Winmark Corporation 10-Q Summary
Business Context and Reporting Period
This is a Quarterly Report (Form 10-Q) for Winmark Corporation for the period ended September 29, 2007. Winmark 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 Leasing (equipment leasing via Winmark Capital and Wirth Business Credit). As of the reporting date, the company operated 890 franchises and territories.
Key Financial Metrics
| Metric | 9 Months Ended 9/29/07 | 9 Months Ended 9/30/06 | 3 Months Ended 9/29/07 | 3 Months Ended 9/30/06 |
|---|---|---|---|---|
| Total Revenue | $23,141,300 | $20,486,200 | $7,951,800 | $7,239,600 |
| Net Income | $2,395,600 | $2,601,900 | $1,186,200 | $838,200 |
| Diluted EPS | $0.43 | $0.43 | $0.21 | $0.14 |
| Operating Cash Flow | $3,936,900 | $3,344,600 | N/A | N/A |
| Cash & Equivalents | $812,900 | $1,301,800 | $812,900 | $1,301,800 |
| Total Debt (Line of Credit + Notes) | $30,655,800 | $15,378,200 | $30,655,800 | $15,378,200 |
| Current Ratio | 1.0 | 1.4 | 1.0 | 1.4 |
Note: Total Debt includes $13.5M on the line of credit and $17.15M in renewable subordinated notes.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 13.0% year-over-year for the nine-month period, driven primarily by a 143.4% increase in leasing income ($2.94M vs $1.21M) and a 6.2% increase in royalties.
- Net Income Decline: Despite revenue growth, net income for the nine months decreased 7.9% to $2.4M. This was due to a significant increase in interest expense (156.5% increase to $1.1M) and higher selling, general, and administrative (SG&A) expenses.
- Leasing Expansion: The net investment in leases grew from $18.3M to $33.2M, reflecting aggressive portfolio growth funded by increased borrowings.
- Merchandise Sales: Direct franchisee merchandise sales decreased 8.0% for the nine months, a result of a strategic shift encouraging franchisees to purchase directly from vendors.
- Stock Repurchases: The company repurchased 309,343 shares for $5.5M during the nine-month period.
Outlook, Risks, and Management Commentary
- Liquidity: Management states that cash from operations, the $25M credit facility (extended to 2012), and renewable subordinated notes are adequate to fund operations and leasing growth for 2007. However, the current ratio tightened to 1.0 from 1.4.
- Franchise Health: Renewal activity remains strong, with 25 of 28 available franchise agreements renewed in the first nine months.
- Investment Portfolio: The company holds $9.5M in long-term investments (Tomsten, Inc. and BridgeFunds, LLC). Management is evaluating these for impairment in the fourth quarter. A voting agreement with Tomsten was terminated in October 2007, and the CEO joined Tomsten's board.
- Interest Rate Risk: The company has $13.5M in variable-rate debt. A 1% increase in rates would reduce annual pre-tax earnings by approximately $38,000.
- Related Party Transactions: Significant transactions occurred with the CEO and other executives regarding stock repurchases and the purchase of subordinated notes.
Investor Verification Checklist
- Debt Servicing: Verify the sustainability of the $30.6M debt load given the 156% increase in interest expense and the tight current ratio of 1.0.
- Leasing Portfolio Quality: Review the allowance for credit losses ($785k) and the concentration risk (one customer represents 11% of total assets) in the rapidly expanding leasing segment.
- Investment Valuation: Monitor the fourth-quarter impairment testing of the $9.5M illiquid investments in Tomsten and BridgeFunds.
- Franchisee Economics: Assess the long-term impact of the strategic shift away from direct merchandise sales on franchisee profitability and royalty base.
- Related Party Conflicts: Review the terms of the subordinated notes purchased by the CEO and the stock repurchase agreements with former executives.