Winmark Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparable period ended April 1, 2017. Financial statements are unaudited. Winmark franchises five value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses.
Financial performance
| Metric | Q1 2018 | Comparable period | Change |
|---|---|---|---|
| Revenue | $18.16 million | $17.81 million | +2.0% |
| Operating income | $10.07 million | $9.31 million | +8.2% |
| Net income | $6.96 million | $5.55 million | +25.4% |
| Basic / diluted EPS | $1.81 / $1.69 | $1.33 / $1.25 | Higher |
| Operating margin | 55.5% | 52.3% | +3.2 percentage points |
| Net margin | 38.3% | 31.2% | +7.1 percentage points |
| Operating cash flow | $10.30 million | $8.72 million | Higher |
- Royalties rose 5.7% to $11.05 million, attributed primarily to 39 additional stores versus the prior-year quarter and higher franchisee retail sales. Total franchised stores were 1,223 at quarter-end; 16 opened, four closed, and all 16 agreements eligible for renewal were renewed.
- Leasing income declined to $5.53 million from $5.86 million, while leasing expense fell to $0.55 million from $1.27 million. Management reported leasing income net of leasing expense of $5.0 million versus $4.6 million.
- SG&A increased 2.8% to $6.69 million, mainly from compensation, benefits, and advertising production expenses. Interest expense increased to $0.74 million from $0.50 million.
- The effective tax rate fell to 25.4% from 37.0%, primarily reflecting the federal corporate tax-rate reduction enacted under the Tax Cuts and Jobs Act. The prior-year results were retrospectively restated for the new revenue standard.
Cash, debt, and liquidity
- Cash, cash equivalents, and restricted cash totaled $1.91 million at March 31, 2018, up from $1.16 million at December 30, 2017. Operating activities provided $10.30 million; investing activities used $0.49 million; financing activities used $9.07 million.
- Investing included $6.20 million of equipment purchases for lease customers and $5.88 million of principal collections on lease receivables. The net leasing portfolio was $41.91 million, up from $41.28 million at year-end.
- Line-of-credit borrowings were $24.6 million, down from $35.4 million at year-end, with $25.4 million available under the $50 million facility. Notes payable had $31.4 million of principal outstanding; carrying value was approximately $31.27 million, net of issuance costs. Discounted lease-rental liabilities were approximately $4.29 million.
- Management reported compliance with debt covenants and stated that available cash, franchise cash flow, lease-discounting sources, and the line of credit were expected to fund planned operations through 2018. This is management’s expectation, not a guarantee.
- Quarterly dividends paid were $0.11 per share. No common shares were repurchased during the quarter.
Material developments, outlook, and risks
- Winmark adopted ASC 606 using the full retrospective method. Initial franchise fees and marketing and software license fees are recognized over the estimated franchise term; certain contract-acquisition commissions are capitalized and amortized. Adoption changed reported franchise-fee, other-revenue, expense, and balance-sheet amounts; prior-year results were restated.
- One leasing customer represented approximately 27% of total assets. A portion of receivables from that customer is assigned as collateral in non-recourse financing. The allowance for lease credit losses was $0.78 million; all lease balances were reported as accruing, with none delinquent at March 31, 2018.
- All $24.6 million of line-of-credit borrowings were subject to short-term rate changes. Management estimated that a 1% increase in short-term rates would reduce annual pretax earnings by $246,000; no interest-rate derivatives were in place.
- Management identified franchisee support and sales, new franchise openings, lease originations and write-offs, and SG&A control as important to operating-income growth. The filing provides no specific earnings or revenue guidance. Management cautioned that quarterly results are not necessarily indicative of full-year results.
- The company reported no material litigation, no material changes to the risk factors in its 2017 Form 10-K, and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether royalty growth and franchisee retail sales continue, and whether store openings, closures, and renewals support the franchise base.
- How the concentrated leasing exposure performs, including customer credit quality, lease collections, and future credit-loss provisions.
- Whether cash generation and available borrowing capacity remain sufficient for lease funding, debt service, and operations, particularly if interest rates rise.
- The effects of ASC 606 deferrals and the lower tax rate on comparability and future reported results.
- Debt balances, facility availability, covenant compliance, and the timing and cost of scheduled note repayments.