Winmark Corporation 10-Q Summary: Period Ended June 30, 2007
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2007, and the six months ended June 30, 2007. Winmark Corporation operates two primary segments: franchising (brands include Play It Again Sports, Once Upon A Child, Plato's Closet, Music Go Round, and Wirth Business Credit) and equipment leasing (Winmark Capital Corporation and Wirth Business Credit). As of June 30, 2007, the company operated 869 franchises and territories.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2007 | Six Months Ended July 1, 2006 |
|---|---|---|
| Total Revenue | $15,189,500 | $13,246,600 |
| Net Income | $1,209,400 | $1,763,700 |
| Earnings Per Share (Diluted) | $0.21 | $0.29 |
| Operating Cash Flow | $2,217,500 | $1,733,100 |
| Cash and Equivalents (End of Period) | $1,550,300 | $1,343,200 |
| Line of Credit Outstanding | $12,500,000 | $600,000 |
| Renewable Subordinated Notes | $14,740,100 | $12,138,600 (Long-term only) |
| Current Ratio | 0.73 | 0.63 |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 14.7% year-over-year to $15.2 million. Leasing income surged 158% to $1.77 million due to a larger lease portfolio. Royalties increased 5.0% to $10.0 million, driven by 26 additional Plato's Closet stores and higher franchisee sales.
- Profitability Decline: Despite revenue growth, Net Income decreased 31.4% to $1.21 million. This was primarily due to a 493% increase in interest expense ($720,600 vs. $121,400) resulting from increased borrowings to fund the leasing portfolio and stock repurchases.
- Expense Increases: Selling, General, and Administrative (SG&A) expenses rose 15.5% to $10.1 million, attributed to higher salaries (including costs related to leasing staff departures), outside services, and credit loss provisions.
- Segment Performance: The Franchising segment contribution decreased slightly by 2.5% to $4.05 million. The Leasing segment operating loss improved by 2.8% to a loss of $1.63 million, as increased income partially offset higher direct costs.
Outlook, Risks, and Unusual Items
- Liquidity Strategy: The company utilized a $20 million credit facility, drawing $12.5 million to fund leasing growth and stock repurchases. Management believes cash from operations and available credit are adequate for 2007 needs.
- Stock Repurchases: The company repurchased 268,205 shares for $4.77 million during the six-month period. Approximately 227,253 shares remain available under the current plan.
- Related Party Transactions: CEO John L. Morgan purchased $900,000 in subordinated notes during the period. The company also repurchased shares from former executives and directors.
- Executive Changes: Mark T. Hooley, President of Wirth Business Credit, resigned in April 2007 and transitioned to a consultant role.
- Risk Factors: The company faces interest rate risk on its variable-rate line of credit. A 1% increase in rates would reduce annual pretax earnings by $125,000. Additionally, the leasing segment carries credit risk, with an allowance for credit losses of $687,400.
Investor Verification Checklist
- Debt Servicing: Verify the sustainability of the $12.5 million line of credit draw and the $14.7 million in subordinated notes given the 493% spike in interest expense.
- Leasing Portfolio Quality: Review the allowance for credit losses ($687,400) and the provision for credit losses ($253,600) to assess the health of the rapidly expanding leasing segment.
- Franchise Growth vs. Costs: Confirm that the 36 new franchise openings and 12 renewals will generate sufficient royalty growth to offset the rising SG&A expenses.
- Stock Repurchase Impact: Assess the impact of the $4.8 million in share buybacks on long-term liquidity and capital allocation priorities.
- Related Party Note Terms: Review the specific terms and voting rights associated with the subordinated notes purchased by the CEO and other insiders.