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WINA > SEC Filings for WINA > Form 10-Q on 23-Apr-2014All Recent SEC Filings

Show all filings for WINMARK CORP

Form 10-Q for WINMARK CORP


23-Apr-2014

Quarterly Report


ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

As of March 29, 2014, we had 1,021 franchises operating under the Plato's Closet, Once Upon A Child, Play it Again Sports, Music Go Round and Style Encore brands and had a leasing portfolio of $40.0 million. Management closely tracks the following financial criteria to evaluate current business operations and future prospects: royalties, leasing activity, and selling, general and administrative expenses.

Our most profitable source of franchising revenue is royalties received from our franchise partners. During the first three months of 2014, our royalties increased $0.3 million or 4.0% compared to the first three months of 2013.

During the first three months of 2014, we purchased $6.5 million in equipment for lease customers compared to $4.7 million in the first three months of 2013. Overall, our leasing portfolio (net investment in leases - current and long-term) increased to $40.0 million at March 29, 2014 from $37.5 million at December 28, 2013. Leasing income net of leasing expense during the first three months of 2014 was $4.1 million compared to $3.1 million in the same period last year. Fluctuations in period-to-period leasing income and leasing expense result primarily from the manner and timing in which leasing income and leasing expense is recognized over the term of each particular lease in accordance with accounting guidance applicable to leasing. For this reason, we believe that more meaningful levels of leasing activity are the purchases of equipment for lease customers and the medium- to long-term trend in the size of the leasing portfolio.

Management continually monitors the level and timing of selling, general and administrative expenses. The major components of selling, general and administrative expenses include salaries, wages and benefits, advertising, travel, occupancy, legal and professional fees. During the first three months of 2014, selling, general and administrative expense increased $0.5 million, or 8.7%, compared to the first three months of 2013.

Management also monitors several nonfinancial factors in evaluating the current business operations and future prospects including franchise openings and closings and franchise renewals. The following is a summary of our franchising activity for the first three months ended March 29, 2014:

                                                                   THREE MONTHS ENDED 3/29/14
                                                                   AVAILABLE
                       TOTAL                            TOTAL         FOR          COMPLETED
                      12/28/13    OPENED     CLOSED    3/29/14      RENEWAL         RENEWALS
Plato's Closet
Franchises - US and
Canada                     391          6          0        397              6                6

Once Upon A Child
Franchises - US and
Canada                     282          6          0        288             12               12

Play It Again
Sports
Franchises - US and
Canada                     300          0          0        300             11               10

Music Go Round
Franchises - US             29          0          0         29              1                1

Style Encore
Franchises - US              3          4          0          7              -                -

Total Franchised
Stores                   1,005         16          0      1,021             30               29


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Renewal activity is a key focus area for management. Our franchisees sign 10-year agreements with us. The renewal of existing franchise agreements as they approach their expiration is an indicator that management monitors to determine the health of our business and the preservation of future royalties. During the first three months of 2014, we renewed 29 of the 30 franchise agreements available for renewal.

Our ability to grow our operating income is dependent on our ability to:
(i) effectively support our franchise partners so that they produce higher revenues, (ii) open new franchises, (iii) increase lease originations and minimize write-offs in our leasing portfolios, and (iv) control our selling, general and administrative expenses.

Results of Operations



The following table sets forth selected information from our Consolidated
Condensed Statements of Operations expressed as a percentage of total revenue:



                                                     Three Months Ended
                                               March 29, 2014   March 30, 2013
Revenue:
Royalties                                                60.5 %           64.5 %
Leasing income                                           30.1             25.9
Merchandise sales                                         5.4              5.1
Franchise fees                                            2.4              3.1
Other                                                     1.6              1.4
Total revenue                                           100.0 %          100.0 %

Cost of merchandise sold                                 (5.2 )           (4.9 )
Leasing expense                                          (2.1 )           (2.1 )
Provision for credit losses                              (0.3 )           (0.1 )
Selling, general and administrative expenses            (41.3 )          (42.1 )
Income from operations                                   51.1             50.8
Interest expense                                         (0.4 )           (0.7 )
Interest and other income (expense)                         -             (0.1 )
Income before income taxes                               50.7             50.0
Provision for income taxes                              (19.4 )          (19.2 )
Net income                                               31.3 %           30.8 %

Comparison of Three Months Ended March 29, 2014 to Three Months Ended March 30, 2013

Revenue

Revenues for the first three months of 2014 totaled $14.6 million compared to $13.1 million for the comparable period in 2013.

Royalties and Franchise Fees

Royalties increased to $8.8 million for the first three months of 2014 from $8.5 million for the first three months of 2013, a 4.0% increase. The increase was due to higher Once Upon A Child and Plato's Closet royalties of $0.2 million and $0.1 million, respectively. The increase in royalties for these brands is primarily from having 18 additional Once Upon A Child and 30 additional Plato's Closet franchise stores in the first three months of 2014 compared to the same period last year.


