Business context and reporting period
Winmark Corporation’s Form 10-K covers the fiscal year ended December 30, 2017, a 52-week year; fiscal 2016 was a 53-week year. The company franchises five value-focused resale retail brands and operates middle-market equipment leasing and small-ticket financing businesses. It had 1,211 franchised stores and a $41.3 million net leasing portfolio at year-end. The filing also reports unaudited fourth-quarter results.
Financial performance and position
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Total revenue | $69.7 million | $66.6 million |
| Operating income | $38.8 million | $38.3 million |
| Net income | $24.6 million | $22.2 million |
| Diluted EPS | $5.66 | $5.13 |
| Operating margin | 55.6% | 57.5% |
| Net margin | 35.2% | 33.4% |
| Cash from operations | $25.2 million | $26.3 million |
- Royalties rose 3.7% to $45.6 million, reflecting store growth and higher franchisee retail sales. Leasing income increased 6.9% to $18.5 million; leasing expense rose to $3.3 million. Merchandise sales were $2.6 million and franchise fees were $1.5 million.
- Franchising segment contribution increased 2.9% to $29.5 million; leasing segment contribution decreased 3.7% to $9.3 million.
- Year-end cash was $1.1 million; working capital was $11.9 million. Total debt was $67.6 million, and shareholders’ equity was negative $30.7 million, largely following tender-offer repurchases.
- The $50.0 million revolving credit facility had $35.4 million drawn and $14.6 million available. Notes had $32.2 million principal outstanding. The company reported compliance with debt covenants.
- Cash dividends were $0.43 per share for the year. The company spent approximately $49.9 million to repurchase 400,000 shares in its 2017 tender offer.
Material changes versus the prior comparable period
- Revenue increased 4.8% and net income increased 10.6%; operating income rose 1.3%, while operating margin declined from 57.5% to 55.6%.
- SG&A increased 5.9% to $25.3 million, partly from compensation, advertising and outside services, including costs for the new Winmark Franchise Partners initiative.
- Cash from operations declined by $1.1 million, primarily because of higher income-tax payments. Investing activities provided $0.1 million, versus $3.2 million used in 2016; financing activities used $25.4 million.
- Debt increased from $45.4 million to $67.6 million, principally to help fund the tender offer. The company’s share repurchases also drove its shareholders’ deficit deeper.
Fourth-quarter results
Unaudited fourth-quarter 2017 revenue was $17.8 million, operating income was $10.7 million, and net income was $7.7 million. Diluted EPS was $1.86, compared with $17.4 million revenue, $10.5 million operating income, $6.2 million net income and $1.41 diluted EPS in fourth-quarter 2016.
Outlook, risks and unusual items
- Management expected cash on hand, franchising cash flow, lease-discounting sources and the revolving credit facility to fund planned operations through 2018. No specific revenue or earnings guidance was provided.
- Management expects the federal corporate tax-rate reduction to lower its future effective tax rate. The 2017 tax provision included a $1.5 million benefit from remeasuring deferred taxes after enactment of the Tax Act and a $793,400 discrete stock-option tax benefit.
- The company expects adoption of the new revenue-recognition standard in 2018 to defer approximately $7 million of franchise-fee revenue on the balance sheet, with a corresponding retained-earnings adjustment, net of deferred taxes. Management did not expect the change to affect royalty revenue.
- Key risks include franchise renewals and openings, competition (including online resale marketplaces), access to used merchandise, leasing credit losses and residual values, debt and covenant obligations, interest-rate exposure, regulation, and data security. One leasing customer represented approximately 30% of net investment in leases according to the risk disclosure; the notes separately state leased assets with one customer were about 26% of total assets.
- A 1% increase in short-term interest rates was estimated to reduce annual pretax earnings by $354,000. There were no interest-rate derivatives. The filing reports no material litigation and no off-balance-sheet arrangements.
- Auditors gave unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal controls were effective.
Important facts for investors to verify
- Reconcile the customer concentration disclosures for the leasing portfolio and assess the customer’s credit quality and collateral.
- Review debt maturities, amortization, interest-rate exposure, covenant headroom and the effect of the tender-offer borrowing on financial flexibility.
- Assess whether franchise openings, renewals and store-level sales can sustain royalty growth; 62 agreements were signed but unopened at year-end, most expected to open in 2018.
- Evaluate the leasing portfolio’s credit-loss allowance, equipment residual-value assumptions and future originations.
- Confirm the actual impact of the 2018 revenue-recognition transition and the expected lower tax rate on reported earnings and cash taxes.