Winmark Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 26, 2016; unaudited. Winmark franchises five resale retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 1,154 franchised stores and a $38.3 million net leasing portfolio at quarter-end.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $16.18 million | $21.02 million | Down 23.0% |
| Operating income | $8.04 million | $9.97 million | Down 19.4% |
| Operating margin | 49.7% | 47.4% | Up 2.3 percentage points |
| Net income | $4.56 million | $6.05 million | Down 24.6% |
| Net margin | 28.2% | 28.8% | Down 0.6 percentage points |
| Diluted EPS | $1.06 | $1.17 | Down 9.4% |
| Cash from operations | $10.61 million | $11.75 million | Down $1.14 million |
- Royalties rose 5.6% to $10.27 million, supported by more Once Upon A Child and Plato’s Closet stores and higher Once Upon A Child franchisee sales. Franchise fees increased to $0.37 million.
- Leasing income fell to $4.51 million from $10.01 million, mainly because of lower equipment sales to customers. Leasing expense also declined, to $0.90 million from $4.26 million. Management reported leasing income net of leasing expense of $3.6 million versus $5.8 million.
- SG&A increased 6.3% to $6.55 million, attributed mainly to website development, franchisee support and advertising production. Interest expense rose to $0.64 million from $0.09 million, primarily due to higher average corporate borrowings.
- At March 26, cash and cash equivalents were $1.21 million; current assets were $21.94 million and current liabilities $9.95 million. Current assets include $18.12 million of current lease investments.
- Operating cash flow was $10.61 million; investing activities provided $0.61 million and financing activities used $11.01 million. The company spent $4.73 million on lease equipment, collected $5.34 million of lease principal, repaid $9.4 million net on its line of credit, repurchased $1.48 million of stock and paid $0.29 million in dividends.
- Line-of-credit borrowings were $33.5 million, leaving $26.5 million available under the $60 million facility; rates ranged from 2.68% to 3.50%. Notes had $23.5 million principal outstanding at 5.50%, with quarterly required principal payments. Total debt principal was approximately $57 million. The company reported compliance with debt covenants.
- Shareholders’ deficit was $27.26 million. The company repurchased 16,149 shares during the quarter; 144,033 shares remained authorized for repurchase.
Material changes and operating developments
- Total revenue fell primarily because of lower leasing income. Franchising revenue increased, and franchising segment contribution rose to $5.91 million from $5.64 million; leasing segment contribution declined to $2.13 million from $4.34 million.
- The leasing portfolio decreased from $39.0 million at year-end 2015 to $38.3 million. Equipment purchases for leasing customers were $4.7 million, compared with $7.9 million in the prior-year quarter.
- Stores increased from 1,150 to 1,154, with 14 openings and 10 closures. The company renewed 19 of 20 agreements available for renewal.
- Cash decreased from $2.16 million at the end of Q1 2015 to $1.21 million at the end of Q1 2016. The filing attributes lower operating cash flow versus the prior-year quarter primarily to lower net income.
Outlook, risks and other items
- Management stated that cash on hand, franchising cash flows, lease discounting sources and the line of credit should fund planned operations through 2016. It expects to meet expenses, finance leasing activity and service debt from operating cash flows and other financing options.
- Management cautioned that debt service capacity depends on future performance and access to refinancing, asset sales, borrowing or equity financing if needed. It said lease discounting financing was expected to remain available at competitive rates through established financial-institution relationships.
- A 1 percentage-point rise in short-term interest rates would reduce annual pretax earnings by approximately $335,000, based on line-of-credit borrowings at quarter-end; no interest-rate derivatives were in place.
- Leased assets associated with three customers represented approximately 19%, 14% and 11% of total assets, respectively. The allowance for lease credit losses was $0.84 million; $2,000 of leases were on non-accrual at quarter-end.
- The filing’s forward-looking statement refers to intent to finance a “Tender Offer” through an expanded credit facility and an additional term loan; the provided filing text does not clearly explain the offer’s terms or status.
- No material litigation or material changes to previously disclosed risk factors were reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
- New revenue recognition, financial instrument, lease and stock-compensation accounting standards were described as under evaluation; the company had not yet determined their impact.
Key facts for investors to verify
- Whether the sharp year-over-year decline in leasing income reflects timing and equipment-sale mix, and how leasing portfolio originations and returns develop.
- Customer concentration in the leasing portfolio and any changes in delinquency, credit-loss reserves or non-accrual leases.
- Debt repayment needs, covenant headroom, variable-rate exposure and the availability and cost of refinancing or lease discounting.
- Details and subsequent developments related to the “Tender Offer” and the proposed financing referenced in the forward-looking statement.
- Whether royalty growth, store openings and renewals can sustain franchising growth while SG&A increases.