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Franchise fees decreased to $349,000 for the first three months of 2014 compared to $414,600 for the first three months of 2013, primarily as a result of opening five fewer franchises in the 2014 period compared to the same period in 2013.

Leasing Income

Leasing income increased to $4.4 million for the first three months of 2014 compared to $3.4 million for the same period in 2013. The increase is primarily due to a higher level of equipment sales to customers as well as the classification of certain leases as sales-type leases in accordance with accounting guidance applicable to lessors.

Merchandise Sales

Merchandise sales include the sale of product to franchisees either through our Computer Support Center or through the Play It Again Sports buying group (together, "Direct Franchisee Sales"). Direct Franchisee Sales increased to $788,000 for the first three months of 2014 compared to $665,700 in the same period of 2013. The increase is due to an increase in technology purchases by our franchisees.

Cost of Merchandise Sold

Cost of merchandise sold includes in-bound freight and the cost of merchandise associated with Direct Franchisee Sales. Cost of merchandise sold increased to $754,700 for the first three months of 2014 compared to $641,100 in the same period of 2013. The increase was due to an increase in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the first three months of 2014 and 2013 was 95.8% and 96.3%, respectively.

Leasing Expense

Leasing expense increased to $306,600 for the first three months of 2014 compared to $279,700 for the first three months of 2013. The increase is primarily due to an increase in the associated cost of equipment sales to customers discussed above.

Provision for Credit Losses

Provision for credit losses was $38,900 for the first three months of 2014 compared to $13,800 for the first three months of 2013. The increase in provision for credit losses is primarily due to the increase in lease payments receivable associated with the larger lease portfolio.

Selling, General and Administrative

Selling, general and administrative expenses increased 8.7% to $6.0 million in the first three months of 2013 from $5.5 million in the same period of 2013. The increase was primarily due to an increase in compensation and benefits expenses.

Interest Expense

Interest expense decreased to $62,100 for the first three months of 2014 compared to $89,500 for the first three months of 2013. The decrease is primarily due to lower average corporate borrowings when compared to last year.

Interest and Other Income (Expense)

During the first three months of 2013, we had interest and other income of $100 compared to $(10,200) of interest and other income (expense) in the first three months of 2013. Interest and other income during the first quarter of 2014 included gains on sales of marketable securities that did not occur during the first quarter of 2013. (See Note 4 - "Investments").


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Income Taxes

The provision for income taxes was calculated at an effective rate of 38.3% for the first three months of 2014 and 2013.

Segment Comparison of Three Months Ended March 29, 2014 to Three Months Ended March 30, 2013

Franchising Segment Operating Income

The franchising segment's operating income for the first three months of 2014 of $4.7 million was comparable to $4.8 million for the first three months of 2013.

Leasing Segment Operating Income

The leasing segment's operating income for the first three months of 2014 increased by $0.9 million to $2.7 million from $1.8 million for the first three months of 2013. The increase in segment contribution was due to an increase in leasing income net of leasing expense.

Liquidity and Capital Resources

Our primary sources of liquidity have historically been cash flow from operations and borrowings. The components of the consolidated condensed statement of operations that reduce our net income but do not affect our liquidity include non-cash items for depreciation and compensation expense related to stock options.

We ended the first quarter of 2014 with $2.4 million in cash and cash equivalents and a current ratio (current assets divided by current liabilities) of 0.8 to 1.0 compared to $2.2 million in cash and cash equivalents and a current ratio of 1.3 to 1.0 at the end of the first quarter of 2013.

Operating activities provided $7.0 million of cash during the first three months of 2014 compared to $6.7 million provided during the same period last year. The increase in cash provided by operating activities in the first three months of 2014 compared to 2013 primarily resulted from the increase in net income.

Investing activities used $2.4 million of cash during the first three months of 2014. The 2014 activities consisted primarily of the purchase of equipment for lease customers of $6.5 million and principal collections on lease receivables of $4.3 million.

Financing activities used $12.8 million of cash during the first three months of 2014. Our most significant financing activities during the first quarter of 2014 consisted of $26.0 million for the payment of dividends, $1.1 million to repurchase 14,066 shares of our common stock and borrowings on our line of credit of $14.0 million, with such borrowings incurred primarily to fund in part the dividends and stock repurchases. (See Note 7 - "Shareholders' Equity" and Note 8 - "Line of Credit").

As of March 29, 2014, we had no off balance sheet arrangements.

As of March 29, 2014, our borrowing availability under our credit agreement with The PrivateBank and Trust Company and BMO Harris Bank, N.A. (the "Line of Credit") was $35.0 million (the lesser of the borrowing base or the aggregate line of credit). There were $14.0 million in borrowings outstanding at March 29, 2014 under the Line of Credit bearing interest ranging from 2.40% to 3.25%, leaving $21.0 million available for additional borrowings.


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The Line of Credit, which has a termination date of February 28, 2018, has been and will continue to be used for general corporate purposes. The Line of Credit is secured by a lien against substantially all of our assets, contains customary financial conditions and covenants, and requires maintenance of minimum levels of debt service coverage and tangible net worth and maximum levels of leverage (all as defined within the Line of Credit). As of March 29, 2014, we were in compliance with all of our financial covenants.

