Winmark Corporation — Q2 2016 Form 10-Q
Business context and period: The quarter ended June 25, 2016; comparisons are with the quarter and six months ended June 27, 2015. Winmark franchises five value-oriented retail brands and operates middle-market and small-ticket equipment leasing businesses. At quarter-end, it had 1,169 franchised stores and a $37.0 million net leasing portfolio.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $16.30m | $15.48m | $32.48m | $36.50m |
| Operating income | $9.32m | $8.08m | $17.36m | $18.06m |
| Net income | $5.39m | $4.75m | $9.96m | $10.81m |
| Diluted EPS | $1.25 | $1.00 | $2.31 | $2.18 |
| Operating margin | 57.2% | 52.2% | 53.5% | 49.4% |
| Net margin | 33.1% | 30.7% | 30.7% | 29.6% |
- Quarterly revenue rose 5.3%, operating income 15.3%, and net income 13.5% year over year. For the first six months, revenue declined 11.0%, operating income 3.9%, and net income 7.9%.
- Six-month royalty revenue increased 4.5% to $20.83 million; leasing income declined to $8.67 million from $13.67 million. Management attributed the leasing revenue comparison primarily to lower equipment sales to customers. Leasing expense also fell substantially, to $1.36 million from $4.77 million; management cautions that leasing income and expense timing varies by contract. Net leasing income after leasing expense was $7.3 million versus $8.9 million.
- Six-month franchising segment contribution rose to $12.77 million from $11.85 million; leasing segment contribution fell to $4.59 million from $6.21 million. SG&A was essentially flat at $12.49 million for the six-month period.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $13.16 million, versus $12.80 million; management attributed the increase primarily to lower cash income-tax payments. Investing activities provided $1.91 million, including $10.59 million of lease-equipment purchases and $12.47 million of lease principal collections. Financing activities used $15.01 million, including net debt repayments, share repurchases, and dividends. Cash increased $52,100 to $1.06 million.
- At June 25, total assets were $42.82 million, down from $47.41 million at December 26, 2015. Net investment in leases was $36.96 million, down from $38.99 million. Shareholders’ deficit narrowed to $21.93 million from $30.67 million.
- Debt included $30.5 million drawn on the revolving line and $23.0 million principal outstanding on notes. The line had $24.5 million of additional availability; its borrowings bore rates of 2.70%–3.50%. The notes bear 5.50% interest and require quarterly principal payments. The company reported compliance with debt covenants. The line and notes are secured by substantially all assets.
- Management said cash on hand, franchising cash flows, lease-discounting sources, and the line of credit should fund planned operations through 2017. There were no off-balance-sheet arrangements reported.
Business developments, outlook and risks
- During the first six months, Winmark opened 36 franchises and closed 17. It renewed 39 of 41 agreements available for renewal. Royalties benefited from additional Once Upon A Child, Plato’s Closet, and Style Encore locations.
- The company repurchased 17,194 shares for $1.57 million during the first six months and paid $0.70 million in dividends. At quarter-end, authorization remained for repurchases of 142,988 shares.
- No formal earnings or revenue guidance was provided. Management’s liquidity outlook is subject to future performance and access to refinancing, borrowing, asset sales, or equity financing if needed. The filing warns that those options may not be available on acceptable terms.
- A 1% increase in short-term rates would reduce annual pretax earnings by an estimated $305,000 on the revolving-line borrowings outstanding at quarter-end; no interest-rate derivatives were in place. Three leasing customers represented approximately 21%, 13%, and 10% of total assets, respectively.
- All lease investment was classified as accruing at quarter-end, with no delinquent or non-accrual balances reported. The company disclosed no material litigation and no material changes to the risk factors in its latest Form 10-K. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether royalty growth and franchise openings can continue to offset the leasing segment’s lower six-month contribution and shrinking portfolio.
- The drivers and sustainability of leasing revenue and expense, which management says can fluctuate with lease timing and equipment sales.
- Lease-customer concentration, credit-loss allowance adequacy, and the effect of future delinquencies or write-offs.
- Debt repayment capacity, covenant headroom, revolving-line availability and rate exposure, particularly given low cash balances and secured borrowing.
- The basis for management’s expectation that available funding will cover planned operations through 2017, and any subsequent changes in dividends or share repurchases.