,746 (16,611) 67 24,273 (6,921) 17,352 $ 173 1,377 4,942 127 6,619 1,053 1,831 9,503 71 40,746 (18,505) 64 22,376 (5,993) 16,383 $ 27,584 $ 25,886 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirteen Consolidated Statements of Operations (in thousands, except share and per share amounts) Revenues Sales Franchise fees and royalties License royalties Interest income Investment and other income Total revenues Costs and Expenses Cost of sales Restaurant operating expenses Depreciation and amortization Amortization of intangible assets General and administrative expenses Interest expense Impairment charge on long-lived assets Impairment charge on notes receivable Other expense (income), net Total costs and expenses Income (loss) from continuing operations before provision (benefit) for income taxes Provision (benefit) for income taxes Income (loss) from continuing operations Loss from discontinued operations, net of income tax benefit of $(82) and $(95) in 2003 and 2002, respectively Income (loss) from operations before cumulative effect of a change in accounting principle Cumulative effect of change in accounting principle, net of tax benefit of $(854) in 2003 Net income (loss) Per Share Information Basic income (loss) per share: Income (loss) from continuing operations Loss from discontinued operations Cumulative effect of change in accounting principle Net income (loss) Diluted income (loss) per share: Income (loss) from continuing operations Loss from discontinued operations Cumulative effect of change in accounting principle Net income (loss) Weighted-average shares used in computing net income (loss) per share Basic Diluted The accompanying notes are an integral part of these statements. Fifty-Two Fifty-Three Fifty-Two Weeks Ended Weeks Ended Weeks Ended March 28, 2004 March 30, 2003 March 31, 2002 $20,765 6,286 2,970 199 459 30,679 14,775 3,806 971 261 7,519 75 25 208 45 27,685 2,994 1,100 1,894 — 1,894 $ 24,762 5,977 2,585 292 156 33,772 16,592 5,621 1,314 278 8,600 132 1,367 1,425 232 35,561 (1,789) (283) (1,506) (124) $27,425 7,944 2,038 500 1,568 39,475 18,269 6,559 1,395 888 9,292 256 392 185 (210) 37,026 2,449 1,057 1,392 (143) (1,630) 1,249 — $ 1,894 (12,338) $(13,968) — $ 1,249 $ $ $ $ .36 — — .36 .33 — — .33 $ $ $ (.25) (.03) (2.06) (2.34) (.25) (.03) (2.06) $ (2.34) $ $ $ $ .20 (.02) — .18 .20 (.02) — .18 5,306,000 5,678,000 5,976,000 5,976,000 7,048,000 7,083,000 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page fourteen Consolidated Statements of Stockholders’ Equity (in thousands, except share amounts) Fifty-Two Weeks Ended March 28, 2004 and March 30, 2003 and Fifty-Three Weeks Ended March 31, 2002 Common Common Shares Stock Additional Paid-in Capital Accumulated Deficit Accumulated Other Com- prehensive Treasury Stock, at Cost Amount Shares Income Balance, March 25, 2001 Repurchase of treasury stock Net income Comprehensive income Balance, March 31, 2002 Repurchase of treasury stock Unrealized gains on marketable securities, net of deferred income taxes of $50 Reclassification adjustment for net gains realized in net loss, net of deferred income taxes of $4 Net loss Comprehensive loss Balance, March 30, 2003 Repurchase of treasury stock Unrealized gains on marketable securities, net of deferred income taxes of $7 Reclassification adjustment for net gains realized in net income, net of deferred income taxes of $5 Net income Comprehensive income 7,065,202 — — — 7,065,202 — $71 — — — 71 — — — — — — 7,065,202 — — — — — — — — 71 — — — — — $40,746 — — — 40,746 — — — — — 40,746 — — — — — $ (5,786) — 1,249 — (4,537) — — — (13,968) — (18,505) — — — 1,894 — $— — — — — — 70 (6) — — 64 — 10 (7) — — Compre- hensive Income (Loss) $ 1,249 $ 1,249 Total Stock- holders’ Equity $ 35,031 (135) 1,249 — 36,145 (5,858) 70 $ 70 (6) (13,968) (6) (13,968) — $(13,904) — 41,691 — — 41,691 1,599,547 $ — (135) — — (135) (5,858) — — — — — — — — 1,641,238 210,063 (5,993) (928) 16,383 (928) — — — — — — — — 10 $10 (7) 1,894 (7) 1,894 — $ 1,897 Balance, March 28, 2004 7,065,202 $71 $40,746 $(16,611) $67 1,851,301 $(6,921) $ 17,352 The accompanying notes are an integral part of this statement. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page f ifteen Consolidated Statements of Cash Flows (in thousands) Cash Flows From Operating Activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Cumulative effect of change in accounting principle, net of tax benefit Depreciation and amortization Amortization of intangible assets Amortization of bond premium Gain on disposal of fixed assets Gain on sale of available for sale securities Impairment of long-lived assets Impairment of notes receivable (Recovery of ) provision for doubtful accounts Deferred income taxes Changes in operating assets and liabilities: Marketable securities and investment in limited partnership Notes and accounts receivable Inventories Prepaid expenses and other current assets Other assets Accounts payable, accrued expenses and other current liabilities Deferred franchise fees Other liabilities Net cash provided by (used in) operating activities Cash Flows From Investing Activities: Proceeds from sale of available for sale securities Purchase of available for sale securities Purchases of property and equipment Payments received on notes receivable Proceeds from sales of property and equipment Net cash (used in) provided by investing activities Cash Flows From Financing Activities: Principal repayments of notes payable and capitalized lease obligations Repurchase of treasury stock Net cash used in financing activities Net change in cash and cash equivalents Cash and Cash Equivalents, beginning of year Cash and Cash Equivalents, end of year Cash Paid During the Year for: Interest Income taxes Noncash Financing Activities: Loans to franchisees in connection with sale of restaurants The accompanying notes are an integral part of these statements. Fifty-Two Fifty-Three Fifty-Two Weeks Ended Weeks Ended Weeks Ended March 28, 2004 March 30, 2003 March 31, 2002 $ 1,894 $(13,968) $ 1,249 — 971 261 127 (206) (12) 25 208 (17) 945 — 294 (354) 179 18 467 46 430 5,276 2,497 (5,461) (449) 797 489 (2,127) (187) (928) (1,115) 2,034 1,415 12,338 1,907 278 85 (39) (10) 1,367 1,425 82 (585) 981 2 203 627 32 (1,647) (205) (577) 2,296 6,088 (2,884) (562) 273 781 3,696 (553) (5,858) (6,411) (419) 1,834 — 1,661 888 — (1,226) — 685 185 267 509 (4,171) (26) (69) (295) 104 (2,538) (324) 20 (3,081) — — (2,082) 812 3,348 2,078 (1,353) (135) (1,488) (2,491) 4,325 $ 3,449 $ 1,415 $ 1,834 $ $ 74 253 $ 600 $ $ $ 138 57 $ 264 $ 149 44 $ 416 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page sixteen Notes to Consolidated Financial Statements (in thousands, except share and per share amounts) March 28, 2004, March 30, 2003 and March 31, 2002 Note A—Description and Organization of Business Nathan’s Famous, Inc. and subsidiaries (collectively the “Company” or “Nathan’s”) has historically operated or franchised a chain of retail fast food restaurants featuring the Nathan’s famous brand of all beef frankfurters, fresh crinkle-cut french fried potatoes and a variety of other menu offerings. Since fiscal 1998, the Company has supplemented the Nathan’s franchise program with the Nathan’s Branded Product Program, which enables foodservice retailers to sell some of Nathan’s proprietary products outside of the realm of a tradi- tional franchise relationship. During fiscal 2000, the Company acquired the intellectual property rights, including trademarks, recipes and franchise agreements of Roasters Corp. and Roasters Franchise Corp. (“Roasters”), the franchisor of Kenny Rogers Roasters. In addition, Nathan’s completed a merger with Miami Subs Corporation (“Miami Subs”) whereby it acquired the remaining 70% of Miami Subs common stock not previously owned by the Company. Miami Subs features a wide variety of lunch, dinner and snack foods, including hot and cold sandwiches and various ethnic foods. Roasters features home-style family foods based on a menu centered around wood-fire rotisserie chicken. The Company consid- ers its subsidiaries to be in the foodservice industry, and has pursued co-branding and co-hosting initiatives; accordingly, management has evaluated the Company as a single reporting unit. At March 28, 2004, the Company’s restaurant system, consisting of Nathan’s Famous, Kenny Rogers Roasters and Miami Subs restau- rants, included 7 Company-owned units concentrated in the New York metropolitan area, 338 franchised or licensed units, including 6 units operating pursuant to management agreements and approxi- mately 3,300 branded product points of sale under the Nathan’s Branded Product Program, located in 44 states, the District of Columbia, and 12 foreign countries. Note B—Summary of Significant Accounting Policies 1. Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All intercom- pany balances and transactions have been eliminated in consolidation. 2. Fiscal Year The Company’s fiscal year ends on the last Sunday in March, which results in a 52- or 53-week reporting period. The results of operations and cash f lows for the fiscal years ended March 28, 2004 and March 30, 2003 are on the basis of 52-week reporting periods. The results of operations and cash f lows for the fiscal year ended March 31, 2002 are on the basis of a 53-week reporting period. 3. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial state- ments and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates made by management in preparing the consoli- dated financial statements include revenue recognition, the allowance for doubtful accounts, the allowance for impaired notes receivable, the self-insurance reserve and impairment charges on goodwill and long-lived assets. 4. Cash and Cash Equivalents The Company considers all highly liquid instruments pur- chased with an original maturity of three months or less to be cash equivalents. Cash restricted for untendered shares associated with the acquisition of Nathan’s in 1987 amounted to $83 at March 28, 2004 and March 30, 2003, respectively, and is included in cash and cash equivalents. 5. Impairment of Notes Receivable Nathan's follows the guidance in Statement of Financial Accounting Standards (“SFAS”) No. 114 (“SFAS No. 114”) “Account- ing by Creditors for Impairment of a Loan,” as amended. Pursuant to SFAS No. 114, a loan is impaired when, based on current informa- tion and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agree- ment. When evaluating a note for impairment, the factors considered include: (a) indications that the borrower is experiencing business problems such as operating losses, marginal working capital, inadequate cash f low or business interruptions, (b) loans secured by collateral that is not readily marketable, or (c) that are susceptible to deteriora- tion in realizable value. When determining impairment, manage- ment's assessment includes its intention to extend certain leases beyond the minimum lease term and the debtor's ability to meet its obligation over that extended term. In certain cases where Nathan's has determined that a loan has been impaired, it generally does not expect to extend or renew the underlying leases. Based on the Company's analysis, it has determined that there are notes that have incurred such an impairment. Following are summaries of impaired notes receivable and the allowance for impaired notes receivable: Total recorded investment in impaired notes receivable Allowance for impaired notes receivable Recorded investment in impaired notes receivable, net Allowance for impaired notes receivable at beginning of the fiscal year Impairment charges on notes receivable Impaired notes written off Allowance for impaired notes receivable at end of the fiscal year March 28, March 30, 2004 2003 $ 2,248 (2,051) $ 2,598 (2,065) $ 197 $ 533 $ 2,065 208 (222) $ 640 1,425 — $ 2,051 $ 2,065 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page seventeen Based on the present value of the estimated cash f lows of iden- tified impaired notes receivable, the Company records interest income on its impaired notes receivable on a cash basis. The following represents the interest income recognized and average recorded investment of impaired notes receivable. March 28, March 30, March 31, 2003 2004 2002 Interest income recorded on impaired notes receivable Average recorded investment in impaired notes receivable $ 19 $ 96 $2,341 $1,624 $ 47 $936 6. Inventories Inventories, which are stated at the lower of cost or market value, consist primarily of restaurant food items, supplies, marketing items and equipment in connection with the Branded Product Program. Cost is determined using the first-in, first-out method. 