We may utilize discounted lease financing to provide funds for a portion of our leasing activities. Rates for discounted lease financing reflect prevailing market interest rates and the credit standing of the lessees for which the payment stream of the leases are discounted. We believe that discounted lease financing will continue to be available to us at competitive rates of interest through the relationships we have established with financial institutions.

We believe that the combination of our cash on hand, the cash generated from our franchising business, cash generated from discounting sources and our Line of Credit will be adequate to fund our planned operations through 2014.

Critical Accounting Policies

The Company prepares the consolidated condensed financial statements of Winmark Corporation and Subsidiaries in conformity with accounting principles generally accepted in the United States of America. As such, the Company is required to make certain estimates, judgments and assumptions that it believes are reasonable based on information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. There can be no assurance that actual results will not differ from these estimates. The critical accounting policies that the Company believes are most important to aid in fully understanding and evaluating the reported financial results include the following:

Revenue Recognition - Royalty Revenue and Franchise Fees

The Company collects royalties from each retail franchise based on a percentage of retail store gross sales. The Company recognizes royalties as revenue when earned. At the end of each accounting period, estimates of royalty amounts due are made based on applying historical weekly sales information to the number of weeks of unreported franchisee sales. If there are significant changes in the actual performance of franchisees versus the Company's estimates, its royalty revenue would be impacted. During the first three months of 2014, the Company collected $18,700 more than it estimated at December 28, 2013. As of March 29, 2014, the Company's royalty receivable was $952,800.

The Company collects initial franchise fees when franchise agreements are signed and recognizes the initial franchise fees as revenue when the franchise is opened, which is when the Company has performed substantially all initial services required by the franchise agreement. Franchise fees collected from franchisees but not yet recognized as income are recorded as deferred revenue in the liability section of the consolidated condensed balance sheet. As of March 29, 2014, deferred franchise fees were $2,130,100.


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Leasing Income Recognition

Leasing income for direct financing leases is recognized under the effective interest method. The effective interest method of income recognition applies a constant rate of interest equal to the internal rate of return on the lease. Generally, when a lease is more than 90 days delinquent (where more than three monthly payments are owed), the lease is classified as being on non-accrual and the Company stops recognizing leasing income on that date. Payments received on leases in non-accrual status generally reduce the lease receivable. Leases on non-accrual status remain classified as such until there is sustained payment performance that, in the Company's judgment, would indicate that all contractual amounts will be collected in full.

In certain circumstances, the Company may re-lease equipment in its existing portfolio. As this equipment may have a fair value greater than its carrying amount when re-leased, the Company may be required to account for the lease as a sales-type lease. At inception of a sales-type lease, revenue is recorded that consists of the present value of the future minimum lease payments discounted at the rate implicit in the lease. In subsequent periods, the recording of income is consistent with the accounting for a direct financing lease.

For leases that are accounted for as operating leases, income is recognized on a straight-line basis when payments under the lease contract are due.

Allowances for Credit Losses

The Company maintains an allowance for credit losses at an amount that it believes to be sufficient to absorb losses inherent in its existing lease portfolio as of the reporting dates. Leases are collectively evaluated for potential loss. The Company's methodology for determining the allowance for credit losses includes consideration of the level of delinquencies and non-accrual leases, historical net charge-off amounts and review of any significant concentrations.

A provision is charged against earnings to maintain the allowance for credit losses at the appropriate level. If the actual results are different from the Company's estimates, results could be different. The Company's policy is to charge-off against the allowance the estimated unrecoverable portion of accounts once they reach 121 days delinquent. (See Note 5 - "Investment in Leasing Operations").

Stock-Based Compensation

The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of the awards on the date of grant using an option-pricing model is affected by stock price as well as assumptions regarding a number of complex and subjective variables. These variables include implied volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

The Company evaluates the assumptions used to value awards on an annual basis. If factors change and the Company employs different assumptions for estimating stock-based compensation expense in future periods or if the Company decides to use a different valuation model, the future periods may differ significantly from what it has recorded in the current period and could materially affect operating income, net income and earnings per share.


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Forward Looking Statements

The statements contained in this Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" that are not strictly historical fact, including without limitation, the Company's belief that it will have adequate capital and reserves to meet its current and contingent obligations and operating needs, as well as its disclosures regarding market rate risk are forward looking statements made under the safe harbor provision of the Private Securities Litigation Reform Act. Such statements are based on management's current expectations as of the date of this Report, but involve risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by such forward looking statements. Investors are cautioned to consider these forward looking statements in light of important factors which may result in material variations between results contemplated by such forward looking statements and actual results and conditions. See the section appearing in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013 entitled "Risk Factors" and Part II, Item 1A in this Report for a more complete discussion of certain factors that may cause the Company's actual results to differ from those in its forward looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date they were made. The Company undertakes no obligation to revise or update publicly any forward-looking statements for any reason.


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