Winmark Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 27, 2014; comparisons are with the quarter ended September 28, 2013. Year-to-date figures cover nine months. Financial statements are unaudited. Winmark franchises resale retail brands and operates middle-market and small-ticket equipment leasing businesses. At quarter-end it had 1,070 franchises and a $43.2 million net leasing portfolio.
Key financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $16.40 million | $14.79 million | $45.00 million | $41.96 million |
| Operating income | $9.18 million | $8.54 million | $23.70 million | $22.28 million |
| Net income | $5.62 million | $5.25 million | $14.46 million | $13.65 million |
| Diluted EPS | $1.09 | $1.00 | $2.76 | $2.61 |
| Operating margin | 56.0% | 57.7% | 52.7% | 53.0% |
| Net margin | 34.3% | 35.5% | 32.1% | 32.5% |
Revenue mix and drivers: Q3 royalties were $10.73 million, leasing income $4.12 million, merchandise sales $0.79 million and franchise fees $0.56 million. Year-to-date royalties grew 6.7% to $28.74 million, primarily reflecting more Plato’s Closet and Once Upon A Child locations. Franchise fees rose to $1.51 million. Leasing income was $11.66 million year-to-date; management cited a larger portfolio. Q3 leasing expense rose to $0.81 million from $0.40 million, partly due to equipment costs and leases classified as sales-type leases.
Cash flow and liquidity: Operating activities generated $15.43 million in the first nine months, versus $17.04 million a year earlier; management attributed the decrease primarily to higher cash taxes. Investing activities used $6.32 million, including $21.39 million in equipment purchases for lease customers and $15.52 million of lease principal collections. Financing activities used $17.73 million, including $26.63 million of dividends and $11.56 million of share repurchases, partly offset by net line-of-credit borrowings. Cash fell to $2.02 million from $10.64 million at December 28, 2013. The reported current ratio was 0.8 at quarter-end.
Debt and balance sheet: The company had $20.0 million outstanding under its $35.0 million secured revolving credit facility at 2.40%–3.25%, with $15.0 million available. The facility matures February 28, 2018; the company reported covenant compliance. Total assets were $49.94 million, compared with $53.04 million at year-end 2013. Net investment in leases was $43.15 million, up from $37.54 million. Management said cash, franchise cash generation, lease discounting and the credit line should fund planned operations through 2015.
Changes, outlook and risks
- Q3 revenue increased 10.9% and net income increased 7.1% year over year; year-to-date revenue increased 7.2% and net income increased 5.9%. Margins declined modestly, while higher SG&A, interest expense and Q3 leasing expense offset part of revenue growth.
- The company paid a $5.00-per-share special dividend totaling $25.8 million in March, funded with cash and net credit-line borrowing, as well as quarterly dividends. It repurchased 166,030 shares for $11.6 million during the first nine months.
- Franchise activity included 73 openings and 8 closures year-to-date; 70 of 71 agreements eligible for renewal were renewed. Management identified franchisee performance, new openings, lease originations and credit losses, and expense control as important to operating income growth. No quantified earnings or revenue guidance was provided.
- Credit and concentration risk merit attention: one leasing customer represented approximately 16% of total assets. The lease portfolio had no reported delinquent or non-accrual balances at September 27, 2014, compared with $416,400 in non-accrual leases at year-end 2013; the allowance for lease credit losses was $927,200.
- A 1 percentage-point increase in short-term interest rates would reduce annual pretax earnings by an estimated $200,000 on period-end borrowings. No interest-rate derivatives were in place. The company reported no material litigation, no material changes to the prior 10-K risk factors, and no off-balance-sheet arrangements.
- The company was evaluating the impact of the new revenue-recognition standard, effective for reporting periods beginning after December 15, 2016. Management cautioned that nine-month results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether lease growth and equipment originations generate attractive returns while maintaining credit quality, especially given the customer concentration.
- How cash levels, the below-1.0 current ratio, dividends and repurchases affect liquidity and borrowing needs.
- Whether margins recover as leasing mix and expenses fluctuate, and whether royalty growth continues with franchise openings and renewals.
- The sensitivity of earnings and covenant headroom to interest rates and additional borrowing, and the company’s assumptions supporting liquidity through 2015.