7. Marketable Securities In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the Company determines the appropriate classification of securities at the time of purchase and reassesses the appropriateness of the classification at each reporting date. At March 28, 2004 and March 30, 2003, all marketable securi- ties held by the Company have been classified as available-for-sale and, as a result, are stated at fair value. Realized gains and losses on the sale of securities, as determined on a specific identification basis, are included in the accompanying consolidated statements of opera- tions. Unrealized gains and losses on available-for-sale securities are included as a component of accumulated other comprehensive income in the accompanying consolidated balance sheet. 8. Sales of Restaurants The Company observes the provisions of SFAS No. 66, “Accounting for Sales of Real Estate,” (“SFAS No. 66”) which estab- lishes accounting standards for recognizing profit or loss on sales of real estate. SFAS No. 66 provides for profit recognition by the full accrual method, provided (a) the profit is determinable, that is, the collectibility of the sales price is reasonably assured or the amount that will not be collectible can be estimated, and (b) the earnings process is virtually complete, that is, the seller is not obliged to per- form significant activities after the sale to earn the profit. Unless both conditions exist, recognition of all or part of the profit shall be post- poned and other methods of profit recognition shall be followed. In accordance with SFAS No. 66, the Company recognizes profit on sales of restaurants under the full accrual method, the installment method and the deposit method, depending on the specific terms of each sale. The Company continues to record depreciation expense on the property subject to the sales contracts that are accounted for under the deposit method and records any principal payments received as a deposit until such time that the transaction meets the sales criteria of SFAS No. 66. As of March 28, 2004 and March 30, 2003, the Company had deposits on the sales of restaurants of $0 and $161, respectively, included in accrued expenses and other current liabilities in the accompanying consolidated balance sheets. 9. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated primarily on the straight-line basis over the estimated use- ful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful life or the lease term of the related asset. The estimated useful lives are as follows: Building and improvements Machinery, equipment, furniture and fixtures Leasehold improvements 5–25 years 5–15 years 5–20 years 10. Intangible Assets Intangible assets consist of (i) the goodwill resulting from the acquisition of Nathan’s in 1987; (ii) trademarks and trade names, fran- chise rights and recipes in connection with Roasters and (iii) goodwill and certain identifiable intangibles resulting from the Miami Subs acquisition. These intangible assets were being amortized over periods from 10 to 40 years through March 31, 2002. On April 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), which supercedes APB Opinion No. 17, “Intangible Assets” and certain provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of ” (“SFAS No. 121”). SFAS No. 142 requires that goodwill and other intangibles be reported separately; eliminates the requirement to amortize goodwill and indefinite-lived intangible assets; addresses the amortization of intangible assets with a definite life; and addresses impairment testing and recognition of goodwill and intangible assets. SFAS No. 142 changes the method of accounting for the recover- ability of goodwill for the Company, such that it is evaluated at the brand level based upon the estimated fair value of the brand. Fair value can be determined based on discounted cash f lows, on compa- rable sales or valuations of other restaurant brands. The impairment review involves a two-step process as follows: Step 1: Compare the fair value for each reporting unit to its car- rying value, including goodwill. For each reporting unit where the carrying value, including goodwill, exceeds the reporting unit’s fair value, move on to step 2. If a reporting unit’s fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary. Step 2: Allocate the fair value of the reporting unit to its identi- fiable tangible and intangible assets, excluding goodwill and liabilities. This will derive an implied fair value for the reporting unit’s goodwill. Then, compare the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount of the report- ing unit’s goodwill is greater than the implied fair value of its goodwill, an impairment loss must be recognized for the excess. The transitional impairment charge, if any, is recorded as a cumulative effect of accounting change for goodwill. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page eighteen The Company completed its initial SFAS No. 142 transitional impairment test of goodwill in April 2002, including an assessment of a valuation of the Nathan’s, Miami Subs and Roasters reporting units by an independent valuation consultant, and has recorded an impairment charge requiring the Company to write-off substantially all of the goodwill related to the acquisitions, trademarks and recipes as a cumulative effect of accounting change in the first quarter of fiscal 2003. The fair value was determined through the combination of a present value analy- sis as well as prices of comparative businesses. The changes in the net carrying amount of goodwill, trademarks and recipes recorded in the first quarter of fiscal 2003 are as follows: Balance as of April 1, 2002 Cumulative effect of accounting change for goodwill and other intangible assets Balance as of March 30, 2003 Goodwill Trademarks Recipes Total $ 11,083 (10,988) $ 95 $ 2,242 (2,174) $ 68 $ 30 (30) $ — $ 13,355 (13,192) $ 163 The table below presents amortized and unamortized intangible assets as of March 28, 2004 and March 30, 2003: March 28, 2004 March 30, 2003 Amortized intangible assets: Royalty streams Favorable leases Other Unamortized intangible assets: Trademarks, tradenames and recipes Goodwill Gross Carrying Amount Net Accumulated Carrying Amortization Amount $4,259 285 6 $4,550 $(1,269) (285) (1) $(1,555) $2,990 — 5 $2,995 68 $3,063 $ 95 Gross Carrying Amount $4,259 285 16 $4,560 Accumulated Amortization Net Carrying Amount $(1,008) (285) (16) $(1,309) $3,251 — — $3,251 68 $3,319 $ 95 The following table provides a reconciliation of the reported net income (loss) and net income (loss) per share for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, adjusted as though SFAS No. 142 had been effective for all periods: Reported net income (loss) before cumulative effect of change in accounting principle Add back discontinued amortization expense Adjusted net income (loss) before cumulative effect of change in accounting principle Cumulative effect of change in accounting principle Adjusted net income (loss) Reported basic net income (loss) per common share before cumulative effect of change in accounting principle Effect of discontinued amortization expense Adjusted basic net income (loss) per common share before cumulative effect of change in accounting principle Cumulative effect of change in accounting principle Adjusted basic net income (loss) per common share Reported diluted net income (loss) per common share before cumulative effect of change in accounting principle Effect of discontinued amortization expense Adjusted diluted net income (loss) per common share before cumulative effect of change in accounting principle Cumulative effect of change in accounting principle Adjusted diluted net income (loss) per common share 2004 $1,894 — 1,894 — 2003 $ (1,630) — (1,630) (12,338) 2002 $1,249 555 1,804 — $1,894 $(13,968) $1,804 $ $ $ $ .36 — .36 — .36 .33 — .33 — .33 $ (.28) — $ $ $ (.28) (2.06) (2.34) (.28) — (.28) (2.06) $ $ $ (2.34) $ .18 .08 .26 — .26 .18 .07 .25 — .25 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page nineteen As of March 28, 2004, and March 30, 2003, the Company has reevaluated the impact of SFAS No. 142 on its goodwill and intangi- ble assets, and determined no additional impairment charges were deemed necessary. Total amortization expense for intangible assets was $261, $278 and $888 for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002. The Company estimates future annual amorti- zation expense of approximately $261 per year for each of the next five years. In the fourth quarter of fiscal 2003, the Company recorded an impairment charge of $239 related to its favorable leases. This impairment charge, which was based upon the fact that such locations had incurred negative cash f lows from operations for fiscal 2003 and were projected to incur negative cash f lows in fiscal 2004, was recorded as a component of impairment charge on long-lived assets. (See Note B-11.) 11. Long-Lived Assets Long-lived assets and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived assets to the estimated undis- counted future cash f lows 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 f lows. Impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment factors are deter- mined to be present. The Company considers a history of restaurant operating losses to be its primary indicator of potential impairment for individual restaurant locations. The Company has identified one, seven and two units that have been impaired, and recorded impairment charges of $25, $1,367, (inclusive of $239 related to favorable leases discussed in Note B-10), and $685 in the statements of operations for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. The Company periodically reviews intangible assets for impair- ment, whenever events or changes in circumstances indicate that the carrying amounts of those assets may not be recoverable. (See Note B-10 for a description of impairment charges recorded on goodwill and other intangible assets during the fiscal year ended March 30, 2003 as a result of the adoption of SFAS No. 142.) No impairment charges were recorded with respect to such intangible assets for the fiscal years ended March 28, 2004 and March 31, 2002. 