Winmark Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; comparisons are to the periods ended June 25, 2011. The interim financial statements are unaudited. Winmark franchises four value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses. At quarter-end it had 946 franchised stores and a $32.1 million net leasing portfolio.
Financial performance and liquidity
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Revenue | $12.19m | $15.22m | $24.03m | $26.33m |
| Operating income | $6.03m | $6.08m | $11.87m | $11.30m |
| Net income | $3.40m | $3.40m | $6.92m | $6.43m |
| Diluted EPS | $0.65 | $0.65 | $1.31 | $1.23 |
| Operating margin | 49.4% | 40.0% | 49.4% | 42.9% |
- First-half operating cash flow was $8.29m, down from $11.28m, primarily due to higher cash income-tax payments. Investing activities used $1.48m; financing activities used $13.79m. Cash declined $6.98m to $2.04m.
- At June 30, current assets were $16.31m and current liabilities $22.04m; the reported current ratio was 0.7. Shareholders’ equity was $14.89m, down from $35.11m at year-end, primarily reflecting the special dividend.
- Line-of-credit borrowings were $12.8m at 2.99%–3.75%, with $22.2m additional availability under a $35m facility maturing February 29, 2016. Winmark reported compliance with covenants. It also had $946,100 of discounted lease rentals payable, including current and long-term amounts.
- First-half equipment purchases for lease customers were $10.9m, while lease-receivable collections were $8.6m. The net leasing investment rose to $32.1m from $29.8m at December 31, 2011.
Material changes and management commentary
- Q2 revenue declined about 20%, while first-half revenue declined about 9%; net income was roughly flat in Q2 and increased about 8% for the first half.
- Royalties rose 12.8% in Q2 and 15.2% in the first half, supported by higher sales at Plato’s Closet and Once Upon A Child and 33 more Plato’s Closet stores than in the comparable periods. First-half franchise fees increased to $555,000 from $320,000.
- Leasing income fell to $3.29m from $6.98m in Q2 and to $5.68m from $10.22m in the first half. Management attributed the decline to lower equipment sales to customers and cautioned that reported leasing income and expense fluctuate with lease-specific recognition timing. First-half leasing income less leasing expense was $5.1m versus $6.4m.
- Franchising segment contribution increased 15.1% in Q2 and 22.1% in the first half. Leasing segment contribution declined to $1.76m from $2.37m in Q2 and to $2.77m from $3.84m in the first half.
- SG&A increased 3.8% in Q2 and 4.9% in the first half, mainly from compensation and benefits. The first-half credit-loss provision was a $67,900 recovery, compared with a $21,300 provision in 2011, reflecting recoveries and lower delinquencies.
Outlook, risks and unusual items
- Management said cash on hand, franchising cash generation, lease-discounting sources and the credit line should be adequate to fund planned operations through 2013. No numerical earnings or revenue guidance was provided.
- The company paid a $5.00-per-share special dividend, totaling $25.4m, and a $0.03 quarterly dividend in March. A further $0.04-per-share quarterly dividend was paid in June. The special dividend was funded with cash and $12.8m of net line-of-credit borrowing.
- Winmark repurchased 49,256 shares for $2.6m in the first half at an average $52.27 per share; 446,616 shares remained authorized for repurchase at June 30.
- Long-term investments included illiquid stakes in Tomsten and BridgeFunds. Winmark held 22% of Tomsten and recorded a $278,100 first-half share of its losses. The $2.0m BridgeFunds note investment remained impaired, with an $883,100 valuation allowance; no further impairment was recorded in the first half. No principal or interest payments were received during that period, interest accrual had stopped in 2010, and a July 2012 amendment extended the notes’ maturity to June 30, 2013.
- One leasing customer represented approximately 11% of total assets. A 1% increase in short-term interest rates was estimated to reduce annual pretax earnings by $128,000; all line-of-credit borrowings were subject to variable rates, and no interest-rate derivatives were in place.
- Management reported no material litigation, no material change in previously disclosed risk factors, and no material change in internal control over financial reporting. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether royalty growth and franchisee retail-sales trends can continue, including store openings, closures and renewals (61 of 63 available agreements were renewed in the first half).
- Lease originations, portfolio performance and customer concentration, and whether timing-driven leasing revenue changes affect future results.
- Liquidity after the special dividend: cash, variable-rate debt, covenant headroom and the company’s ability to fund operations through 2013.
- Recoverability and timing of cash flows from the BridgeFunds notes and Tomsten investment, including the amended BridgeFunds maturity.
- Potential effects of higher interest rates and changes in lease credit losses on earnings and cash generation.