Business context and reporting period
Winmark Corporation’s fiscal 2014 Form 10-K covers the 52-week year ended December 27, 2014; the filing also reports unaudited fourth-quarter results. Winmark franchises five value-oriented resale retail brands and operates middle-market equipment leasing and small-ticket financing businesses. It had 1,092 franchised stores and a $44.0 million net leasing portfolio at year-end.
Key financial results
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Revenue | $61.2 million | $55.7 million | +9.8% |
| Operating income | $33.1 million | $29.8 million | +11.0% |
| Net income | $20.1 million | $18.2 million | +10.1% |
| Diluted EPS | $3.85 | $3.48 | +10.6% |
| Operating margin | 54.0% | 53.5% | +0.5 percentage points |
| Net cash from operations | $18.0 million | $21.6 million | Down $3.7 million |
Royalties, the largest revenue source, rose 7.2% to $39.0 million. Leasing income rose 11.9% to $16.2 million; leasing segment contribution increased 19.1% to $9.4 million. Franchising segment contribution increased 8.1% to $23.6 million. SG&A rose 7.2% to $23.8 million, primarily due to compensation and benefits. The effective income tax rate was 38.4%, unchanged from 2013.
In fourth-quarter 2014, revenue was $16.2 million versus $13.8 million a year earlier; operating income was $9.4 million versus $7.5 million; net income was $5.6 million versus $4.6 million; and diluted EPS was $1.09 versus $0.87.
Cash, debt and liquidity
Year-end cash and cash equivalents fell to $2.1 million from $10.6 million. Operating activities provided $18.0 million; investing activities used $7.1 million; and financing activities used $19.5 million. Cash paid for income taxes increased to $16.2 million from $10.1 million. Equipment purchases for lease customers were $27.5 million, while principal collections on lease receivables were $20.7 million.
Debt under the revolving credit facility was $18.5 million, compared with no year-end borrowings in 2013. The $35.0 million facility expires February 28, 2018, leaving $16.5 million available at year-end; borrowings bore rates of 2.41%–3.25%. The company was in compliance with its covenants. The debt is classified as current because Winmark can repay it within one year. Working capital was negative $0.6 million, versus positive $20.2 million, largely reflecting that classification and the year’s capital returns.
Material changes, outlook and risks
- Winmark paid a $5.00-per-share special dividend totaling $25.8 million, in addition to $1.2 million of quarterly dividends, and repurchased 166,030 shares for $11.6 million. Net line-of-credit borrowings were associated in part with these capital returns.
- The franchise network grew from 1,005 to 1,092 stores: 95 opened and eight closed. Of 88 agreements eligible for renewal, 87 were renewed. Management reported 105 signed retail franchise agreements and expected approximately 90 to open in 2015.
- Management stated that cash, franchising cash generation, lease-discounting sources and the credit facility should be adequate to fund planned operations, including leasing activity, through 2015. No quantified earnings or revenue guidance was provided.
- Style Encore remained an early-stage concept, with 24 stores operating and 36 awarded but not yet open. The company cautioned that the concept may not succeed.
- Key risks include franchise renewals and openings, the availability of quality used merchandise, intense retail and leasing competition, lease defaults and adequacy of credit-loss reserves, economic weakness affecting small and leveraged business customers, and credit-facility covenant and counterparty risks. Two leasing customers represented approximately 15% and 10% of total assets, respectively.
- The lease portfolio grew to $44.0 million from $37.5 million. The allowance for credit losses declined to $386,000 from $823,000, with $606,500 of write-offs in 2014; the filing reports no delinquent or non-accrual leases at year-end. Assess credit quality and allowance sufficiency alongside portfolio growth.
- Tomsten and BridgeFunds investments had been written down to zero in 2012; Tomsten was in Chapter 11 proceedings. No additional impairment charges were recorded in 2013 or 2014. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether 2015 franchise openings and renewal rates met management’s expectations, particularly for the developing Style Encore brand.
- Whether lease originations, customer concentrations, delinquencies, write-offs and the credit-loss allowance support continued growth in leasing income.
- How liquidity and covenant headroom evolved after the special dividend, share repurchases and $18.5 million of year-end borrowings.
- Whether operating cash flow recovered after higher tax payments and lower year-end cash balances.
- The future dividend and repurchase policy, which is discretionary and subject to financial condition, cash needs and loan covenants.