Winmark Corporation — 2015 Second-Quarter Form 10-Q
Business and period: The filing covers the quarter and six months ended June 27, 2015. Winmark franchises five value-oriented retail brands and operates middle-market and small-ticket equipment-leasing businesses. It reported 1,116 franchised stores and a $38.7 million net leasing portfolio at quarter-end.
Financial performance
| Metric | Three months ended June 27, 2015 | Year-over-year change | Six months ended June 27, 2015 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $15.48 million | +10.2% | $36.50 million | +27.7% |
| Income from operations | $8.08 million | +14.0% | $18.06 million | +24.3% |
| Net income | $4.75 million | +11.0% | $10.81 million | +22.3% |
| Diluted EPS | $1.00 | vs. $0.82 | $2.18 | vs. $1.67 |
| Operating margin | 52.2% | vs. 50.5% | 49.4% | vs. 50.8% |
| Net margin | 30.7% | vs. 30.5% | 29.6% | vs. 30.9% |
Revenue drivers: Royalties increased 11.0% in the quarter and 10.7% for the six-month period, reflecting additional Plato’s Closet and Once Upon A Child stores and higher franchisee retail sales. Six-month leasing income rose to $13.67 million from $7.53 million, primarily due to higher equipment sales to customers. Leasing expense also rose substantially, to $4.77 million from $0.43 million for the six months. Management cautions that leasing income and expense timing varies with lease accounting. SG&A increased 2.4% year over year for the six months. Franchise fees declined, partly because fewer stores opened.
Cash flow, debt and liquidity
- Six-month operating cash flow was $12.80 million, versus $7.60 million a year earlier; management attributed the increase primarily to higher net income and lower cash income-tax payments.
- Investing activities provided $5.37 million, including $16.61 million in lease-receivable collections and $11.42 million in equipment purchases for lease customers.
- Financing activities used $19.14 million. The company ended the period with $1.12 million in cash, compared with $2.09 million at December 27, 2014.
- At June 27, borrowings included $49.1 million on the revolving credit line and $25.0 million in Prudential notes (carrying amount approximately $24.9 million after issuance costs). The revolver had a $60.0 million commitment, leaving $10.9 million available. Revolver rates were 2.44%–3.25%; the notes bear 5.50% interest, mature in 10 years and require quarterly principal payments.
- Management said cash on hand, franchising cash flow, lease-discounting sources and the credit line should fund planned operations through 2016. The company was in compliance with debt covenants at quarter-end.
Material changes, outlook and risks
- Tender offer and leverage: Winmark repurchased 875,000 shares at $84.72 per share in a tender offer, costing approximately $74.3 million including fees. It partly financed the offer with increased revolving borrowings and a $25 million Prudential note issuance. Shareholders’ equity consequently moved from $21.61 million to a $41.48 million deficit; outstanding shares fell to 4,128,031 from 4,998,512 at year-end.
- Leasing portfolio and credit: Net investment in leases declined to $38.71 million from $44.02 million at year-end. The six-month credit-loss provision was a $162,200 credit, reflecting net recoveries of $621,000. Three leasing customers represented approximately 17%, 15% and 13% of total assets, respectively. No lease balances were reported as delinquent or on non-accrual at quarter-end.
- Rate exposure: All $49.1 million outstanding on the revolver was subject to short-term rate changes. A one-percentage-point rate increase would reduce annual pretax earnings by an estimated $491,000. No interest-rate derivatives were in place.
- Other operating indicators: Winmark opened 32 stores and closed eight in the first six months. It renewed 41 of 42 franchise agreements available for renewal. Management identifies franchisee support, new openings, lease originations and loss control, and SG&A discipline as key to operating-income growth.
- Forward-looking matters: Management’s liquidity outlook depends on future operating performance and access to financing. If cash is insufficient for debt service, refinancing, asset sales, additional borrowing or equity issuance may be needed and may not be available on acceptable terms. The filing reports no material litigation, no off-balance-sheet arrangements, and no material changes to previously disclosed risk factors apart from increased leverage. Revenue and operating results for the first half are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether franchise royalties and store growth continue to offset slower franchise-fee revenue and support operating margins.
- Whether leasing originations, portfolio size, recoveries and customer concentrations develop as expected; leasing results can be affected by timing and credit performance.
- Debt-service capacity, covenant headroom, the availability and cost of refinancing, and exposure to floating short-term rates after the tender-offer financing.
- The effect of the large share repurchase on per-share results and the company’s equity position; confirm the remaining authorization of 166,700 shares.
- The expected impact of the pending revenue-recognition standard; management was evaluating its effect and expected adoption beginning in fiscal 2018.