Winmark Corporation — Q3 2011 Form 10-Q
Business context and period: Unaudited results cover the quarter and nine months ended September 24, 2011, compared with periods ended September 25, 2010. Winmark franchises four resale retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 923 franchised stores and a $30.2 million net leasing portfolio at quarter-end.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $11.77m | $11.01m | $38.10m | $30.73m |
| Income from operations | $6.65m | $5.21m | $17.94m | $13.21m |
| Net income | $3.48m | $2.69m | $9.91m | $7.21m |
| Diluted EPS | $0.66 | $0.51 | $1.89 | $1.39 |
| Operating margin | 56.4% | 47.3% | 47.1% | 43.0% |
| Net margin | 29.6% | 24.4% | 26.0% | 23.4% |
- Quarterly revenue rose 7.0% and nine-month revenue 24.0%; net income rose 29.5% and 37.5%, respectively. Royalties increased 14.5% in Q3 and 10.9% year to date, primarily reflecting higher sales at Plato’s Closet and Once Upon A Child and more Plato’s Closet locations.
- Nine-month leasing income increased to $12.58m from $7.29m, while leasing expense rose to $4.15m from $1.37m. Management attributed the changes largely to higher equipment sales to leasing customers and the timing of lease-income and expense recognition. Leasing income net of leasing expense was $8.4m versus $5.9m.
- Provision for credit losses was a $13,100 recovery in Q3 versus a $130,500 provision a year earlier; nine-month provision was $8,200 versus $142,400. Nine-month SG&A was essentially unchanged at $14.10m.
- Cash flow: Nine-month operating cash flow was $15.43m versus $7.77m; investing used $1.94m versus providing $3.33m; financing used $11.85m versus $18.42m. Ending cash was $3.90m. Operating cash flow included a $2.6m increase in income taxes payable, primarily related to tax depreciation on lease-equipment purchases.
- Liquidity and debt: Current assets were $19.15m and current liabilities $9.27m (current ratio 2.1). No line-of-credit borrowings were outstanding at September 24; the $30m facility was fully available, subject to borrowing-base limitations, and covenants were met. The company said cash, franchise cash generation, lease-discounting sources and the credit line should fund planned operations through 2012. Discounted lease rentals were $74,900 current and $2,400 long term.
- Total assets were $42.78m and shareholders’ equity $30.35m. The company repurchased 99,494 shares for $3.53m during the first nine months and paid $398,400 in dividends.
Material developments, outlook and risks
- BridgeFunds impairment: Winmark recorded a $546,100 impairment on its investment in BridgeFunds notes during the nine months, including a $293,200 Q3 charge. The net investment was $1.7m, including related interest receivable; the notes matured June 30, 2012 under an amended agreement. Winmark had stopped accruing interest in 2010 and received no principal payments in the first nine months of 2011. The impairment estimate depends on assumptions about settlements, liabilities and defaults.
- Other investments: Long-term investments included $4.2m in two private companies. Winmark invested another $1.0m in Tomsten in June, bringing its ownership to 22.0%; its nine-month equity-method loss was $444,600. Available-for-sale securities had a $119,600 unrealized loss.
- One leasing customer represented approximately 13% of total assets. The company’s lease portfolio decreased to $30.2m from $30.7m at year-end, despite $15.6m of equipment purchases and $15.1m of lease-receivable collections during the period.
- Franchise activity included 34 openings and 14 closures; 67 of 68 agreements available for renewal were renewed. All 15 Wirth Business Credit franchise territories were terminated during Q1 for various reasons.
- No specific earnings or revenue guidance was provided. Management identified growth drivers as supporting franchisee sales, opening franchises, increasing lease originations while limiting write-offs, and controlling SG&A. Management cautioned that interim results are not necessarily indicative of full-year results.
- The filing reported no material litigation, no material changes to the prior annual report’s risk factors, and no off-balance-sheet arrangements. Interest-rate exposure on the credit line would arise if borrowings were made; there were no borrowings or interest-rate derivatives at quarter-end. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether BridgeFunds’ expected cash flows support the remaining $1.7m net carrying value and timely repayment by the amended maturity date.
- Tomsten’s operating performance and the recoverability of Winmark’s investment, including the investment’s goodwill component.
- Leasing portfolio credit quality, customer concentration, originations and collections; the filing reports $27,500 of non-accrual leases at quarter-end.
- Whether franchisee sales, store openings and renewals sustain royalty growth, and the implications of the Wirth territory terminations.
- The quality and repeatability of operating cash flow, including the benefit from increased income taxes payable, and continued availability of the credit line and lease-discounting financing.