Winmark Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended April 1, 2017; comparative period ended March 26, 2016. Winmark franchises five value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 1,184 franchised stores and a $41.7 million net leasing portfolio at quarter-end. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $17.62 million | $16.18 million | +8.9% |
| Operating income | $9.14 million | $8.04 million | +13.6% |
| Net income | $5.42 million | $4.56 million | +18.7% |
| Diluted EPS | $1.22 | $1.06 | +15.1% |
| Operating margin | 51.8% | 49.7% | +2.1 percentage points |
| Net margin | 30.7% | 28.2% | +2.5 percentage points |
| Operating cash flow | $8.73 million | $10.62 million | Down $1.88 million |
Revenue growth was led by leasing income, up to $5.86 million from $4.51 million, while royalties rose 1.8% to $10.45 million. Franchise fees fell to $269,300 from $372,500. Selling, general and administrative expenses declined 0.8% to $6.50 million; interest expense fell to $499,100 from $640,700. The effective tax rate was 37.3%, compared with 38.2%.
Cash and cash equivalents were $1.72 million at April 1, versus $1.25 million at December 31, 2016. Current assets were $20.80 million and current liabilities $8.36 million. The balance sheet showed a $2.28 million shareholders’ deficit, improved from a $7.85 million deficit at year-end. Net cash used in investing activities was $235,300, including $7.51 million of lease-equipment purchases and $7.29 million of lease-receivable collections. Financing activities used $8.03 million, principally reflecting debt repayment.
Debt included $16.2 million drawn on a $55.0 million revolving line, leaving $38.8 million available, and $21.5 million principal outstanding under the Prudential note agreement. The line bore interest of 3.19%–4.00%; notes bear 5.50%. The company reported covenant compliance. Line commitments automatically decline by $5.0 million each May.
Changes and operating developments
- Leasing segment contribution increased to $2.99 million from $2.13 million, reflecting higher leasing income net of leasing expense. Equipment purchases for lease customers rose to $7.5 million from $4.7 million.
- Franchising segment contribution increased to $6.14 million from $5.91 million. The company opened 10 stores and closed 12 during the quarter; 17 of 17 agreements eligible for renewal were renewed.
- Operating cash flow was lower mainly because Q1 2016 included $2.5 million of refunds for prior-year tax overpayments.
- Winmark adopted stock-compensation accounting guidance in Q1 2017 and recorded $96,100 of excess tax benefits as a discrete tax benefit. The company reported no share repurchases and paid a $0.10-per-share quarterly dividend.
Outlook, risks and contingencies
Management expected cash on hand, franchising cash flows, lease-discounting sources and the credit line to fund planned operations through 2017. It noted that future performance and debt-service capacity depend on business and economic conditions and access to refinancing, asset sales, additional borrowing or equity if needed. Management identified franchise support and openings, lease originations and write-offs, and control of overhead as important to operating-income growth. The filing provides no specific earnings or revenue guidance.
Interest-rate risk is material: a 1% increase in short-term rates was estimated to reduce annual pretax earnings by $162,000; no interest-rate derivatives were in place. Two leasing customers represented approximately 21% and 15% of total assets, respectively. No leases were reported delinquent or on non-accrual at quarter-end. Management reported no material litigation, no material changes to the prior Form 10-K risk factors, and no off-balance-sheet arrangements. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether leasing income growth and elevated equipment originations translate into sustained portfolio and segment profitability.
- Customer concentration in leased assets and the credit quality, residual values and recoverability of the $41.7 million lease portfolio.
- Cash generation and liquidity after the scheduled annual $5.0 million reduction in line commitments and ongoing required note repayments.
- The effect of the $96,100 stock-option tax benefit on reported earnings and the company’s future effective tax rate.
- The impact of upcoming revenue-recognition and lease-accounting standards; management was still evaluating their effects.