Winmark Corporation — Q3 2012 Form 10-Q
Business context and period. Unaudited results cover the three and nine months ended September 29, 2012, compared with periods ended September 24, 2011. Winmark franchises four value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 958 franchised stores and a $34.1 million net leasing portfolio at quarter-end.
Financial performance
| Metric | Q3 2012 | Q3 2011 | First 9 months 2012 | First 9 months 2011 |
|---|---|---|---|---|
| Revenue | $14.80 million | $11.77 million | $38.82 million | $38.10 million |
| Operating income | $8.46 million | $6.65 million | $20.34 million | $17.94 million |
| Net income | $4.26 million | $3.48 million | $11.18 million | $9.91 million |
| Diluted EPS | $0.82 | $0.66 | $2.13 | $1.89 |
| Operating margin | 57.2% | 56.4% | 52.4% | 47.1% |
| Net margin | 28.8% | 29.6% | 28.8% | 26.0% |
- Q3 revenue rose 25.7% and net income rose 22.3% year over year. Nine-month revenue increased 1.9% and net income increased 12.8%.
- Nine-month operating cash flow was $14.67 million, versus $15.43 million. Investing activities used $3.69 million; financing activities used $17.75 million. Cash declined to $2.25 million from $9.02 million at year-end 2011.
- At September 29, current assets were $15.36 million and current liabilities $20.46 million (current ratio about 0.75). The company had $10.7 million outstanding on its line of credit at 2.97%–3.75%, with $24.3 million available under the $35 million facility. It also reported $1.23 million of discounted lease rentals payable.
- Net investment in leases was $34.14 million, up from $29.85 million at year-end. Long-term investments were $2.51 million, net of allowances.
Changes and management commentary
- Nine-month royalties increased 14.8% to $25.16 million, attributed to higher franchisee sales at Plato’s Closet and Once Upon A Child and 30 additional Plato’s Closet stores. The franchise network grew from 930 to 958: 40 openings and 12 closures. Management reported 75 renewals out of 78 agreements eligible.
- Nine-month leasing income fell to $9.99 million from $12.58 million, while leasing expense fell to $1.34 million from $4.15 million. Management cautioned that lease revenue and expenses vary with recognition timing, and cited equipment purchases and portfolio trends as more meaningful activity measures. Equipment purchased for lease customers was $17.37 million, versus $15.58 million.
- SG&A increased 8.1% for the nine-month period, mainly due to compensation, benefits and sales commissions. The provision for credit losses was a $69,600 benefit, compared with an $8,200 expense, reflecting net recoveries and lower delinquencies.
- The board paid a $5.00-per-share special dividend, totaling $25.4 million, plus quarterly dividends; total dividends paid in the first nine months were $25.92 million. The special dividend was funded partly with $12.8 million of net line-of-credit borrowings. The company also repurchased 92,652 shares for $4.9 million.
Outlook, risks and unusual items
- Management said cash on hand, franchising cash flows, discounted lease financing and the credit line should fund planned operations through 2013. This is management’s assessment, not quantified earnings guidance. Nine-month results are not necessarily indicative of full-year results.
- Winmark recorded a $660,700 third-quarter impairment charge on BridgeFunds notes, citing a smaller receivables portfolio without improved performance. It received no principal or interest payments on the notes during the first nine months; maturity was extended to June 30, 2013. The net investment was about $0.7 million, including related interest receivable.
- Winmark recorded a $650,400 nine-month equity-investment loss from Tomsten, in which it owns 22%. In Q3 it ceased providing management services to Tomsten, and its CEO resigned from Tomsten’s board. Management identified $2.5 million of illiquid investments in Tomsten and BridgeFunds.
- One leasing customer represented approximately 10% of total assets. The line of credit is secured by substantially all assets and has financial covenants; Winmark reported compliance at quarter-end. A 1% rise in short-term rates would reduce annual pretax earnings by an estimated $107,000; no interest-rate derivatives were in place.
- The company reported no material litigation, no material changes to previously disclosed risk factors, effective disclosure controls, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether franchisee sales, royalties and store openings sustain growth, and whether renewal performance remains strong.
- Lease originations, portfolio quality, customer concentration and the adequacy of credit-loss allowances as the leasing portfolio expands.
- BridgeFunds collections and cash-flow assumptions underlying its valuation, plus the recoverability of the Tomsten investment.
- Liquidity after the special dividend and repurchases, covenant headroom, borrowing costs and the availability of discounted lease financing.
- Whether management’s stated funding capacity through 2013 remains supported by operating cash flow and leasing activity.