Winmark Corp. 10-Q Summary: Period Ended September 30, 2006
Business Context and Reporting Period
Winmark Corporation (Winmark) operates a franchise business model with brands including Play It Again Sports, Once Upon A Child, Plato's Closet, Music Go Round, and Wirth Business Credit. The company also operates equipment leasing businesses. This report covers the quarterly period ended September 30, 2006, and the nine-month period ended on that date. As of the reporting date, the company operated 829 franchises.
Key Financial Metrics
Revenue and Profit (Nine Months Ended Sept 30, 2006):
- Total Revenue: $20.49 million (up 3.5% from $19.80 million in 2005).
- Net Income: $2.60 million (up 20.0% from $2.17 million in 2005).
- Earnings Per Share (Diluted): $0.43 (up from $0.34 in 2005).
- Operating Income: $4.04 million (up 10.6% from $3.65 million in 2005).
Cash Flow and Liquidity:
- Cash and Cash Equivalents: $1.30 million (down from $2.95 million at year-end 2005).
- Net Cash Provided by Operating Activities: $3.34 million.
- Net Cash Used in Investing Activities: $9.38 million (primarily due to $11.6 million in equipment purchases for lease contracts).
- Net Cash Provided by Financing Activities: $4.38 million (driven by $15.34 million in note issuances, partially offset by $12.18 million in stock repurchases).
- Current Ratio: 1.4 to 1.0.
Debt and Capital Structure:
- Renewable Unsecured Subordinated Notes: $15.34 million outstanding (weighted average interest rate 9.02%).
- Line of Credit: $15 million facility available; $0 outstanding as of September 30, 2006.
- Share Repurchases: 519,000 shares repurchased in the first nine months of 2006 for $12.18 million.
Material Changes vs. Prior Period
- Revenue Mix Shift: Royalties increased 10.6% to $14.32 million, driven by new store openings (particularly Plato's Closet) and higher franchisee sales. Conversely, merchandise sales decreased 34.5% to $3.53 million due to the 2005 sale of all company-owned retail stores and a strategic shift toward franchisees purchasing directly from vendors.
- Leasing Segment Expansion: Leasing income surged 342% to $1.21 million due to a larger portfolio ($15.4 million). However, the segment reported an operating loss of $1.51 million due to $2.72 million in direct startup costs.
- Expense Growth: Selling, General, and Administrative (SG&A) expenses increased 10.8% to $12.93 million, attributed to leasing infrastructure costs, salaries, and advertising, partially offset by the elimination of costs associated with former company-owned stores.
- Investment Activity: The company recorded a $360,000 gain on the sale of an investment in Commercial Credit Group, Inc., which was recognized in interest and other income.
Outlook, Risks, and Management Commentary
Management Commentary: Management emphasizes that profitability depends on supporting franchise partners, opening new franchises, increasing lease originations, and controlling SG&A expenses. The company renewed 26 franchise agreements available for renewal during the period, indicating franchisee retention.
Capital Resources: The company believes cash from operations, existing cash, the line of credit, and the shelf registration for up to $50 million in subordinated notes will be adequate to fund operations and leasing expansion for the remainder of 2006.
Risks and Contingencies:
- Executive Departure: Stephen M. Briggs resigned as President, COO, and Board member on October 4, 2006.
- Investment Risk: The company holds $11.5 million in long-term investments in private companies (Tomsten, CCG, BridgeFunds), which are illiquid and subject to impairment risks.
- Leasing Credit Risk: The company maintains an allowance for credit losses on its lease portfolio; actual losses could differ from estimates.
- Related Party Transactions: Significant stock repurchases and note purchases were made from related parties, including the Chairman and Rush River Group, LLC.
Investor Verification Checklist
- Verify the sustainability of the leasing segment's operating losses as the portfolio matures and startup costs decline.
- Confirm the impact of the CEO/COO transition on strategic execution and future franchise growth.
- Monitor the liquidity position given the significant cash outflow for leasing equipment and stock repurchases, reducing cash reserves to $1.3 million.
- Review the valuation and potential impairment risks of the $11.5 million in long-term private equity investments.
- Assess the effectiveness of the new subordinated notes in funding growth without over-leveraging the balance sheet.