Winmark Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 26, 2015; comparisons are with the periods ended September 27, 2014. The unaudited filing covers a franchising business and equipment-leasing operations. At quarter-end, Winmark had 1,133 franchised stores and a $40.3 million net leasing portfolio.
Financial highlights
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $16.0 million | $16.4 million | $52.5 million | $45.0 million |
| Operating income | $9.3 million | $9.2 million | $27.4 million | $23.7 million |
| Net income | $5.3 million | $5.6 million | $16.1 million | $14.5 million |
| Diluted EPS | $1.23 | $1.09 | $3.39 | $2.76 |
| Operating margin | 58.4% | 56.0% | 52.2% | 52.7% |
| Net margin | 33.4% | 34.3% | 30.8% | 32.1% |
- Cash flow: Nine-month operating cash flow was $18.2 million, investing cash flow was positive $3.6 million, and financing cash flow was negative $22.8 million. Cash declined $1.0 million to $1.1 million.
- Liquidity and debt: Cash and marketable securities totaled $1.3 million. At September 26, the company had $46.2 million drawn on its $60 million line of credit, with $13.8 million available, plus notes payable with a $24.4 million net carrying amount. The line borrowings carried rates of 2.46%–3.25%; notes bear 5.50% interest and have a 10-year final maturity.
- Balance sheet: Total assets were $46.8 million; shareholders’ equity was a $36.0 million deficit. Current assets of $22.5 million exceeded current liabilities of $11.4 million.
Material changes versus comparable periods
- Q3 revenue fell 2.5% and net income fell 5.0%, while operating income rose modestly. Royalties increased 5.2%, but leasing income declined to $3.2 million from $4.1 million.
- For nine months, revenue rose 16.7% and net income rose 11.7%. Royalties increased 8.7%; leasing income increased to $16.9 million from $11.7 million. Management attributed leasing revenue changes to equipment sales and lease accounting treatment.
- Interest expense increased to $1.1 million for nine months from $0.4 million, mainly because of higher average borrowings. SG&A rose 2.0% to $18.2 million.
- The leasing portfolio declined from $44.0 million at year-end 2014 to $40.3 million. Equipment purchases for lease customers were $18.5 million, down from $21.4 million; principal collections were $22.0 million.
- Winmark completed a tender offer for 875,000 shares at $84.72 per share, costing approximately $74.3 million including fees. The repurchase, funded in part with increased borrowing, drove the shift to a shareholders’ deficit. No shares were repurchased during Q3.
- Franchise stores increased from 1,092 to 1,133 during the first nine months; 53 opened and 12 closed. All 58 agreements up for renewal were renewed.
Outlook, commentary, and risks
- Management said cash on hand, franchising cash flows, lease-discounting sources, and the credit line should fund planned operations through 2016. This is not a specific earnings or revenue forecast.
- Management expects to fund expenses, leasing activity, and debt service primarily from operating cash flow, with refinancing or other financing options as appropriate. It cautioned that refinancing or raising capital may not be available on acceptable terms.
- The company was in compliance with line-of-credit and note covenants at quarter-end. Its debt is secured by substantially all assets. A 1 percentage-point increase in short-term rates would reduce annual pretax earnings by an estimated $462,000; no interest-rate derivatives were in place.
- Three leasing customers represented approximately 18%, 13%, and 12% of total assets, respectively. All reported lease balances were accruing, with no delinquent or non-accrual balances at quarter-end; the allowance for lease credit losses was $882,000.
- The company reported no material litigation, no material changes to previously disclosed risk factors other than increased leverage, and no off-balance-sheet arrangements. Disclosure controls were deemed effective.
Investor facts to verify
- Debt repayment schedule, covenant headroom, refinancing capacity, and sensitivity to variable interest rates following the tender-offer borrowing.
- Whether franchise royalty growth and store openings can continue, and the financial health of franchisees.
- Lease originations, portfolio contraction, recoveries, allowance adequacy, and exposure to the three largest leasing customers.
- Cash generation and liquidity after the large repurchase, including whether management’s funding expectation through 2016 remains supportable.
- Potential impact of the forthcoming revenue-recognition standard; the filing says the company was still evaluating its effect.