12. Self-Insurance The Company is self-insured for portions of its general liability coverage. As part of Nathan's risk management strategy, its insurance programs include deductibles for each incident and in the aggregate for a policy year. As such, Nathan's accrues estimates of its ultimate self-insurance costs throughout the policy year. These estimates have been developed based upon Nathan's historical trends, however, the final cost of many of these claims may not be known for five years or longer. Accordingly, Nathan's annual self-insurance costs may be sub- ject to adjustment from previous estimates as facts and circumstances change. The self-insurance accruals at March 28, 2004 and March 30, 2003 were $346 and $596, respectively and are included in “Accrued expenses and other current liabilities” in the accompanying consoli- dated balance sheets. During the fiscal year ended March 28, 2004, approximately $268 of previously recorded insurance accruals for items that have been concluded without further payment were reversed. During the fiscal year ended March 30, 2003, the self-insurance accrual was reduced by approximately $829, due principally to the satisfaction of a claim against the Company totaling $659 and the reversal of approximately $196 of previously recorded self-insurance accruals in connection with the conclusion of claims relating to prior policy years. 13. Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, marketable securities, accounts receivable and accounts payable approximate fair value due to the short-term maturities of the instruments. The carry- ing amounts of notes payable and capital lease obligations and notes receivable approximate their fair values as the current interest rates on such instruments approximates current market interest rates on similar instruments. 14. Stock-Based Compensation At March 28, 2004, the Company has five stock-based employee compensation plans, which are described more fully in Note K. The Company accounts for stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations (“APB No. 25”) and has adopted the disclo- sure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” Under APB No. 25, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Accordingly, no compensa- tion expense has been recognized in the consolidated financial state- ments in connection with employee stock option grants. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty The following table illustrates the effect on net income (loss) and net income (loss) per share had the Company applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation. Fiscal Year Ended March 28, March 30, March 31, 2003 2004 2002 Net income (loss), as reported Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards $ 1,894 $(13,968) $1,249 (170) (165) (410) Pro forma net income (loss) $ 1,724 $(14,133) $ 839 Net income (loss) per share Basic—as reported Diluted—as reported Basic—pro forma Diluted—pro forma $ $ $ $ .36 .33 .32 .30 $ $ $ $ (2.34) (2.34) (2.36) (2.36) $ $ $ $ .18 .18 .12 .12 Pro forma compensation expense may not be indicative of pro forma expense in future years. For purposes of estimating the fair value of each option on the date of grant, the Company utilized the Black-Scholes option-pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vest- ing restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assump- tions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The weighted-average option fair values and the assumptions used to estimate these values are as follows: Weighted-average option fair values Expected life (years) Interest rate Volatility Dividend yield 2004 2003 2002 $1.60 7.0 3.85% 30.6% 0% $2.19 10.0 5.30% 32.8% 0% $1.30 6.6 4.06% 32.3% 0% 15. Start-up Costs Preopening and similar costs are expensed as incurred. 16. Revenue Recognition—Company-owned Restaurants Sales by Company-owned restaurants, which are typically paid in cash by the customer, are recognized upon the performance of services. 17. Revenue Recognition—Franchising Operations In connection with its franchising operations, the Company receives initial franchise fees, development fees, royalties, contributions to marketing funds, 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 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 per- formed or satisfied, which generally occurs when the franchised restaurant commences operations. The following services are typi- cally provided by the Company 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, review- ing construction compliance and equipping the restaurant. • Provision of appropriate menus to coordinate with the restau- rant design and location to be developed. • Provide management training for the new franchisee and selected staff. • Assistance with the initial operations 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 agree- ments may be canceled by the Company. Revenue from develop- ment agreements is deferred and recognized 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. At March 28, 2004 and March 30, 2003, $173 and $127, respectively, of deferred franchise fees are included in the accompanying consolidated balance sheets. For the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, the Company earned franchise fees from new unit openings, transfers and co-branding of $428, $418 and $693, respectively. During the fiscal year ended March 30, 2003, the Company recognized $207 in connection with the forfeiture of two Master Development Agreements. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-one The following is a summary of franchise openings and closings for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002: Franchised restaurants operating at the beginning of the period New franchised restaurants opened during the period Franchised restaurants closed during the period Franchised restaurants operating at the end of the period 2004 2003 2002 343 364 386 40 24 18 (45) (45) (40) 338 343 364 The Company recognizes franchise royalties 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. Revenue from sub-leasing properties to franchisees is recognized as income as the revenue is earned and becomes receiv- able and deemed collectible. Sub-lease rental income is presented net of associated lease costs in the accompanying consolidated statements of operations. 18. Revenue Recognition—Branded Products Operations The Company recognizes revenue from the Branded Product Program when it is determined by the manufacturer that the prod- ucts have been delivered via third-party common carrier to Nathan’s customers. An accrual for the cost of the product to the Company is recorded simultaneously with the revenue. 19. Interest Income Interest income is accrued when it is earned and deemed realiz- able by the Company. 20. Investment and Other Income The Company recognizes gains on the sale of fixed assets under the full accrual method in accordance with provisions of SFAS No. 66 (See Note B-8). Deferred revenue associated with supplier contracts is generally amortized on a straight-line basis over the life of the contract. Investments classified as trading securities are recorded at fair value and the unrealized gains or losses are recognized as a compo- nent of “Investment and other income.” During the fiscal year ended March 30, 2003, the Company liquidated its investment in trading securities. Investment and other income consists of the following: Gain on disposal of fixed assets Realized gains (losses) on marketable securities Unrealized losses on trading securities Loss on subleasing of rental properties Gain from the early termination of sales agreement Other income 2004 2003 2002 $ 206 $ 39 $1,226 12 — (312) — 553 (242) — (243) 135 467 7 (43) (215) — 593 $ 459 $ 156 $1,568 21. Concentrations of Credit Risk The Company’s accounts receivable consist principally of receivables from franchisees for royalties and advertising contribu- tions and receivables from sales under the Branded Product Program. At March 28, 2004 and March 30, 2003, no franchisee or Branded Product Program customer represented 10% or greater of accounts receivable. (See Note D.) 22. Advertising The Company administers various advertising funds on behalf of its subsidiaries and franchisees to coordinate the marketing efforts of the Company. Under these arrangements, the Company collects and disburses fees paid by franchisees and Company-owned stores for national and regional advertising, promotional and public relations programs. Contributions to the advertising funds are based on speci- f ied percentages of net sales, generally ranging up to 3%. Net Company-owned store advertising expense was $241, $608 and $940, for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. 23. Classif ication of Operating Expenses Cost of sales consists of the following: • The cost of products sold by the Company-operated restaurants, Branded Product Program and other distribution channels. • The cost of labor and associated costs of in-store restaurant management and crew. • The cost of paper products used in Company-operated restaurants. • Other direct costs such as fulfillment, commissions, freight and samples. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-two Restaurant operating expenses consist of the following: • Occupancy costs of Company-operated restaurants. • Utility costs of Company-operated restaurants. • Repair and maintenance expenses of the Company-operated restaurant facilities. • Marketing and advertising expenses done locally and contribu- tions to advertising funds for Company-operated restaurants. • Insurance costs directly related to Company-operated restaurants. 24. Income Taxes 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 operating loss and 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 tem- porary differences are expected to be recovered or settled. A valua- tion allowance has been established to reduce deferred tax assets attributable to net operating losses and credits of Miami Subs. 25. Reclassif ications Certain prior year balances have been reclassified to conform with current year presentation. 26. Recently Issued Accounting Standards In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). SFAS No. 143 addresses financial and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. The Company has evaluated the effect of the adoption of SFAS No. 143 on its financial position and results of operations, and it has not had a material impact on the financial position and results of operations of the Company. In April 2002, the FASB issued Statement of Financial Account- ing Standards No. 145 (“SFAS No. 145”), “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current criteria for extraordinary classification. Additionally, any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB Opinion No. 30 for classification as an extraordinary item shall be reclassified. In addition, SFAS No. 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. SFAS No. 145 also contains other nonsubstantive corrections to authorita- tive accounting literature. SFAS No. 145 has not had a material impact on the financial position and results of operations of the Company. In April 2003, the FASB issued Statement of Financial Account- ing Standards No. 149 (“SFAS No. 149”), “Amendment of State- ment No. 