Winmark Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 29, 2013; comparisons are to the periods ended June 30, 2012. Winmark franchises resale retail concepts and operates middle-market and small-ticket equipment leasing businesses. At quarter-end it had 986 franchised stores and a $37.2 million net lease portfolio.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Revenue | $14.0 million | $12.2 million | $27.2 million | $24.0 million |
| Operating income | $7.1 million | $6.0 million | $13.7 million | $11.9 million |
| Operating margin | 50.3% | 49.4% | 50.5% | 49.4% |
| Net income | $4.3 million | $3.4 million | $8.4 million | $6.9 million |
| Diluted EPS | $0.83 | $0.65 | $1.61 | $1.31 |
Revenue grew 15.0% in Q2 and 13.1% in the first half; net income rose 27.4% and 21.3%, respectively. First-half franchising revenue was $19.6 million and leasing revenue was $7.5 million. Segment contribution was $9.7 million from franchising and $4.1 million from leasing.
Royalty revenue increased 11.9% in Q2 and 6.9% in the first half, reflecting more Plato’s Closet and Once Upon A Child stores and higher sales at those franchisees. Leasing income rose, primarily from a larger portfolio and leases classified as sales-type; leasing expense also increased. SG&A increased 12.6% in Q2 and 10.2% in the first half, mainly due to compensation, benefits and advertising, including costs associated with launching Style Encore. Merchandise sales declined as franchisees purchased less technology.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was $9.7 million, compared with $8.3 million a year earlier. Investing activities used $1.8 million, including $10.2 million of lease-equipment purchases and $8.5 million of lease-receivable collections. Financing activities used $8.0 million, including $8.8 million of net line-of-credit repayments, $0.8 million of share repurchases and $0.45 million of dividends.
- Cash was $2.0 million at June 29, 2013, down $0.2 million from year-end. Current assets were $20.8 million and current liabilities $11.3 million; the company reported a current ratio of 1.8 to 1.0.
- Line-of-credit borrowings were $2.0 million at 3.75%, with $33.0 million available under the $35.0 million facility. The facility matures February 29, 2016, is secured by substantially all assets, and the company reported covenant compliance.
- Net investment in leases totaled $37.2 million, up from $36.2 million at year-end. Lease rentals discounted with financial institutions are also recorded as liabilities; the filing reports $0.9 million current and $0.4 million long-term. Total shareholders’ equity was $27.0 million.
Outlook, risks and unusual items
Management said cash on hand, franchising cash flow, lease-discounting sources and the credit facility should fund planned operations through 2014. This is a liquidity assessment, not earnings guidance; the filing gives no specific revenue or profit forecast. Management cautioned that interim results are not necessarily indicative of full-year results.
Tomsten, Inc., in which Winmark had invested $8.5 million for a 22% interest, filed for Chapter 11 reorganization on April 29, 2013. Winmark had fully impaired the investment in 2012 and carried it at zero; there was no further equity-investment loss in 2013. A separate $2.0 million BridgeFunds note investment was also impaired and carried at zero, with no cash flows expected. Leasing credit risk and the estimates used in lease-loss allowances, royalty recognition and investment impairment remain relevant; management reported no non-accrual leases at June 29. Interest-rate sensitivity was estimated at a $20,000 annual pretax earnings reduction for a 1 percentage-point rate increase on then-outstanding borrowings. No material litigation or material changes to previously disclosed risk factors were reported.
Winmark had 37 franchise openings and 19 closings in the first half, reaching 986 stores; 45 of 48 agreements available for renewal were renewed. It paid quarterly dividends of $0.04 and $0.05 per share and repurchased 13,288 shares for $0.8 million during the first half.
Important facts for investors to verify
- Whether franchisee retail sales, openings and renewals sustain royalty growth, and how the new Style Encore concept affects expenses and results.
- Lease originations, equipment purchases, portfolio growth, collections, delinquency trends and the adequacy of the $0.8 million lease credit-loss allowance.
- Availability and terms of discounted lease financing and compliance with credit-facility covenants, particularly as the business funds lease growth.
- Whether management’s stated liquidity coverage through 2014 remains supported by operating cash generation and available borrowing capacity.
- The status and potential recoveries, if any, from the impaired Tomsten and BridgeFunds investments.