Winmark Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 30, 2019; comparisons are with the three months ended March 31, 2018 unless otherwise noted. Winmark franchises five value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 1,241 franchised stores and a $35.1 million net leasing portfolio at quarter-end. The interim financial statements are unaudited.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $18.33 million | $18.16 million | Up 0.9% |
| Operating income | $10.07 million | $10.07 million | Essentially flat |
| Net income | $7.27 million | $6.96 million | Up 4.5% |
| Basic / diluted EPS | $1.86 / $1.73 | $1.81 / $1.69 | Higher |
| Operating margin | 54.9% | 55.5% | Down 0.6 percentage points |
| Net margin | 39.7% | 38.3% | Up 1.4 percentage points |
| Cash provided by operating activities | $14.17 million | $10.30 million | Up $3.87 million |
Royalties were $11.76 million, up 6.4%, attributed mainly to higher franchisee retail sales and additional stores. Leasing income fell to $5.16 million from $5.53 million; merchandise sales declined to $0.61 million from $0.78 million. SG&A increased 4.3% to $6.98 million, mainly from sales-related compensation. Interest expense declined to $0.44 million from $0.74 million, primarily reflecting lower average corporate borrowings. The effective tax rate was 24.4%, versus 25.4%.
Franchising segment contribution rose to $7.50 million from $6.79 million, while leasing segment contribution fell to $2.57 million from $3.28 million. Leasing income net of leasing expense was $4.46 million, compared with $4.97 million. The credit-loss provision was $10,100, versus $95,000; the ending lease-loss allowance was $651,400, and no lease investment was reported delinquent or on non-accrual at March 30, 2019.
Cash, debt and liquidity
Cash, cash equivalents and restricted cash totaled $1.13 million at quarter-end, down from $1.91 million a year earlier. Operating cash flow included $4.66 million of lease principal collections classified as operating activities after adoption of the new lease standard; comparable 2018 collections were classified as investing activities. Accordingly, the reported increase in operating cash flow is not directly comparable. Investing activities used $1.84 million, including $1.72 million for lease equipment. Financing activities used $13.77 million, including the share repurchase and dividends.
At March 30, 2019, the company had $11.5 million drawn on its $50 million revolving credit facility, leaving $38.5 million available; the drawn balance bore interest at 5.50%. Notes payable had approximately $28.1 million of principal outstanding ($17.5 million Series A and $10.6 million Series B), with stated rates of 5.50% and 5.10%. The balance sheet carried $28.03 million of notes payable net of issuance costs. Discounted lease-rental liabilities were approximately $5.01 million, financed on a non-recourse basis at a 6.43% weighted-average rate. The company reported covenant compliance. Its line of credit is secured by substantially all assets and terminates in July 2021.
Current assets were $20.98 million and current liabilities $14.11 million. The balance sheet also reflected $6.06 million in operating lease right-of-use assets and $5.82 million in long-term operating lease liabilities; adoption of the lease standard resulted in approximately $6.0 million of right-of-use assets and $6.3 million of lease liabilities. Shareholders’ deficit was $21.50 million, following the company’s substantial tender-offer repurchase.
Material changes and notable items
- In March, Winmark completed a self-tender for 150,000 shares at $159.63 per share, for approximately $24.0 million including fees. It was partly financed with net revolver borrowings. The company paid a $0.15-per-share quarterly dividend, totaling $0.59 million.
- Lease-equipment purchases fell to $1.72 million from $6.20 million, and the lease portfolio declined from $39.0 million at December 29, 2018 to $35.1 million. Management attributed the decline to lower purchases by two customers.
- Four franchises opened and four closed; all 26 agreements available for renewal were renewed.
- Winmark adopted lease accounting Topic 842 prospectively in fiscal 2019. Management said adoption did not materially affect the income statement or shareholders’ equity; it changed the cash-flow classification of lease principal collections.
Outlook, risks and contingencies
No specific earnings or revenue guidance was provided. Management expected cash on hand, franchising cash flows, discounted lease financing and the line of credit to fund planned operations through 2019. It cautioned that results are not necessarily indicative of the full year and that debt-service capacity depends on future performance and access to financing. Key operating priorities include supporting franchisee sales, opening franchises, growing lease originations, limiting write-offs and controlling SG&A.
Risk considerations include customer and portfolio concentration: leased assets with two customers represented approximately 19% and 10% of total assets, respectively. A 1 percentage-point increase in short-term rates was estimated to reduce annual pretax earnings by $115,000 on the then-outstanding revolver borrowings; the company had no interest-rate derivatives. Management reported no material change to the risk factors in its 2018 Form 10-K, no material litigation, and no off-balance-sheet arrangements. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Investor verification points
- Assess whether the royalty growth and 100% renewal rate can continue, and track franchise openings, closures and franchisee sales.
- Monitor lease originations, portfolio contraction, leasing-segment contribution and customer concentration, including subsequent customer purchases and credit performance.
- Reconcile operating cash-flow growth against the lease-collection classification change before treating it as underlying improvement.
- Evaluate the $24.0 million tender offer, resulting leverage, remaining repurchase authorization of 130,604 shares and the company’s negative shareholders’ equity.
- Confirm borrowing availability, covenant compliance, debt repayment requirements and sensitivity to interest rates as financing needs evolve.