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. The adoption of SFAS No. 149 has not had a material impact on the Company’s financial position and results of operations. In May 2003, the FASB issued Statement of Financial Account- ing Standards No. 150 (“SFAS No. 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classi- fies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. The adoption of SFAS No. 150 has not had a material impact on the Company’s financial position and results of operations. In December 2003, the FASB issued a revision to FASB Interpre- tation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN No. 46(R)” or the “Inter- pretation”). FIN No. 46(R) clarifies the application of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling finan- cial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial sup- port. FIN No. 46(R) requires the consolidation of these entities, known as variable interest entities, by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-three The revisions of FIN No. 46(R) (a) clarified some requirements of the original FIN No. 46, which had been issued in January 2003, (b) simplified some of the implementation problems, and (c) added new scope exceptions. FIN No. 46(R) delayed the effective date of the FIN No. 46(R) for public companies, to the end of the first reporting period ending after March 15, 2004, except that all public companies must at a minimum apply the unmodified provisions of FIN No. 46(R) to entities that were previously considered “special- purpose entities” in practice and under the FASB literature prior to the issuance of FIN No. 46(R) by the end of the first reporting period ending after December 15, 2003. FIN No. 46(R) added several new scope exceptions, including one which states that companies are not required to apply the provi- sions to an entity that meets the criteria to be considered a “business” as defined in FIN No. 46(R) unless one or more of four named conditions exist. The Company has no equity ownership interests in its fran- chisees, and has not consolidated any of these entities in the Company’s financial statements. The Company will continue to monitor devel- opments regarding the Interpretation as they occur. The Company adopted the provisions of FIN No. 46(R) in its fourth fiscal quarter of 2004. The Company does not provide more than half of the equity subordinated debt or other subordinated financial support to any franchise entity. The Company has further concluded that the fran- chise entities were not designed such that substantially all of their activities either involve or are conducted on behalf of Nathan’s. As such, the Company has not consolidated any franchised entity in the financial statements. If, at some future date, Nathan’s does provide more than half of the subordinated financial support to a franchise entity, consolidation would not be automatic. The franchise entity would then be subject to further testing under the guidelines of FIN No. 46(R). In December 2003, the SEC issued Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB No. 104”), which codifies, revises and rescinds certain sections of SAB No. 101, “Revenue Recognition in Financial Statements,” in order to make this interpre- tative guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material impact on the Company’s financial position or results of operations. Note C—Income (Loss) Per Share Basic income (loss) per common share is calculated by dividing income (loss) by the weighted-average number of common shares out- standing and excludes any dilutive effects of stock options or warrants. Diluted income (loss) per common share gives effect to all potentially dilutive common shares that were outstanding during the period. Dilutive common shares used in the computation of diluted income (loss) per common share result from the assumed exercise of stock options and warrants, using the treasury stock method. The following chart provides a reconciliation of information used in calculating the per share amounts for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively: Basic EPS Basic calculation Effect of dilutive employee stock options and warrants Diluted EPS Diluted calculation Income (Loss) from Continuing Operations 2004 2003 2002 2004 Shares 2003 Income (Loss) Per Share from Continuing Operations 2002 2004 2003 2002 $1,894 $(1,506) $1,392 5,306,000 5,976,000 7,048,000 $ .36 $(.25) $.20 — — — 372,000 — 35,000 (.03) — — $1,894 $(1,506) $1,392 5,678,000 5,976,000 7,083,000 $ .33 $(.25) $.20 Options and warrants to purchase 1,374,981 shares of the Company’s common stock for the year ended March 30, 2003 were excluded from the calculation of diluted loss per share as the impact of their inclusion would have been anti-dilutive. Options and warrants to purchase 811,918 and 862,838 shares of common stock for the years ended March 28, 2004 and March 31, 2002, respectively, were not included in the computa- tion of diluted earnings per share because the exercise prices exceeded the average market price of common shares during the respective periods. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-four Note D—Notes and Accounts Receivable, Net Note E—Marketable Securities Notes and accounts receivable, net, consist of the following: The cost, gross unrealized gains, gross unrealized losses and fair Notes receivable, net of impairment charges Franchise and license royalties Branded product sales Other Less: allowance for doubtful accounts Less: notes receivable due after one year March 28, March 30, 2004 $ 573 1,404 687 329 2,993 328 313 2003 $ 998 1,465 737 565 3,765 418 740 Notes and accounts receivable, net $2,352 $2,607 Notes receivable at March 28, 2004 and March 30, 2003 princi- pally resulted from sales of restaurant businesses to Miami Subs’ and Nathan’s franchisees and are generally guaranteed by the purchaser and collateralized by the restaurant businesses and assets sold. The notes are generally due in monthly installments of principal and interest with a balloon payment at the end of the term, with interest rates ranging principally between 5% and 10% (See Note B-5). Accounts receivable are due within 30 days and are stated at amounts due from franchisees and licensees, net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the indus- try as a whole. The Company writes off accounts receivable when they are deemed to be uncollectible. Changes in the Company’s allowance for doubtful accounts are as follows: Beginning balance Bad debt (recoveries) expense Other Accounts written off Ending balance 2004 $418 (17) — (73) 2003 2002 $ 644 82 — (308) $ 880 267 27 (530) $328 $ 418 $ 644 market value for marketable securities by major security type at March 28, 2004 and March 30, 2003 are as follows: Gross Gross Fair 2004: Available-for-sale securities: Cost Unrealized Unrealized Market Value Losses Gains Bonds $7,382 $107 $(12) $7,477 2003: Available-for-sale securities: Bonds $ 4,513 $181 $(71) $ 4,623 Proceeds from the sale of available-for-sale and trading securities and the resulting gross realized gains and losses included in the deter- mination of net income are as follows: Available-for-sale securities: Proceeds Gross realized gains Gross realized losses Trading securities: Proceeds Gross realized gains Gross realized losses 2004 2003 2002 $2,497 17 (5) $6,088 12 (2) $ — $ 767 — (252) — — $ — — — $2,933 8 (1) Effective April 1, 2002, the Company transferred the Company’s bond portfolio formerly classified as trading securities to available-for- sale securities due to a change in the Company’s investment strategies. As required by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the transfer of these securities between categories of investments has been accounted for at fair value and the unrealized holding loss previously recorded through April 1, 2002 of $20 from the trading category has not been reversed. The net unreal- ized gains for the fiscal years ended March 28, 2004 and March 30, 2003, respectively, of $3 and $64, net of deferred income taxes, has been included as a component of comprehensive income. During the fiscal year ended March 30, 2003, the Company liq- uidated its investment in limited partnership and received proceeds of $767 and recorded a loss of $252 which is included as a component of investment and other income in the accompanying consolidated statement of operations for the fiscal year ended March 30, 2003. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-f ive Note F—Property and Equipment, Net Property and equipment consists of the following: Construction-in-progress Land Building and improvements Machinery, equipment, furniture and fixtures Leasehold improvements Less: accumulated depreciation and amortization March 28, March 30, 2004 2003 $ 103 1,281 1,854 5,980 4,123 13,341 8,247 $ 31 1,665 2,255 5,297 4,042 13,290 7,027 $ 5,094 $ 6,263 Depreciation expense on property and equipment was $971, $1,907 and $1,661 for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. 1. Sales of Restaurants On April 1, 2002, the Company adopted the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). This statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of ” and Account- ing Principles Board Opinion No. 30, “Reporting Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 retained the fundamental provisions of SFAS No. 121 for recognition and measurement of impairment, but amends the accounting and reporting standards for segments of a business to be disposed of. SFAS No. 144 has broadened the definition of discontinued operations to include components of an entity whose cash f lows are clearly identifiable, as compared to a seg- ment of a business. SFAS No. 144 requires the Company to classify as discontinued operations any restaurant that it sells, abandons or otherwise disposes of where the Company will have no further involvement in such restaurant’s operations. During the fiscal year ended March 28, 2004, the Company sold three Company-owned restaurants for total consideration of $1,083 and entered into two management agreements with fran- chisees to operate two Company-owned restaurants. As the Company expects to have a continuing stream of cash f lows for all of these restaurants, the results of operations for these Company-operated restaurants are included as a component of continuing operations in the accompanying consolidated statements of operations. The assets associated with these restaurants that were sold were included in Assets held for sale in the March 30, 2003 consolidated balance sheet. During the fiscal year ended March 30, 2003, the Company sold three Company-owned restaurants for total consideration of $591. In August 2002, an operating restaurant, which had been clas- sified as held for sale at March 30, 2003, was sold to a non-franchisee for $75. In October 2002, a non-operating restaurant, which had been classified as held for sale was sold to a non-franchisee for $466 and an operating restaurant was sold to a franchisee in exchange for a $50 note. As these restaurants were either classified as held-for-sale prior to the adoption of SFAS No. 144 or the Company has a con- tinuing stream of cash f lows in the case of the franchised restaurant, the results of operations for these Company-operated restaurants that were sold are included as a component of continuing operations in the accompanying consolidated statements of operations for the fiscal years ended March 30, 2003 and March 31, 2002. In December 2002, the Company abandoned the operations of one Company-owned restaurant pursuant to a lease termination agreement with the land- lord. The results of operations for this restaurant have been classified as discontinued operations for all periods presented as the Company does not have any continuing involvement in the operations of this restaurant or a continuing stream of cash f lows with this restaurant. As discussed in Note F-2 below, during f iscal 2003, the Company also abandoned the operations of seven Company-operated restaurants located within certain Home Depot Home Improvement Centers. Pursuant to SFAS No. 144, the results of operations for all seven of these restaurants have been presented as discontinued opera- tions in the accompanying consolidated statement of operations for all periods presented, as the Company has no continuing involve- ment in the operations of these restaurants or cash f lows relating to any of these restaurants. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-six During the fiscal year ended March 31, 2002, the Company sold two Company-owned restaurants and a non-restaurant property for total proceeds of $3,348. The Company recognized a gain of $1,226 in connection with these sales. In May 2001, the Company completed the sale of a restaurant property for approximately $1,500 pursuant to an order of condem- nation by the State of Florida. Concurrent with the sale, the Company satisfied a related note payable of approximately $793 plus accrued interest. The Company appealed the value of this property and on November 19, 2001, an Order was entered by the Circuit Court of the 11th Judicial Circuit of Florida in and for Miami-Dade County pursuant to which the State of Florida Department of Transportation was ordered to pay to the Company, an aggregate value of $2,350, plus legal fees in the amount of $253 in connection with the condemnation by the State of Florida of the restaurant. The additional proceeds received by the Company of approximately $850 is recorded as a component of “investment and other income” in the accompanying consolidated statement of operations for the year ended March 31, 2002. 2. Foodservice License Termination Within Home Depot Stores In August 2002, the Company received written notice from Home Depot U.S.A., Inc. (“Home Depot”) that Home Depot ter- minated seven License Agreements with the Company pursuant to which the Company operated Nathan's restaurants in certain Home Depot Improvement Centers. In accordance with the termination notices, the Company ceased its operations in all seven Home Depot locations during the fiscal year ended March 30, 2003. Pursuant to SFAS No. 144, the results of operations for all seven of these restaurants have been presented as discontinued operations in the accompanying consolidated statement of operations as the Company has no continuing involvement in the operations of these restaurants or cash f lows relating to any of these restaurants. The Company revised the estimated useful lives of these assets to ref lect the shortened useful lives and recorded additional depreciation expense of approximately $428 during the fiscal year ended March 30, 2003. Pursuant to the termination provisions of certain of the lease agree- ments with Home Depot, the Company received payments of $184. Following is a summary of the results of operations for these seven restaurants for the fiscal years ended March 30, 2003 and March 31, 2002: Revenues (Loss) income before income taxes(A) 2003 2002 $3,096 $4,099 $ (166) $ 316 (A) (Loss) income before income taxes for the fiscal year ended March 30, 2003 includes addi- tional depreciation expense of $428, as a result of revising the estimated useful lives of these restaurants. 3. Discontinued Operations As described in Notes F-1 and F-2 above, the Company has classified the results of operations of eight restaurants as discontinued operations in accordance with SFAS No. 144. The following is a summary of the results of operations for these eight restaurants for the fiscal years ended March 30, 2003 and March 31, 2002: Revenues Loss before income taxes(A) 2003 2002 $3,543 $4,857 $ (206) $ (238) (A) Loss before income taxes for the fiscal year ended March 30, 2003 includes additional depre- ciation expense of $428, as a result of revising the estimated useful lives of these restaurants. There were no restaurants that were classified as discontinued operations during fiscal 2004. Note G—Accrued Expenses, Other Current Liabilities and Other Liabilities Accrued expenses and other current liabilities consist of the following: Payroll and other benefits Professional and legal costs Self-insured retention Rent, occupancy and lease reserve termination costs Taxes payable Unexpended advertising funds Deferred marketing funds Other Other liabilities consist of the following: Deferred income—supplier contracts Deferred development fees Deferred gain on sales of fixed assets Deferred rental liability Tenant’s security deposits on subleased property March 28, March 30, 2004 $1,369 259 346 757 544 440 410 711 2003 $1,324 349 596 739 556 — 396 982 $4,836 $4,942 March 28, March 30, 2004 $1,137 453 269 264 111 $2,234 2003 $1,148 170 183 242 88 $1,831 Lease Reserve Termination Costs In connection with the Company’s acquisition of Miami Subs, Nathan’s planned to permanently close 18 underperforming Company-owned restaurants; Nathan’s expected to abandon or sell the related assets at amounts below the historical carrying amounts recorded by Miami Subs. In accordance with APB No. 16, “Business Combinations,” the write-down of these assets was ref lected as part of the purchase price allocation. The Company has closed or sold all 18 units. As of March 28, 2004, the Company has recorded charges 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-seven to operations of approximately $1,461 ($877 after tax) for lease reserves and termination costs in connection with these properties. Changes in the Company’s reserve for lease reserve and termi- nation costs are as follows: Beginning balance Additions Payments Ending balance 2004 2003 2002 $529 80 (77) $336 209 (16) $ 678 30 (372) $532 $529 $ 336 Note H—Notes Payable and Capitalized Lease Obligations A summary of notes payable and capitalized lease obligations is as follows: March 28, March 30, 2004 2003 Note payable to bank at 8.5% through January 2003, 4.5% from February 2003 through January 2006 and adjusting to prime plus 0.25% in February 2006 and February 2009 and maturing in 2010 Capital lease obligations Less current portion Long-term portion $ 986 53 1,039 (173) $1,167 59 1,226 (173) $ 866 $1,053 The above notes are secured by the related property and equipment. In August 2001, Miami Subs entered into an agreement with a franchisee and a bank, which called for the assumption of a note payable by the franchisee and the repayment of an existing note receivable from the franchisee. The Company guarantees the fran- chisee’s note payable with the bank. The Company’s maximum obli- gation for loans funded by the lender was approximately $261 as of March 28, 2004. At March 28, 2004, the aggregate annual maturities of notes payable and capitalized lease obligations are as follows: 2005 2006 2007 2008 2009 Thereafter $ 173 174 175 176 176 165 $1,039 The Company maintains a $5,000 line of credit with its primary banking institution. Borrowings under the line of credit are intended to be used to meet the normal short-term working capital needs of the Company. The line of credit is not a commitment and, therefore, credit availability is subject to ongoing approval. The line of credit expires on October 1, 2004, and bears interest at the prime rate plus 1% (5.00% at March 28, 2004). There were no borrowings outstand- ing under this line of credit as of March 28, 2004. Note I—Other Expense (Income), Net Included in other expense (income), in the accompanying con- solidated statements of operations is (i) $45 of lease termination expense in connection with two properties for the fiscal year ended March 28, 2004, (ii) $232 in lease reserves in connection with four vacant properties for the fiscal year ended March 30, 2003 and (iii) the reversal of a previous litigation accrual of ($210) for the fiscal year ended March 31, 2002. During the fiscal year ended March 31, 2002, the Company reversed an accrual of $210 related to its successful appeal of a previous award in an action entitled: Miami Subs Corporation or MIAMI S V. MURRAY FAMILY TRUST/KENNETH DASH PARTNERSHIP. In this case, the court found that Miami Subs breached a fiduciary duty it owed to defendants and awarded the Murray Family Trust $200. Both Miami Subs and defendants appealed the court's decision, and in November 1996, the appeal was argued before the Supreme Court of New Hampshire. In December 1997, the Supreme Court ruled in favor of Miami Subs, vacated the damage award, reversed the award of attorney fees and remanded to a trial court for a deter- mination of damages for the alleged breach of fiduciary duty to the Murray Family Trust. In May 1998, the trial court awarded the Murray Family Trust compensatory damages in the amount of $200, which Miami Subs accrued for. Miami Subs appealed the damage award, and in December 1999, the Supreme Court of New Hampshire heard the second appeal. On February 1, 2001, the Supreme Court of New Hampshire ruled in favor of Miami Subs and vacated the damage award. The plaintiff had the right to further appeal the reversal for a period of 90 days, until May 2, 2001. No further action was taken by the plaintiff and upon passage of the 90-day period the liti- gation award was reversed into income. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-eight Note J—Income Taxes Income tax provision (benefit) consists of the following for the fis- cal years ended March 28, 2004, March 30, 2003 and March 31, 2002: Federal Current Deferred State and local Current Deferred 2004 2003 2002 $ 94 804 898 60 142 202 $ — $ 985 (93) (281) (281) 892 46 (48) (2) 181 (16) 165 $1,100 $(283) $1,507 Total income tax provision (benefit) for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002 differs from the amounts computed by applying the United States Federal income tax rate of 34% to income before income taxes as a result of the following: Computed “expected” tax (benefit) expense Nondeductible amortization Impairment on nondeductible favorable lease intangible assets State and local income taxes, net of Federal income tax benefit Tax-exempt investment earnings Tax refunds received Nondeductible meals and entertainment and other 2004 2003 2002 $1,018 37 $(609) 99 $ 833 169 — 87 181 (46) (62) 140 (48) — (28) 48 — 106 (68) — 17 $1,100 $(283) $1,057 Deferred tax liabilities Amortization of intangibles Difference in tax bases of installment gains not yet recognized Unrealized gain on marketable securities and income on investment in limited partnership Other Total gross deferred tax liabilities Net deferred tax asset Less valuation allowance March 28, March 30, 2004 2003 $ — $ 80 196 46 2 244 335 46 — 461 4,529 (751) 5,477 (751) $3,778 $4,726 The Company utilized net operating loss carryforwards (“NOL’s”) of approximately $1,965 during fiscal 2004. The determination that the net deferred tax asset of $3,778 and $4,726, at March 28, 2004 and March 30, 2003, respectively, is realizable is based on anticipated future taxable income. At March 28, 2004, the Company had a NOL of approximately $1,289 remaining (after certain IRS agreed-upon adjustments and other reductions due to expiring losses) which is available to offset future taxable income through 2005 and general business credit carry- forwards remaining of approximately $120 which may be used to off- set liabilities through 2008. These losses and credits are subject to limitations imposed under the Internal Revenue Code pursuant to Sections 382 and 383 regarding changes in ownership. As a result of these limitations, the Company has recorded a valuation allowance for the Miami Subs loss carryforwards and credits related to the acqui- sition of Miami Subs. The valuation allowance also includes various state NOL’s related to the post-acquisition losses of Miami Subs not utilized on a consolidated basis and carried forward on a state basis. The tax effects of temporary differences that give rise to signifi- cant portions of the deferred tax assets and deferred tax liabilities are presented below: Note K—Stockholders’ Equity, Stock Plans and Other Employee Benefit Plans Deferred tax assets Accrued expenses Allowance for doubtful accounts Impairment of notes receivable Deferred revenue Depreciation expense and impairment of long-lived assets Expenses not deductible until paid Amortization of intangibles Net operating loss and other carryforwards Other March 28, March 30, 2004 2003 $ 668 131 908 816 988 138 308 751 65 $ 672 167 855 806 1,152 238 407 1,540 101 Total gross deferred tax assets $4,773 $5,938 1. Stock Option Plans On December 15, 1992, the Company adopted the 1992 Stock Option Plan (the “1992 Plan”), which provides for the issuance of incentive stock options (“ISO’s”) to officers and key employees and nonqualified stock options to directors, officers and key employees. Up to 525,000 shares of common stock have been reserved for issuance under the 1992 Plan. The terms of the options are generally ten years, except for ISO’s granted to any employee, whom prior to the granting of the option, owns stock representing more than 10% of the voting rights, for which the option term will be five years. The exercise price for nonqualified stock options outstanding under the 1992 Plan can be no less than the fair market value, as defined, of the Company’s common stock at the date of grant. For ISO’s, the exercise price can generally be no less than the fair market value of 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page twenty-nine the Company’s common stock at the date of grant, with the excep- tion of any employee who prior to the granting of the option, owns stock representing more than 10% of the voting rights, for which the exercise price can be no less than 110% of fair market value of the Company’s common stock at the date of grant. On May 24, 1994, the Company adopted the Outside Director Stock Option Plan (the “Directors’ Plan”), which provides for the issuance of nonqualified stock options to nonemployee directors, as defined, of the Company. Under the Directors’ Plan, 200,000 shares of common stock have been authorized and issued. Options awarded to each nonemployee director are fully vested, subject to forfeiture under certain conditions and shall be exercisable upon vesting. In April 1998, the Company adopted the Nathan’s Famous, Inc. 1998 Stock Option Plan (the “1998 Plan”), which provides for the issuance of nonqualified stock options to directors, officers and key employees. Up to 500,000 shares of common stock have been reserved for issuance under the 1998 Plan. In June 2001, the Company adopted the Nathan’s Famous, Inc. 2001 Stock Option Plan (the “2001 Plan”), which provides for the issuance of nonqualified stock options to directors, officers and key employees. Up to 350,000 shares of common stock have been reserved for issuance under the 2001 Plan. In June 2002, the Company adopted the Nathan’s Famous, Inc. 2002 Stock Incentive Plan (the “2002 Plan”), which provides for the issuance of nonqualified stock options or restricted stock awards to directors, officers and key employees. Up to 300,000 shares of com- mon stock have been reserved for issuance under the 2002 Plan. The 1992 Plan expired with respect to the granting of new options on December 2, 2002. The 1998 Plan, the 2001 Plan, the 2002 Plan and the Directors’ Plan expire on April 5, 2008, June 13, 2011, June 17, 2012 and December 31, 2004, respectively, unless ter- minated earlier by the Board of Directors under conditions specified in the Plan. The Company issued 478,584 stock options to employees of Miami Subs Corporation to replace 957,168 of previously issued Miami Subs options pursuant to the merger agreement and issued 47,006 new options. All options were fully vested upon consumma- tion of the merger. Exercise prices range from a low of $3.1875 to a high of $18.6120 per share and expire at various times through September 30, 2009. 2. Warrants In November 1993, the Company granted to its Chairman and Chief Executive Officer a warrant to purchase 150,000 shares of the Company’s common stock at an exercise price of $9.71 per share, representing 105% of the market price of the Company’s common stock on the date of grant, which exercise price was reduced on January 26, 1996 to $4.50 per share. The shares vested at a rate of 25% per annum commencing November 1994 and the warrant expired, unexercised in November 2003. On July 17, 1997, the Company granted to its Chairman and Chief Executive Officer a warrant to purchase 150,000 shares of the Company’s common stock at an exercise price of $3.50 per share, representing the market price of the Company’s common stock on the date of grant. The shares vested at a rate of 25% per annum com- mencing July 17, 1998 and the warrant expires in July 2007. In November 1996, the Company granted to a nonemployee consultant a warrant to purchase 50,000 shares of its common stock at an exercise price of $3.94 per share, which represented the market price of the Company’s common stock on the date of grant. Upon the date of grant, one-third of the shares vested immediately, one-third vested on the first anniversary thereof, and the remaining one-third vested on the second anniversary thereof. The warrant expired, unexercised, on November 24, 2001. In connection with the merger with Miami Subs, the Company issued 579,040 warrants to purchase common stock to the former shareholders of Miami Subs. These warrants expire on September 30, 2004 and have an exercise price of $6.00 per share. The Company also issued 63,700 warrants to purchase common stock to the former warrant holders of Miami Subs, of which 18,750 remain outstanding as of March 28, 2004. The exercise price of these warrants is $16.55 per share and expire in March 2006. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty A summary of the status of the Company’s stock option plans and warrants, excluding the 579,040 warrants issued to former shareholders of Miami Subs, at March 28, 2004, March 30, 2003 and March 31, 2002 and changes during the fiscal years then ended is presented in the tables below: Options outstanding—beginning of year Granted Expired Options outstanding—end of year Options exercisable—end of year Weighted-average fair value of options granted Warrants outstanding—beginning of year Expired Warrants outstanding—end of year Warrants exercisable—end of year Weighted-average fair value of warrants granted 2004 Weighted- Average Exercise Price $ 4.01 4.03 11.67 3.92 $ 1.60 $ 4.62 4.50 4.73 $ — Shares 1,754,249 65,000 (40,563) 1,778,686 1,572,268 318,750 (150,000) 168,750 168,750 2003 2002 Weighted- Average Exercise Price $4.29 3.96 7.32 4.01 $2.19 $4.62 4.62 $ — Shares 1,821,146 40,000 (106,897) 1,754,249 1,502,124 318,750 — 318,750 318,750 Weighted- Average Exercise Price $3.86 3.20 6.20 4.29 $1.30 $4.53 3.94 4.62 $ — Shares 1,514,209 307,000 (63) 1,821,146 1,367,479 368,750 (50,000) 318,750 318,750 At March 28, 2004, 348,500 common shares were reserved for future stock option grants. The following table summarizes information about stock options and warrants (excluding the 579,040 warrants issued to the Miami Subs shareholders as part of the merger consideration) at March 28, 2004: Range of exercise prices $3.19 to $ 4.00 4.01 to 6.60 6.61 to 18.61 $3.19 to $18.61 Options and Warrants Outstanding Number Outstanding at 3/28/04 1,534,558 382,128 30,750 1,947,436 Weighted- Average Remaining Contractual Life Weighted- Average Exercise Price 4.9 1.7 1.3 4.2 $ 3.34 5.40 17.30 $ 3.99 Options and Warrants Exercisable Number Exercisable at 3/28/04 1,353,140 357,128 30,750 1,741,018 Weighted- Average Exercise Price $ 3.37 5.47 17.30 $ 4.04 3. Common Stock Purchase Rights On June 20, 1995, the Board of Directors declared a dividend distribution of one common stock purchase right (the “Rights”) for each outstanding share of Common Stock of the Company. The dis- tribution was paid on June 20, 1995 to the shareholders of record on June 20, 1995. The terms of the Rights were amended on April 6, 1998 and December 8, 1999. Each Right, as amended, entitles the registered holder thereof to purchase from the Company one share of the Common Stock at a price of $4.00 per share (the “Purchase Price”), subject to adjustment for anti-dilution. New Common Stock certificates issued after June 20, 1995 upon transfer or new issuance of the Common Stock will contain a notation incorporating the Rights Agreement by reference. The Rights are not exercisable until the Distribution Date. The Distribution Date is the earlier to occur of (i) ten days following a public announcement that a person or group of affiliated or associ- ated persons (an “Acquiring Person”) acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of the Common Stock, as amended, or (ii) ten business days (or such later date as may be determined by action of the Board of 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty-one Directors prior to such time as any person becomes an Acquiring Person) following the commencement, or announcement of an intention to make a tender offer or exchange offer by a person (other than the Company, any wholly-owned subsidiary of the Company or certain employee benefit plans) which, if consummated, would result in such person becoming an Acquiring Person. The Rights will expire on June 19, 2005, unless earlier redeemed by the Company. At any time prior to the time at which a person or group or affiliated or associated persons has acquired beneficial ownership of 15% or more of the outstanding shares of the Common Stock of the Company, the Board of Directors of the Company may redeem the Rights in whole, but not in part, at a price of $.001 per Right. In addition, the Rights Agreement, as amended, permits the Board of Directors, following the acquisition by a person or group of benefi- cial ownership of 15% or more of the Common Stock (but before an acquisition of 50% or more of Common Stock), to exchange the Rights (other than Rights owned by such 15% person or group), in whole or in part, for Common Stock, at an exchange ratio of one share of Common Stock per Right. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends. The Company has reserved 9,940,178 shares of Common Stock for issuance upon exercise of the Rights. 