Winmark Corporation — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 29, 2019. Financial statements are unaudited. Winmark franchises value-oriented resale retail brands and operates equipment-leasing businesses. At period-end, it had 1,249 franchised stores and a $33.0 million net leasing portfolio.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $17.4 million | $18.2 million | $35.7 million | $36.3 million |
| Operating income | $9.8 million | $10.1 million | $19.9 million | $20.1 million |
| Net income | $7.3 million | $7.1 million | $14.6 million | $14.1 million |
| Diluted EPS | $1.79 | $1.73 | $3.52 | $3.42 |
| Operating margin | 56.6% | 55.5% | 55.7% | 55.5% |
| Net margin | 42.0% | 39.3% | 40.8% | 38.8% |
- Revenue decreased 4.2% for the quarter and 1.6% for the six-month period. Royalties rose 7.0% in Q2 and 6.8% year to date, attributed to higher franchisee retail sales and additional stores. Leasing income fell 34.0% in Q2 and 19.5% year to date, reflecting a smaller portfolio and lower equipment sales to customers.
- Q2 operating income declined 2.3%, while net income increased 2.2%; for six months, operating income declined 1.2% and net income rose 3.3%. Lower interest expense and effective tax rates supported earnings. Effective tax rates were 21.8% in Q2 and 23.2% year to date.
- Franchising segment contribution increased to $8.5 million in Q2 and $15.9 million for six months. Leasing segment contribution declined to $1.4 million and $4.0 million, respectively.
Cash flow, liquidity and capital
- Six-month operating cash flow was $23.7 million, versus $18.4 million a year earlier. The comparison is affected by lease-accounting presentation: $9.5 million of lease principal collections were classified as operating cash flow in 2019, but investing cash flow in 2018.
- Investing activities used $5.8 million, principally $5.7 million of equipment purchases for lease customers. Financing activities used $19.3 million, including the $24.0 million share tender offer and $1.5 million of dividends; net line-of-credit borrowings partly funded the tender offer.
- Cash and restricted cash totaled $1.2 million at June 29, 2019. Current assets were $21.2 million and current liabilities $12.1 million. The company reported $44.0 million available on its $50.0 million revolving credit facility.
- Debt included $6.0 million outstanding on the revolving line and $27.3 million of principal outstanding on Series A and B notes. The notes bear fixed rates of 5.50% and 5.10%; line borrowings bore rates of 4.60%–5.50%. Discounted lease rentals were a further $4.9 million liability, at a weighted-average rate of 6.30%. The company was in compliance with debt covenants.
- Shareholders’ deficit widened to $13.8 million from $4.8 million at year-end, largely reflecting the $24.0 million tender offer. The company repurchased 150,000 shares at $159.63 per share and paid $1.5 million of dividends in the first half.
Outlook, risks and notable items
- Management said cash on hand, franchising cash flows, lease-discounting sources and the credit line should fund planned operations through 2020. It expects to fund expenses, leasing activity and debt service primarily from operating cash flow, with other financing options available if needed. No earnings or revenue guidance was provided.
- Leasing equipment purchases fell to $5.7 million from $12.9 million in the prior-year half, and the leasing portfolio declined from $39.0 million at year-end. Management attributed these changes to lower equipment purchases by one customer. Leased assets with one customer represented approximately 16% of total assets.
- A 1% increase in short-term rates would reduce annual pretax earnings by an estimated $60,000; no interest-rate derivatives were in place. The company also cited potential difficulty refinancing, borrowing or raising capital if cash flows or credit-market access weaken.
- Adoption of the new lease standard on December 30, 2018 resulted in recognition of $6.0 million of operating lease right-of-use assets and $6.3 million of lease liabilities, with no material impact on operating results or equity. No material litigation, material changes to previously disclosed risk factors, or off-balance-sheet arrangements were reported.
- Franchise activity was positive: 13 stores opened and five closed in the first half; 44 of 46 agreements available for renewal were renewed.
Important facts for investors to verify
- Whether franchisee sales and royalty growth can continue to offset declining leasing revenue and segment contribution.
- The leasing customer concentration, future equipment purchases and credit performance of the $33.0 million lease portfolio.
- Cash generation and debt-service capacity given the tender-offer repurchase, ongoing dividends, debt maturities and credit-facility commitment reductions.
- The cash-flow trend using comparable classification after the lease-accounting change, and availability of the stated financing sources through 2020.