Winmark Corporation — FY2018 Form 10-K
Reporting period: Fiscal year ended December 29, 2018 (52 weeks). The filing also reports unaudited fourth-quarter results. Amounts below are in U.S. dollars.
Business context
Winmark franchises five value-focused resale retail concepts—Plato’s Closet, Once Upon A Child, Play It Again Sports, Style Encore and Music Go Round—and operates middle-market equipment leasing and small-ticket financing businesses. It had 1,241 franchised stores in the U.S. and Canada at year-end, up from 1,211: 52 opened and 22 closed. The company also provides franchising advisory services through Winmark Franchise Partners.
Financial performance and liquidity
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Total revenue | $72.5 million | $69.8 million | +3.9% |
| Operating income | $41.8 million | $38.8 million | +7.6% |
| Net income | $30.1 million | $24.6 million | +22.6% |
| Diluted EPS | $7.26 | $5.66 | +28.3% |
| Operating margin | 57.6% | 55.6% | +2.0 percentage points |
| Net margin | 41.6% | 35.2% | +6.4 percentage points |
- Royalties, the largest revenue source, rose 5.7% to $48.2 million, reflecting higher sales at several brands and 29 additional stores across Plato’s Closet, Once Upon A Child and Style Encore. Franchising segment revenue was $54.3 million; leasing revenue was $18.2 million, down 1.6%.
- Net leasing income (leasing income less leasing expense) increased to $16.2 million from $15.2 million. Leasing segment operating contribution rose 6.4% to $9.9 million; franchising contribution rose 8.0% to $31.9 million.
- SG&A increased 3.2% to $26.0 million. The provision for credit losses was $38,600, versus $9,000 in 2017. Interest expense was $2.4 million.
- The effective tax rate fell to 24.1% from 32.6%, primarily reflecting the federal corporate tax-rate reduction to 21%. The lower tax burden was a significant contributor to net-income growth.
- Operating cash flow was $34.9 million, up from $25.2 million; management attributed the increase primarily to lower cash income-tax payments. Investing activities provided $0.5 million. Financing activities used $34.0 million.
- Cash, cash equivalents and restricted cash totaled $2.6 million at year-end. Working capital was $11.8 million. Total assets were $46.7 million.
- Year-end notes payable were $28.9 million; the $50.0 million revolving credit facility had no borrowings outstanding, leaving $50.0 million available. The company reported covenant compliance. It also had $5.7 million of discounted lease rentals outstanding, including $3.0 million current.
- Cash dividends were $0.56 per share, totaling $2.2 million. The company repurchased 12,384 shares for $1.8 million during 2018.
Prior-period and fourth-quarter comparison
- Revenue growth accelerated to 3.9% in 2018 from 4.9% in 2017. Operating income grew 7.6%, compared with 1.6% in 2017.
- Net income increased 22.6%, while diluted EPS rose from $5.66 to $7.26; the decline in weighted-average diluted shares also contributed to EPS growth. The tax-rate reduction materially boosted earnings.
- FY2018 equipment purchases for lease customers were $23.1 million, down from $25.4 million in 2017. The net leasing portfolio declined to $39.0 million from $41.3 million.
- Unaudited Q4 2018 revenue was $17.1 million, versus $17.8 million in Q4 2017; operating income was $10.2 million versus $10.6 million, while net income was $7.7 million versus $7.6 million.
Outlook, risks and notable items
- Management provided no specific revenue or earnings guidance. It said cash on hand, franchising cash flows, lease-discounting sources and the credit facility should be adequate to fund planned operations through 2019.
- On February 28, 2019, the company announced a tender offer for up to 150,000 shares at $159.63 per share—approximately $23.9 million plus expenses—expected to be funded with available cash and credit-facility borrowings.
- Management highlighted franchise openings and renewals, franchisee performance, lease originations and credit losses, and SG&A control as important to operating-income growth. All 61 agreements due for renewal in 2018 were renewed; 47 signed retail franchise agreements remained unopened at year-end, most expected to open in 2019.
- Risks include dependence on franchise renewals and new store openings; uncertain supply of quality used goods; intense retail and leasing competition; lease-credit losses and customer concentration; and debt covenants and access to financing. The filing reports that leased assets with two customers represented approximately 24% and 11% of total assets, respectively, at year-end.
- The company adopted the new revenue-recognition standard retrospectively. It defers initial franchise fees and recognizes marketing and software fees over the franchise term; comparative 2017 and 2016 results were adjusted. It expected lease-accounting changes in 2019 to add approximately $6.0–$6.5 million of right-of-use assets and lease liabilities, without material income-statement or cash-flow effects.
- No material litigation was reported. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether the announced 2019 tender offer was completed, its final cost and resulting debt and share count.
- Subsequent franchise openings and renewals, particularly whether the 47 signed but unopened agreements convert to operating stores.
- Lease-portfolio performance, customer concentration, delinquencies, allowance adequacy and the decline in portfolio size.
- Cash generation and debt repayment capacity after the tender offer, including covenant headroom and use of the revolving facility.
- Whether franchising growth and margins can offset softer leasing revenue and sustain earnings growth without the benefit of the lower tax rate.