4. Stock Repurchase Plan On September 14, 2001, the Board of Directors of the Company authorized the repurchase of up to 1,000,000 shares of the Com- pany’s common stock. As part of the stock repurchase plan, on April 10, 2002, the Company repurchased 751,000 shares of the Company’s common stock for aggregate consideration of $2,741 in a private transaction with a stockholder. The Company completed its initial Stock Repurchase Plan at a cost of approximately $3,670 dur- ing the fiscal year ended March 30, 2003. On October 7, 2002, the Board of Directors of the Company authorized the repurchase of up to 1,000,000 additional shares of the Company’s common stock. Purchases of stock will be made from time to time, depending on market conditions, in open market or in privately negotiated transac- tions, at prices deemed appropriate by management. There is no set time limit on the purchases. The Company expects to fund these stock repurchases from its operating cash f low. Through March 28, 2004, 851,301 additional shares have been repurchased at a cost of approximately $3,251. 5. Employment Agreements The Company and its Chairman and Chief Executive Officer entered into a new employment agreement effective as of January 1, 2000. The new employment agreement expires December 31, 2004. Pursuant to the agreement, the officer receives a base salary of one dollar and an annual bonus equal to 5% of the Company’s consoli- dated pretax earnings for each fiscal year, with a minimum bonus of $250. The new employment agreement further provides for a three- year consulting period after termination of employment during which the officer will receive consulting payments in an annual amount equal to two thirds of the average of the annual bonuses awarded to him during the three fiscal years preceding the fiscal year of termination of his employment. The employment agreement also provides for the continuation of certain benefits following death or disability. In connection with the agreement, the Company issued to the officer 25,000 shares of common stock with a fair market value at the date of grant of approximately $78. In the event that the officer’s employment is terminated with- out cause, he is entitled to receive his salary and incentive payment, if any, for the remainder of the contract term. The employment agree- ment further provides that in the event there is a change in control of the Company, as defined therein, the officer has the option, exercis- able within one year after such an event, to terminate his employ- ment agreement. Upon such termination, he has the right to receive a lump sum payment equal to the greater of (i) his salary and annual bonuses for the remainder of the employment term (including a pro rated bonus for any partial fiscal year), which bonus shall be equal to the average of the annual bonuses awarded to him during the three fiscal years preceding the fiscal year of termination; or (ii) 2.99 times his salary and annual bonus for the fiscal year immediately preceding the fiscal year termination, as well as a lump sum cash payment equal to the difference between the exercise price of any exercisable options having an exercise price of less than the current market price of the Company’s common stock and such then current market price. In addition, the Company will provide the officer with a tax gross-up payment to cover any excise tax due. The Company and its President and Chief Operating Officer entered into an employment agreement on December 28, 1992 for a period commencing on January 1, 1993 and ending on December 31, 1996. The employment agreement has been extended annually through December 31, 2004, based on the original terms, and no nonrenewal notice has been given as of May 25, 2004. The agree- ment provides for annual compensation of $275 plus certain other 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty-two benefits. In November 1993, the Company amended this agreement to include a provision under which the officer has the right to termi- nate the agreement and receive payment equal to approximately three times annual compensation upon a change in control, as defined. The Company and the President of Miami Subs, pursuant to the merger agreement, entered into an employment agreement on September 30, 1999 for a period commencing on September 30, 1999 and ending on September 30, 2002. The agreement provides for annual compensation of $200 plus certain other benefits and automatically renews annually unless 180 days prior written notice is given to the employee. No nonrenewal notice has been given as of May 25, 2004. The agreement includes a provision under which the officer has the right to terminate the agreement and receive payment equal to approximately three times his annual compensation upon a change in control, as defined. In the event a nonrenewal notice is delivered, the Company must pay the officer an amount equal to the employee’s base salary as then in effect. The Company and one executive of Miami Subs entered into a change of control agreement effective November 1, 2001 for annual compensation of $130 per year. The agreement additionally includes a provision under which the executive has the right to terminate the agreement and receive payment equal to approximately three times his annual compensation upon a change in control, as defined. The Company and another executive of Miami Subs entered into an employment agreement effective August 1, 2001 for a period commencing on the date of the agreement and ended on September 30, 2003 and for compensation at $90 per year. The agreement also provided for certain other benefits. The agreement additionally included a provision under which the executive had the right to ter- minate the agreement and receive payment equal to the employee’s annual compensation upon a change in control, as defined. Upon termination of the employment agreement, this employee remained an employee of the Company. Each employment agreement terminates upon death or volun- tary termination by the respective employee or may be terminated by the Company upon 30-days’ prior written notice by the Company in the event of disability or “cause,” as defined in each agreement. 6. 401(k) Plan The Company has a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code covering all nonunion employees over age 21 who have been employed by the Company for at least one year. Employees may contribute to the plan, on a tax- deferred basis, up to 15% of their total annual salary. Company con- tributions are discretionary. Beginning with the plan year ending February 28, 1994, the Company elected to match contributions at a rate of $.25 per dollar contributed by the employee on up to a max- imum of 3% of the employee’s total annual salary. Employer contri- butions for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002 were $21, $25 and $36, respectively. 7. Other Benef its The Company provides, on a contributory basis, medical bene- fits to active employees. The Company does not provide medical benefits to retirees. Note L—Commitments and Contingencies 1. Commitments The Company’s operations are principally conducted in leased premises. The leases generally have initial terms ranging from 5 to 20 years and usually provide for renewal options ranging from 5 to 20 years. Most of the leases contain escalation clauses and common area maintenance charges (including taxes and insurance). Certain of the leases require additional (contingent) rental payments if sales volumes at the related restaurants exceed specified limits. As of March 28, 2004, the Company has noncancelable operating lease commitments, net of certain sublease rental income, as follows: 2005 2006 2007 2008 2009 Thereafter Lease Commitments Sublease Income Net Lease Commitments $ 3,871 3,682 3,485 2,855 1,904 3,643 $19,440 $ 2,075 1,990 1,895 1,593 1,089 2,512 $11,154 $1,796 1,692 1,590 1,262 815 1,131 $8,286 Aggregate rental expense, net of sublease income, under all current leases amounted to $1,584, $2,340 and $2,734 for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. The Company also owns or leases sites, which it in turn sub- leases to franchisees which expire on various dates through 2016 exclusive of renewal options. The Company remains liable for all lease costs when properties are subleased to franchisees. The Company also subleases locations to third parties. Such subleases provide for minimum annual rental payments by the Company aggregating approximately $2,081 and expire on various dates through 2010 exclusive of renewal options. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty-three Contingent rental payments on building leases are typically made based on the percentage of gross sales on the individual restaurants that exceed predetermined levels. The percentage of gross sales to be paid and related gross sales level vary by unit. Contingent rental expense was approximately $67, $88 and $129 for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. 2. Guarantees The Company guarantees certain equipment financing for fran- chisees with a third-party lender. The Company’s maximum obliga- tion, should the franchisees default on the required monthly payment to the third-party lender, for loans funded by the lender, as of March 28, 2004, was approximately $305. The equipment financing expires at various dates through fiscal 2008. The Company also guarantees a franchisee’s note payable with a bank. The note payable matures in fiscal 2007. The Company’s max- imum obligation, should the franchisee default on the required monthly payments to the bank, for loans funded by the lender, as of March 28, 2004, was approximately $261. The guarantees referred to above were entered into by the Company prior to December 31, 2002 and have not been modified since that date, which was the effective date for FIN 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of Others.” 