WINMARK CORP quarterly report, Q2 FY2011

Winmark Corporation — Q2 2011 Form 10-Q

Business context and period: The unaudited report covers the quarter and six months ended June 25, 2011, compared with the periods ended June 26, 2010. Winmark franchises four resale retail brands and operates middle-market and small-ticket equipment leasing businesses. It reported 908 franchised stores and a $29.9 million net leasing portfolio at quarter-end.

Financial performance

MetricQ2 2011Q2 2010Six months 2011Six months 2010
Total revenue$15.22 million$9.88 million$26.33 million$19.72 million
Operating income$6.08 million$4.20 million$11.30 million$8.00 million
Net income$3.40 million$2.34 million$6.43 million$4.52 million
Diluted EPS$0.65$0.45$1.23$0.87
Operating margin40.0%42.5%42.9%40.5%
Net margin22.3%23.7%24.4%22.9%
  • Q2 revenue rose 54%, led by leasing income of $7.0 million versus $2.3 million; leasing expense also rose, to $3.34 million from $0.44 million. Six-month leasing income net of leasing expense was $6.4 million versus $3.9 million.
  • Royalties grew 7.1% in Q2 and 9.0% for six months, mainly reflecting higher sales at Plato’s Closet and Once Upon A Child. Franchise fees declined as fewer stores opened. Six-month merchandise sales increased 27.7%.
  • Q2 operating income rose 45% and net income rose 45%. Six-month operating income increased 41% and net income 42%. The Q2 operating margin declined despite higher earnings, with leasing expense rising faster than revenue; the six-month margin improved.
  • Six-month SG&A increased 1.5% to $9.88 million. The credit-loss provision was $21,300 versus $11,900; net lease write-offs were $83,600 versus $204,900.

Cash, liquidity and capital

  • Six-month operating cash flow was $11.28 million, up from $6.60 million. Investing activities used $1.00 million, including $10.95 million of lease-equipment purchases largely offset by $10.91 million of lease principal collections and a $1.0 million Tomsten investment. Financing activities used $11.50 million.
  • Cash was $1.04 million at June 25, 2011, compared with $2.26 million at December 25, 2010. The filing cites a 1.6-to-1 current ratio at quarter-end. Operating cash flow included a $1.7 million benefit from changes in income taxes payable/receivable.
  • No line-of-credit borrowings were outstanding. The $30 million facility was fully available, subject to borrowing-base limits; the company reported compliance with covenants. Discounted lease rentals totaled approximately $213,000, including current and long-term amounts.
  • The company repurchased 94,099 shares for $3.31 million during the first half and paid $249,200 in dividends. It reported no off-balance-sheet arrangements.

Material developments, outlook and risks

  • Winmark recorded a $252,900 impairment charge on its BridgeFunds notes and stopped accruing interest on the investment in September 2010. The net investment was $1.75 million at June 25; the company received no principal payments in the first half. In July 2011, the notes’ maturity was extended to June 30, 2012.
  • Winmark invested an additional $1.0 million in Tomsten in June, increasing its ownership to 22.0%. It recorded a $219,900 share of Tomsten’s losses for the first half.
  • One leasing customer represented approximately 15% of total assets. The lease portfolio’s allowance for credit losses was $845,500. Management notes that leasing income and expense can vary substantially with the timing and accounting recognition of individual leases.
  • Management said cash on hand, franchise cash generation, lease discounting and the credit line should fund planned operations through 2012. This is an outlook statement, not earnings guidance; the filing cautions that interim results are not necessarily indicative of full-year results.
  • Management identified growth drivers as supporting franchisee sales, opening franchises, increasing lease originations while limiting write-offs, and controlling SG&A. All 42 franchise agreements available for renewal in the first half were renewed; 12 stores opened and seven closed. The 15 Wirth Business Credit territories were terminated in Q1.
  • The company reported no material litigation and no material changes to the risk factors in its prior Form 10-K. Key exposures include lease-credit losses, the recoverability of private-company investments, franchisee performance, and interest-rate risk if the credit line is drawn.

Important facts for investors to verify

  • Whether the leasing revenue and profit trend is sustainable, given management’s warning about timing effects and the decline in total net lease investment from $30.7 million at year-end to $29.9 million.
  • BridgeFunds’ expected cash flows, valuation assumptions, and ability to repay by the amended June 30, 2012 maturity.
  • Tomsten’s operating performance and the carrying value of Winmark’s investment, including the goodwill component.
  • The financial condition and payment performance of the customer representing about 15% of total assets, and the adequacy of the lease-loss allowance.
  • Cash needs, borrowing-base availability, and covenant headroom if franchise or leasing cash flows weaken.