Winmark Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter ended September 24, 2016; unaudited. Comparisons are with the quarter and nine months ended September 26, 2015, and balance-sheet comparisons are with December 26, 2015.
Business context
Winmark franchises Plato’s Closet, Once Upon A Child, Play It Again Sports, Style Encore and Music Go Round, and operates middle-market and small-ticket equipment leasing businesses. At quarter-end it had 1,184 franchised stores and a $37.3 million net leasing portfolio. It reported franchising and leasing as its two segments.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $16.7 million | $16.0 million | $49.2 million | $52.5 million |
| Operating income | $10.4 million | $9.3 million | $27.8 million | $27.4 million |
| Net income | $6.1 million | $5.3 million | $16.1 million | $16.1 million |
| Diluted EPS | $1.41 | $1.23 | $3.72 | $3.39 |
| Operating margin | 62.3% | 58.4% | 56.5% | 52.2% |
| Net margin | 36.4% | 33.4% | 32.6% | 30.8% |
Q3 revenue rose 4.6% year over year, while nine-month revenue fell 6.3%. Nine-month royalties increased 2.9% to $32.1 million; leasing income decreased to $12.8 million from $16.9 million. Nine-month operating income increased modestly, while net income was nearly flat. Management reported effective tax rates of 38.3% for both the quarter and nine-month 2016 periods.
Cash from operating activities was $19.9 million for the first nine months, versus $18.2 million a year earlier. Investing activities provided $1.3 million; the company spent $16.4 million on equipment for lease customers and collected $17.7 million of lease principal. Financing activities used $21.1 million, including $18.7 million in net payments on the line of credit and notes, $1.6 million of share repurchases and $1.1 million of dividends. Cash was $1.1 million at quarter-end.
At September 24, 2016, the company had $25.2 million outstanding on its line of credit, with $29.8 million available, and $22.5 million principal outstanding under its notes. Revolver rates ranged from 2.78% to 3.50%; notes bear 5.50% interest. The company reported compliance with debt covenants. Shareholders’ equity remained in deficit at $15.7 million, improving from a $30.7 million deficit at December 26, 2015.
Material changes and notable items
- Q3 leasing income and leasing expense both increased, primarily because certain leases were classified as sales-type leases. For the nine-month period, leasing income declined mainly due to a lower level of equipment sales to customers; leasing expense also declined.
- Nine-month franchise royalties grew with additional stores in several brands. Winmark opened 54 stores and closed 20 during the period; 58 of 60 agreements available for renewal were renewed.
- Nine-month SG&A declined 3.0%, and Q3 SG&A declined 9.6%, primarily reflecting lower outside services, advertising production, compensation and benefits.
- The company repurchased 17,194 shares during the first nine months and paid quarterly dividends of $0.07 per share in March and $0.10 per share in June and September.
Outlook, risks and contingencies
Management expected cash on hand, franchising cash flows, lease-discounting sources and the line of credit to fund planned operations through 2017. It cautioned that debt-service capacity depends on future performance and access to refinancing or other capital. A one-percentage-point rise in short-term rates would reduce annual pretax earnings by an estimated $252,000; there were no interest-rate derivatives. Two leasing customers represented approximately 18% and 15% of total assets, respectively. Management reported no material litigation, no material changes to the prior annual report’s risk factors, and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether royalty growth and franchise openings/renewals continue, including store closures and performance by brand.
- How leasing originations, portfolio size, lease classifications and customer concentration affect recurring income and credit risk.
- Debt reduction, covenant compliance, revolver availability and sensitivity to short-term interest rates.
- The sustainability of cash generation and shareholder distributions relative to leasing investment and debt obligations.
- The impact of newly issued accounting standards, which the company was still evaluating.