3. Contingencies An employee of a Miami Subs franchised restaurant, com- menced an action for unspecified damages in the United States District Court, Southern District of Florida in January 2004 against Miami Subs Corporation, Miami Subs USA, Inc., Nadia M. Invest- ments, Inc. and DYV SYS International, Inc., both Miami Subs fran- chisees (“the franchisees”), claiming that he was not paid overtime when he worked in excess of 40 hours per week, in violation of the Fair Labor Standards Act. The action also seeks damages for any other employees of the defendants who would be similarly entitled to overtime. Pursuant to the terms of the Miami Subs Franchise Agreement, the franchisees are obligated to operate their Miami Subs franchises in compliance with the law, including all labor laws. Miami Subs intends to assert that it is not an appropriate party to this litiga- tion, to deny any liability to Plaintiff and defend against this action vigorously. An action has been commenced, in the Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida in September 2001 against Miami Subs and EKFD Corporation, a Miami Subs franchisee (“the franchisee”) claiming negligence in connection with a slip and fall which allegedly occurred on the premises of the fran- chisee for unspecified damages. Pursuant to the terms of the Miami Subs Franchise Agreement, the franchisee is obligated to indemnify Miami Subs and hold it harmless against claims asserted and procure an insurance policy which names Miami Subs as an additional insured. Miami Subs has denied any liability to plaintiffs and has made demand upon the franchisee’s insurer to indemnify and defend against the claims asserted. The insurer has agreed to indemnify and defend Miami Subs and has assumed the defense of this action for Miami Subs. Miami Subs has received a claim from a landlord for a franchised location that Miami Subs owes the landlord $150 in connection with the construction of the leased premises. Miami Subs has been the pri- mary tenant at the location since 1993, when the lease was assigned to Miami Subs by the initial tenant under the lease, the party to whom the construction loan was made. To date, the landlord has not commenced legal action. Miami Subs intends to continue to dispute its liability for the construction loan and to vigorously defend any legal action. Ismael Rodriguez commenced an action, in the Supreme Court of the State of New York, Kings County, in May 2004 against Nathan’s Famous, Inc. seeking damages of $1,000 for claims of age discrimination in connection with the termination of Mr. Rodriguez’s employment. Mr. Rodriguez was terminated from his position in connection with his repeated violation of company policies and fail- ure to follow Company-mandated procedures. Nathan’s Famous, Inc. intends to deny any liability and defend this action vigorously. Nathan’s Famous, Inc. has submitted this claim to its insurance car- rier with the expectation that it will be covered by its employment practices liability insurance policy. The Company is involved in various other litigation in the nor- mal course of business, none of which, in the opinion of management, will have a significant adverse impact on its financial position or results of operations. Note M—Related Party Transactions As of March 28, 2004, Miami Subs leased two restaurant proper- ties from Kavala, Inc., a private company owned by the estate of Gus Boulis, a former shareholder of Miami Subs. Future minimum rental commitments due to Kavala at March 28, 2004 under these existing leases was approximately $1,074. Rent expense under these two leases amounted to $206, $198 and $182 for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. Mr. Donald L. Perlyn has been an officer of Miami Subs since 1990, a Director since 1997 and President and Chief Operating Officer since July 1998. Mr. Perlyn has been a director of Nathan’s since October 1999. Mr. Perlyn served as a member of the Board of Directors of Arthur Treacher’s, Inc. until March 2002 when Arthur Treacher’s, Inc. was sold in a private transaction. Miami Subs has been granted certain exclusive co-branding rights by Arthur Treacher’s, Inc. and Mr. Perlyn had been granted options to acquire approximately 175,000 shares of Arthur Treacher’s, Inc. common stock. These options were converted into options of the entity that sold Arthur Treacher’s, Inc. A firm on which Mr. Howard M. Lorber serves as chairman of the board of directors, and the firm’s affiliates received ordinary and 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty-four customary insurance commissions aggregating approximately $26, $41 and $41 for the fiscal years ended March 28, 2004, March 30, 2003 and March 31, 2002, respectively. Note N—Significant Fourth Quarter Adjustments During the fourth quarter of fiscal 2004, the Company’s man- agement continued to monitor and evaluate the collectibility and potential impairment of its assets, in particular, notes receivable, certain fixed assets and certain intangible assets. In connection therewith, impairment charges on certain notes receivable of $108 and impair- ment charges on fixed assets of $25 were recorded in the fourth quarter. It is management’s opinion that these adjustments are properly recorded in the fourth quarter based upon the facts and circum- stances that became available in that period. During the fourth quarter of fiscal 2003, the Company’s man- agement continued to monitor and evaluate the collectibility and Note O—Quarterly Financial Information (Unaudited) potential impairment of its assets, in particular, notes receivable, cer- tain fixed assets and certain intangible assets. In connection therewith, impairment charges on certain notes receivable of $883 and impair- ment charges on fixed assets of $896 were recorded in the fourth quarter. It is management’s opinion that these adjustments are properly recorded in the fourth quarter based upon the facts and circum- stances that became available in that period. During the fourth quarter of fiscal 2002, the Company’s man- agement continued to monitor and evaluate the collectibility and potential impairment of its assets, in particular, notes receivable and certain fixed assets. In connection therewith, impairment charges on certain notes receivable of $185 and impairment charges on fixed assets of $685 were recorded in the fourth quarter. It is management’s opinion that these adjustments are properly recorded in the fourth quarter based upon the facts and circumstances that became available in that period. Fiscal Year 2004 Total revenues(a) Gross profit(b) Net income Per share information Net income per share Basic(c) Diluted(c) Shares used in computation of net income per share Basic(c) Diluted(c) Fiscal Year 2003 Total revenues(a) Gross profit(b) Net income (loss) Per share information Net income (loss) per share Basic(c) Diluted(c) Shares used in computation of net (loss) income per share Basic(c) Diluted(c) First Quarter $ 8,991 2,000 744 $ Second Quarter Third Quarter Fourth Quarter $8,703 1,955 $ 856 $6,511 1,026 $ 237 $ 6,474 1,009 57 $ $ $ .14 .14 $ $ .16 .15 $ $ .04 .04 $ $ .01 .01 5,370,000 5,313,000 5,286,000 5,255,000 5,478,000 5,593,000 5,742,000 5,901,000 $ 9,639 2,397 $(11,992) $9,516 2,665 $ 110 $7,493 1,674 $ (106) $ 7,124 1,434 $(1,980) $ $ (1.89) (1.89) $ $ .02 .02 $ (.02) $ (.02) $ $ (.36) (.36) 6,354,000 6,105,000 5,878,000 5,568,000 6,354,000 6,229,000 5,878,000 5,568,000 (a) Total revenues were adjusted from amounts previously reported to reflect a reclassification of rebates from cost of sales to sales. This reclassification had no impact on gross profit or net income. (b) Gross profit represents the difference between sales and cost of sales. (c) The sum of the quarters does not equal the full year per share amounts included in the accompanying consolidated statements of operations due to the effect of the weighted-average number of shares outstanding during the fiscal years as compared to the quarters. 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty-f ive Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders Nathan’s Famous, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of Nathan’s Famous, Inc. (a Delaware Corporation) and subsidiaries (the “Company”) as of March 28, 2004 and March 30, 2003, and the related consolidated statements of operations, stockholders’ equity and cash f lows for the fifty-two weeks ended March 28, 2004 and March 30, 2003 and the fifty-three weeks ended March 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and signif icant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nathan’s Famous, Inc. and subsidiaries as of March 28, 2004 and March 30, 2003, and the consolidated results of their oper- ations and their consolidated cash f lows for the fifty-two weeks ended March 28, 2004 and March 30, 2003 and the fifty-three weeks ended March 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Melville, New York May 26, 2004 2004 Annual Report Nathan’s Famous, Inc. & Subsidiaries page thirty-six Corporate Directory Nathan’s Famous, Inc. & Subsidiaries L I S T O F D I R E C T O R S Howard M. Lorber Chairman & Chief Executive Officer, Nathan’s Famous, Inc. Wayne Norbitz President & Chief Operating Officer, Nathan’s Famous, Inc. Donald L. Perlyn Executive Vice President, Nathan’s Famous, Inc. Robert J. Eide Chairman & Chief Executive Officer, AEGIS Capital Corp. Barry Leistner President & Chief Executive Officer, Koenig Iron Works, Inc. Brian Genson President, Pole Position Investments A.F. Petrocelli Chairman, President & Chief Executive Officer, United Capital Corp. Charles Raich Managing Partner, Raich, Ende, Malter & Co. LLP L I S T O F O F F I C E R S Howard M. Lorber Chairman & Chief Executive Officer Wayne Norbitz President & Chief Operating Officer Donald L. Perlyn Executive Vice President Carl Paley Senior Vice President—Franchise & Real Estate Development Ronald G. DeVos Vice President—Finance, Chief Financial Officer & Secretary Eric Gatoff Vice President—Corporate Counsel Randy Watts Vice President—Franchise Operations Donald P. Schedler Vice President—Development, Architecture & Construction I N D E P E N D E N T A U D I T O R S Grant Thornton, LLP 445 Broadhollow Road, Melville, New York 11747 C O R P O R A T E C O U N S E L Kramer, Coleman, Wactlar & Lieberman, P.C. 100 Jericho Quadrangle, Jericho, New York 11753 T R A N S F E R A G E N T American Stock Transfer & Trust Company 40 Wall Street, New York, New York 10005 F O R M 1 0 - K The Company’s annual report on Form 10-K as filed with the Securities and Exchange Commission, is available upon written request: Secretary, Nathan’s Famous, Inc. 1400 Old Country Road Westbury, New York 11590 Q U A R T E R L Y S H A R E H O L D E R L E T T E R Will be available on our website. Copies will be provided upon request. C O R P O R A T E H E A D Q U A R T E R S 1400 Old Country Road, Westbury, New York 11590 516-338-8500 Telephone 516-338-7220 Facsimile C O M P A N Y W E B S I T E www.nathansfamous.com Market for Registrant’s Common Stock and Related Stockholder Matters C O M M O N S T O C K P R I C E S D I V I D E N D P O L I C Y Our common stock began trading on the over-the-counter market on February 26, 1993 and is quoted on the Nasdaq National Market System (“Nasdaq”) under the symbol “NATH.” The following table sets forth the high and low closing share prices per share for the periods indicated: High Low Fiscal year ended March 28, 2004 First quarter Second quarter Third quarter Fourth quarter Fiscal year ended March 30, 2003 First quarter Second quarter Third quarter Fourth quarter $3.93 4.87 5.36 5.99 $ 4.31 4.00 3.82 3.70 $3.38 3.48 4.22 5.00 $ 3.35 3.07 3.04 3.50 At June 7, 2004, the closing price per share for our common stock, as reported by Nasdaq, was $5.80. Designed by Curran & Connors, Inc. / www.curran-connors.com We have not declared or paid a cash dividend on our common stock since our initial public offering and do not anticipate that we will pay any dividends in the foreseeable future. It is our Board of Directors’ policy to retain all available funds to finance the development and growth of our business and to purchase stock pursuant to our stock buyback program. The payment of cash dividends in the future will be dependent upon our earnings and financial requirements. S H A R E H O L D E R S As of June 7, 2004, we had 840 shareholders of record, excluding shareholders whose shares were held by brokerage firms, depositories and other institutional firms in “street name” for their customers. A N N U A L S H A R E H O L D E R S ’ M E E T I N G The Annual Meeting of Shareholders of the Company will be held at 10:00 a.m., EST on Thursday, September 9, 2004 in the Conference Room on the lower level of 1400 Old Country Road, Westbury, New York. 1400 Old Country Road, Suite 400 Westbury, New York 11590 www.nathansfamous.com 

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