Winmark Corporation 10-Q Summary: Period Ended July 1, 2006
Business Context and Reporting Period
This Form 10-Q covers the quarterly and six-month periods ended July 1, 2006, for Winmark Corporation. The Company 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 and Wirth Business Credit). As of July 1, 2006, the Company operated 819 franchises.
Key Financial Metrics
| Metric | Six Months Ended July 1, 2006 | Six Months Ended June 25, 2005 |
|---|---|---|
| Total Revenue | $13,246,600 | $13,508,500 |
| Net Income | $1,763,700 | $1,242,500 |
| Earnings Per Share (Diluted) | $0.29 | $0.19 |
| Operating Cash Flow | $1,733,100 | $2,226,100 |
| Cash and Equivalents (End of Period) | $1,343,200 | $6,725,800 |
| Current Ratio | 0.63 | 3.40 |
| Debt Outstanding | $14,720,000 | $0 (Line of Credit) |
Note: Debt includes $11.0 million on the line of credit and $3.72 million in renewable unsecured subordinated notes.
Material Changes vs. Prior Period
- Revenue Mix Shift: Total revenue decreased slightly by 1.9% year-over-year. However, Royalties increased 9.1% and Franchise Fees increased 62.8%, driven by new store openings. Conversely, Merchandise Sales dropped 47.3% due to the strategic decision to have franchisees purchase directly from vendors and the elimination of Company-owned retail stores in 2005.
- Leasing Segment Growth: Leasing income surged 345% to $686,700 due to a larger portfolio ($13.3 million). However, the segment reported an operating loss of $1.07 million due to $1.76 million in startup direct costs.
- Profitability: Net income increased 41.9% to $1.76 million, primarily driven by a $360,000 gain on the redemption of preferred stock in Commercial Credit Group, Inc., and improved royalty margins.
- Liquidity Position: Cash reserves declined significantly from $6.7 million to $1.3 million. This was driven by $12.2 million in stock repurchases and $8.25 million in equipment purchases for leasing, partially offset by $14.7 million in new borrowings.
Guidance, Outlook, and Risks
Management Commentary: Management views the leasing segment losses as temporary startup costs. The Company expects cash generated from operations and existing credit facilities to be adequate for 2006 operations. The Company has a "shelf registration" for up to $50 million in subordinated notes to fund future growth and debt paydown.
Risks and Contingencies:
- Liquidity Risk: The current ratio dropped to 0.63, indicating current liabilities exceed current assets, largely due to the drawdown of the line of credit.
- Interest Rate Risk: The Company has $11.0 million in variable-rate debt. A 1% increase in rates would reduce annual pretax earnings by $110,000.
- Investment Concentration: $11.5 million is held in illiquid long-term investments in private companies (Tomsten, CCG, BridgeFunds).
Investor Verification Checklist
- Debt Covenants: Verify compliance with the amended Credit Facility covenants (tangible net worth, interest coverage, leverage ratio) given the significant drawdown of the $11 million line of credit.
- Leasing Segment Viability: Monitor the leasing segment's ability to transition from startup losses to profitability as the portfolio matures.
- Stock Repurchase Status: Confirm the remaining capacity under the repurchase plan (only 458 shares remain authorized).
- Related Party Transactions: Review the $9.9 million repurchase from Rush River Group (controlled by the CEO) and the $1.5 million note purchase by the CEO.