Winmark Corporation — 2013 Q3 Form 10-Q
Business context and period. Unaudited results cover the three and nine months ended September 28, 2013. Winmark franchises value-oriented resale retail concepts and operates middle-market and small-ticket equipment leasing businesses. At quarter-end, it had 995 franchised stores and a $36.7 million net lease portfolio.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $14.8 million | $14.8 million | $42.0 million | $38.8 million |
| Operating income | $8.5 million | $8.5 million | $22.3 million | $20.3 million |
| Net income | $5.3 million | $4.3 million | $13.6 million | $11.2 million |
| Diluted EPS | $1.00 | $0.82 | $2.61 | $2.13 |
| Operating margin | 57.7% | 57.2% | 53.0% | 52.4% |
| Net margin | 35.5% | 28.8% | 32.5% | 28.8% |
- Revenue drivers: Q3 royalties grew 7.4% to $9.9 million, while leasing income fell to $3.8 million from $4.3 million. For the first nine months, royalties rose 7.1% to $26.9 million and leasing income increased to $11.3 million from $10.0 million. YTD total revenue increased 8.1%.
- Profitability: Q3 net income rose about 23% despite essentially flat revenue. YTD net income increased about 22%. Prior-year comparisons included $372,300 of Q3 equity-investment losses and a $660,700 investment-note impairment; neither recurred in 2013. Lower interest expense also supported results.
- Cash flow: YTD operating activities provided $17.0 million, versus $14.7 million in 2012. Investing activities used $1.8 million, including $15.0 million of lease-equipment purchases and $13.7 million of lease collections. Financing activities used $9.2 million, including $10.8 million of net line-of-credit repayments, $1.9 million of share repurchases and $0.7 million of dividends. Cash increased by $6.0 million to $8.2 million.
- Liquidity and debt: Current assets were $27.2 million and current liabilities $10.3 million at September 28; management reported a 2.6:1 current ratio, versus 0.8:1 at the end of Q3 2012. No line-of-credit borrowings were outstanding; $35.0 million was available, subject to borrowing-base limits. The facility matures February 29, 2016, is secured by substantially all assets, and the company reported covenant compliance. Discounted lease-rental liabilities totaled about $1.2 million.
Changes, outlook and risks
- Royalties benefited from more Plato’s Closet and Once Upon A Child stores and higher franchisee sales. During the first nine months, 53 stores opened and 26 closed; 69 of 73 agreements available for renewal were renewed.
- YTD leasing income less leasing expense was $10.1 million, versus $8.7 million. Management cautioned that period-to-period leasing revenue and expense fluctuate with lease accounting and timing; it views equipment purchases and portfolio trends as more meaningful indicators of activity.
- SG&A rose 8.8% in Q3 and 9.8% YTD, reflecting compensation, benefits and outside services, with launch-related costs for the new Style Encore concept. The lease portfolio grew to $36.7 million from $36.2 million at fiscal year-end.
- Management believed cash, franchising cash generation, lease-discounting sources and the credit line would fund planned operations through 2014. This is a forward-looking assessment, not a guarantee; actual performance may differ, and the filing says interim results are not necessarily indicative of the full year.
- Credit risk remains relevant to the leasing business. The allowance for lease credit losses was $805,500; the filing reported no non-accrual leases at September 28, 2013. Allowance estimates depend on delinquencies, historical losses and other judgments.
- Winmark’s $8.5 million investment in Tomsten had been fully impaired; Tomsten filed for Chapter 11 bankruptcy on April 29, 2013. Its $2.0 million BridgeFunds note investment was also fully impaired, with no expected cash flows. Both had zero carrying value at quarter-end.
- Other items: the company paid quarterly dividends of $0.04 and $0.05 per share in Q1 and Q2 and $0.05 in Q3. It repurchased 28,422 shares for $1.9 million YTD. Management reported no material litigation, no material changes to previously disclosed risk factors, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether royalty growth and franchisee sales continue, including store openings, closures and renewals across the brands.
- Lease originations, equipment-purchase levels, portfolio performance, recoveries, delinquencies and the adequacy of credit-loss reserves.
- The sustainability of higher margins and earnings given increased SG&A and the absence of prior-year investment losses and impairments.
- Availability and terms of lease-discounting finance and the $35.0 million credit facility, including covenant compliance and borrowing-base constraints.
- Cash deployment, share repurchases, dividends, and progress and costs associated with Style Encore.
- Management’s 2014 liquidity outlook and the risk that actual operating results differ from interim results or forward-looking expectations.