Winmark Corporation — Q2 2011 Form 10-Q
Business context and period: The unaudited report covers the quarter and six months ended June 25, 2011, compared with the periods ended June 26, 2010. Winmark franchises four resale retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 908 franchised stores and a $29.9 million net leasing portfolio at quarter-end.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $15.22 million | $9.88 million | $26.33 million | $19.72 million |
| Operating income | $6.08 million | $4.20 million | $11.30 million | $8.00 million |
| Net income | $3.40 million | $2.34 million | $6.43 million | $4.52 million |
| Diluted EPS | $0.65 | $0.45 | $1.23 | $0.87 |
| Operating margin | 40.0% | 42.5% | 42.9% | 40.5% |
| Net margin | 22.3% | 23.7% | 24.4% | 22.9% |
- Q2 revenue rose 54%, led by leasing income of $7.0 million versus $2.3 million; leasing expense also rose, to $3.34 million from $0.44 million. Six-month leasing income net of leasing expense was $6.4 million versus $3.9 million.
- Royalties grew 7.1% in Q2 and 9.0% for six months, mainly reflecting higher sales at Plato’s Closet and Once Upon A Child. Franchise fees declined as fewer stores opened. Six-month merchandise sales increased 27.7%.
- Q2 operating income rose 45% and net income rose 45%. Six-month operating income increased 41% and net income 42%. The Q2 operating margin declined despite higher earnings, with leasing expense rising faster than revenue; the six-month margin improved.
- Six-month SG&A increased 1.5% to $9.88 million. The credit-loss provision was $21,300 versus $11,900; net lease write-offs were $83,600 versus $204,900.
Cash, liquidity and capital
- Six-month operating cash flow was $11.28 million, up from $6.60 million. Investing activities used $1.00 million, including $10.95 million of lease-equipment purchases largely offset by $10.91 million of lease principal collections and a $1.0 million Tomsten investment. Financing activities used $11.50 million.
- Cash was $1.04 million at June 25, 2011, compared with $2.26 million at December 25, 2010. The filing cites a 1.6-to-1 current ratio at quarter-end. Operating cash flow included a $1.7 million benefit from changes in income taxes payable/receivable.
- No line-of-credit borrowings were outstanding. The $30 million facility was fully available, subject to borrowing-base limits; the company reported compliance with covenants. Discounted lease rentals totaled approximately $213,000, including current and long-term amounts.
- The company repurchased 94,099 shares for $3.31 million during the first half and paid $249,200 in dividends. It reported no off-balance-sheet arrangements.
Material developments, outlook and risks
- Winmark recorded a $252,900 impairment charge on its BridgeFunds notes and stopped accruing interest on the investment in September 2010. The net investment was $1.75 million at June 25; the company received no principal payments in the first half. In July 2011, the notes’ maturity was extended to June 30, 2012.
- Winmark invested an additional $1.0 million in Tomsten in June, increasing its ownership to 22.0%. It recorded a $219,900 share of Tomsten’s losses for the first half.
- One leasing customer represented approximately 15% of total assets. The lease portfolio’s allowance for credit losses was $845,500. Management notes that leasing income and expense can vary substantially with the timing and accounting recognition of individual leases.
- Management said cash on hand, franchise cash generation, lease discounting and the credit line should fund planned operations through 2012. This is an outlook statement, not earnings guidance; the filing cautions that interim results are not necessarily indicative of full-year results.
- Management identified growth drivers as supporting franchisee sales, opening franchises, increasing lease originations while limiting write-offs, and controlling SG&A. All 42 franchise agreements available for renewal in the first half were renewed; 12 stores opened and seven closed. The 15 Wirth Business Credit territories were terminated in Q1.
- The company reported no material litigation and no material changes to the risk factors in its prior Form 10-K. Key exposures include lease-credit losses, the recoverability of private-company investments, franchisee performance, and interest-rate risk if the credit line is drawn.
Important facts for investors to verify
- Whether the leasing revenue and profit trend is sustainable, given management’s warning about timing effects and the decline in total net lease investment from $30.7 million at year-end to $29.9 million.
- BridgeFunds’ expected cash flows, valuation assumptions, and ability to repay by the amended June 30, 2012 maturity.
- Tomsten’s operating performance and the carrying value of Winmark’s investment, including the goodwill component.
- The financial condition and payment performance of the customer representing about 15% of total assets, and the adequacy of the lease-loss allowance.
- Cash needs, borrowing-base availability, and covenant headroom if franchise or leasing cash flows weaken.