Winmark Corp. 10-Q Summary: Quarter Ended March 31, 2007
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2007, for Winmark Corporation. The company operates two primary segments: franchising (brands include Play It Again Sports, Once Upon A Child, Plato's Closet, Music Go Round, and Wirth Business Credit) and equipment leasing (Winmark Capital Corporation and Wirth Business Credit). The company utilizes a 52/53-week fiscal year ending on the last Saturday in December.
Key Financial Metrics
| Metric | Q1 2007 | Q1 2006 |
|---|---|---|
| Total Revenue | $7,626,900 | $6,973,300 |
| Net Income | $662,200 | $1,113,300 |
| Earnings Per Share (Diluted) | $0.12 | $0.18 |
| Operating Cash Flow | $788,200 | $1,495,200 |
| Cash and Equivalents (End of Period) | $1,020,600 | $1,847,000 |
| Line of Credit Outstanding | $9,700,000 | $600,000 |
| Renewable Subordinated Notes | $14,085,000 | $0 |
| Current Ratio | 0.78 | 1.25 |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 9.4% year-over-year, driven primarily by a 196.3% surge in leasing income ($775,700 vs. $261,800) and a 39.5% increase in franchise fees due to new store openings.
- Profitability Decline: Net income decreased 40.5% to $662,200. This was largely due to a $360,000 one-time gain on investment redemption in Q1 2006 that did not recur, and increased interest expense ($333,000 vs. $0) from new debt financing.
- Expense Increases: Selling, General, and Administrative (SG&A) expenses rose 15.6% to $4,993,700, attributed to higher salaries, franchisee commissions, and a $151,000 increase in the provision for credit losses.
- Liquidity Shift: The company significantly increased leverage, drawing $9.1 million on its line of credit and issuing $727,000 in subordinated notes to fund leasing growth and stock repurchases. Consequently, the current ratio dropped from 1.25 to 0.78.
Outlook, Risks, and Unusual Items
- Stock Repurchases: The company repurchased 218,205 shares for $3,915,100 in Q1 2007. Approximately 277,253 shares remain available under the current authorization.
- Leasing Expansion: The leasing portfolio grew to $22.8 million. Management expects continued growth in lease originations but notes the segment currently operates at a loss due to startup costs.
- Management Changes: Mark T. Hooley, President of Wirth Business Credit, resigned effective April 27, 2007, and will transition to a consultant role.
- Related Party Transactions: CEO John L. Morgan purchased $500,000 of subordinated notes in February 2007 and an additional $400,000 in April 2007. The company also repurchased stock from former executives.
- Market Risk: The company faces interest rate risk on its $9.7 million variable-rate line of credit. A 1% rate increase would reduce annual pretax earnings by approximately $97,000.
Investor Verification Checklist
- Verify the sustainability of the 196% increase in leasing income against the segment's operating loss of $934,500.
- Monitor the company's ability to maintain liquidity with a current ratio below 1.0 (0.78) and high debt utilization.
- Assess the impact of the $151,000 increase in credit loss provisions on future leasing profitability.
- Review the integration plan following the resignation of the Wirth Business Credit President.
- Confirm the status of the $11.5 million in illiquid long-term investments (Tomsten, CCG, BridgeFunds) for potential impairment risks.