Winmark Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the quarter and nine months ended September 24, 2016. Unaudited results. Winmark franchises five value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses. At quarter-end it had 1,210 franchised stores and a $40.6 million net leasing portfolio.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $17.57M | $16.73M | $51.94M | $49.21M |
| Operating income | $9.85M | $10.44M | $28.12M | $27.80M |
| Net income | $5.72M | $6.09M | $16.91M | $16.05M |
| Diluted EPS | $1.33 | $1.41 | $3.83 | $3.72 |
| Operating margin | 56.1% | 62.3% | 54.2% | 56.5% |
| Net margin | 32.6% | 36.4% | 32.6% | 32.6% |
Q3 revenue rose about 5.0%, while operating income fell about 5.6% and net income fell about 6.2%. Nine-month revenue increased about 5.5%, operating income about 1.2%, and net income about 5.3%.
- Revenue drivers: Q3 royalties rose 8.9% to $12.32M, reflecting franchisee sales and additional stores; leasing income declined to $3.92M from $4.17M. Nine-month royalties increased 5.4% to $33.87M and leasing income rose to $13.72M from $12.84M.
- Costs and segments: Q3 SG&A increased 19.8% to $6.21M, partly due to compensation, advertising production, outside services, and the Winmark Franchise Partners launch. Nine-month SG&A rose 8.5% to $19.18M. Nine-month franchising segment contribution grew to $21.50M from $20.83M; leasing contribution declined to $6.62M from $6.97M.
- Cash flow: Nine-month operating cash flow was $19.24M versus $20.01M. Investing activities provided $0.99M, including $20.08M of lease principal collections and $19.25M in equipment purchases for lease customers. Financing used $20.42M, including the $49.90M tender offer, partly funded by borrowings. Cash ended at $1.06M, down from $1.25M at year-end 2016.
- Liquidity and debt: At September 30, cash was $1.06M and $8.1M remained available on the $50M revolving credit facility. Revolver borrowings were $41.9M; notes had $33.0M aggregate principal outstanding. Total debt principal was approximately $74.9M. The revolver bore rates of 3.23%–4.25%; notes bear 5.10% and 5.50%. Covenants were met. Total shareholders’ deficit widened to $39.39M from $7.85M, principally reflecting the stock repurchase.
Material developments, outlook and risks
- Winmark repurchased 400,000 shares through a tender offer at $124.48 per share for approximately $49.9M including fees. The repurchase was funded in part with increased borrowing. The company paid quarterly dividends of $0.10 and $0.11 per share during the period.
- The credit facility was amended, including extension of its termination date to July 19, 2021; Winmark also issued $12.5M of Series B notes. The company said its increased indebtedness makes it more leveraged.
- Management expected cash on hand, franchising cash flow, lease-financing sources, the credit facility and term-note proceeds to fund planned operations through 2018. No specific earnings or revenue guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
- Management reported all 47 franchise agreements due for renewal in the first nine months were renewed. Forty stores opened and 16 closed in the period.
- Interest-rate exposure is material: all $41.9M outstanding on the revolver was subject to short-term rate changes; a one-percentage-point rate increase was estimated to reduce annual pretax earnings by $419,000. No interest-rate derivatives were in place. Two leasing customers represented approximately 26% and 10% of total assets, respectively.
- ASU 2016-09 adoption generated discrete excess tax benefits of $74,800 for Q3 and $592,800 for the nine-month period. The company expected the upcoming revenue-recognition standard to defer initial franchise fees and recognize them over franchise-agreement terms; it did not expect changes to royalty revenue based on franchisee sales or leasing revenue.
- The company reported no material litigation, no material changes to previously disclosed risk factors other than increased leverage, no off-balance-sheet arrangements, and effective disclosure controls.
Important facts for investors to verify
- Whether franchisee sales, store growth and royalty collections sustain royalty growth.
- Whether leasing originations, customer concentration, delinquencies and credit-loss allowances support the leasing portfolio; only $93,200 was 61–90 days delinquent at quarter-end, with none over 90 days or on non-accrual.
- Debt-service capacity, covenant headroom, refinancing access and sensitivity to floating interest rates following the $49.9M repurchase.
- Drivers and persistence of higher SG&A and the expected financial and systems impact of revenue-recognition adoption in fiscal 2018.
- The company’s liquidity position and funding assumptions underlying management’s outlook through 2018.