WINMARK CORP - Quarter Report: 2012 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 29, 2012

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to

 

Commission File Number: 000-22012

 

 

WINMARK CORPORATION

(Exact name of registrant as specified in its charter)

 

 

605 Highway 169 North, Suite 400, Minneapolis, MN 55441

(Address of principal executive offices) (Zip Code)

 

(763) 520-8500

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x

 

Common stock, no par value, 4,986,539 shares outstanding as of October 19, 2012.

 

 

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WINMARK CORPORATION AND SUBSIDIARIES

 

INDEX

 

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	CONSOLIDATED CONDENSED BALANCE SHEETS: September 29, 2012 and December 31, 2011	3
	CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS: Three Months Ended September 29, 2012 and September 24, 2011 Nine Months Ended September 29, 2012 and September 24, 2011	4
	CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME: Three Months Ended September 29, 2012 and September 24, 2011 Nine Months Ended September 29, 2012 and September 24, 2011	5
	CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS: Nine Months Ended September 29, 2012 and September 24, 2011	6
	NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS	7 – 14
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14 – 23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	24
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	25
Item 4.	Mine Safety Disclosures	25
Item 5.	Other Information	25
Item 6.	Exhibits	26
	SIGNATURES	27

 

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PART I.                                                     FINANCIAL INFORMATION

 

ITEM 1:   Financial Statements

 

WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

		September 29, 2012			December 31, 2011
ASSETS
Current Assets:
Cash and cash equivalents		$	2,249,200		$	9,020,100
Marketable securities		90,400			1,043,800
Receivables, less allowance for doubtful accounts of $18,100 and $15,100		1,164,500			1,316,200
Net investment in leases - current		10,764,800			11,746,900
Income tax receivable		427,800			116,500
Inventories		85,300			68,500
Prepaid expenses		573,300			362,000
Total current assets		15,355,300			23,674,000
Net investment in leases - long-term		23,373,200			18,102,000
Long-term investments, less allowance for losses of $1,543,800 and $883,100		2,506,300			3,817,400
Property and equipment, net		1,229,700			1,474,800
Other assets		677,500			677,500
		$	43,142,000		$	47,745,700
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Line of credit		$	10,700,000		$	—
Accounts payable		1,511,300			1,460,300
Accrued liabilities		2,443,900			1,346,000
Discounted lease rentals		570,100			20,800
Rents received in advance		206,600			274,700
Deferred revenue		1,583,400			1,212,400
Deferred income taxes		3,447,600			3,464,800
Total current liabilities		20,462,900			7,779,000
Long-Term Liabilities:
Discounted lease rentals		658,600			—
Rents received in advance		135,100			269,400
Deferred revenue		923,800			844,300
Other liabilities		1,289,700			1,389,200
Deferred income taxes		2,586,500			2,355,100
Total long-term liabilities		5,593,700			4,858,000
Shareholders’ Equity:
Common stock, no par, 10,000,000 shares authorized, 4,993,927 and 4,987,643 shares issued and outstanding		—			629,800
Accumulated other comprehensive (loss) income		(1,200		)	17,000
Retained earnings		17,086,600			34,461,900
Total shareholders’ equity		17,085,400			35,108,700
		$	43,142,000		$	47,745,700

 

The accompanying notes are an integral part of these financial statements.

 

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 29,  2012			September 24,  2011			September 29,  2012			September 24,  2011
REVENUE:
Royalties		$	9,178,400		$	8,046,400		$	25,160,800		$	21,918,500
Leasing income		4,312,700			2,369,300			9,989,800			12,584,500
Merchandise sales		716,600			664,300			2,083,200			1,998,700
Franchise fees		411,000			516,200			966,000			836,200
Other		180,400			177,300			625,100			765,300
Total revenue		14,799,100			11,773,500			38,824,900			38,103,200
COST OF MERCHANDISE SOLD		684,400			631,400			1,982,200			1,908,500
LEASING EXPENSE		770,700			290,400			1,336,200			4,149,300
PROVISION FOR CREDIT LOSSES		(1,700		)	(13,100		)	(69,600		)	8,200
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		4,882,200			4,219,100			15,239,900			14,095,400
Income from operations		8,463,500			6,645,700			20,336,200			17,941,800
LOSS FROM EQUITY INVESTMENTS		(372,300		)	(224,700		)	(650,400		)	(444,600		)
IMPAIRMENT OF INVESTMENT IN NOTES		(660,700		)	(293,200		)	(660,700		)	(546,100		)
INTEREST EXPENSE		(110,200		)	(26,200		)	(302,300		)	(84,200		)
INTEREST AND OTHER INCOME (EXPENSE)		14,300			(9,000		)	50,600			22,100
Income before income taxes		7,334,600			6,092,600			18,773,400			16,889,000
PROVISION FOR INCOME TAXES		(3,075,100		)	(2,609,100		)	(7,593,500		)	(6,979,000		)
NET INCOME		$	4,259,500		$	3,483,500		$	11,179,900		$	9,910,000
EARNINGS PER SHARE — BASIC		$	.85		$	.70		$	2.22		$	1.99
EARNINGS PER SHARE — DILUTED		$	.82		$	.66		$	2.13		$	1.89
WEIGHTED AVERAGE SHARES OUTSTANDING — BASIC		5,013,822			4,970,046			5,041,023			4,980,160
WEIGHTED AVERAGE SHARES OUTSTANDING — DILUTED		5,222,719			5,263,343			5,257,057			5,239,424

 

The accompanying notes are an integral part of these financial statements.

 

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 29,  2012			September 24, 2011			September 29, 2012			September 24,  2011
NET INCOME		$	4,259,500		$	3,483,500		$	11,179,900		$	9,910,000
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX:
Unrealized net gains (losses) on marketable securities:
Unrealized holding net gains (losses) arising during period		(5,600		)	(118,600		)	(2,000		)	(119,600		)
Reclassification adjustment for net gains included in net income		—			—			(28,000		)	—
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX		(5,600		)	(118,600		)	(30,000		)	(119,600		)
INCOME TAX (EXPENSE) BENEFIT RELATED TO ITEMS OF OTHER COMPREHENSIVE INCOME:
Unrealized net gains/losses on marketable securities:
Unrealized holding net gains/losses arising during period		2,200			46,600			800			47,000
Reclassification adjustment for net gains included in net income		—			—			11,000			—
INCOME TAX (EXPENSE) BENEFIT RELATED TO ITEMS OF OTHER COMPREHENSIVE INCOME		2,200			46,600			11,800			47,000
OTHER COMPREHENSIVE GAIN (LOSS), NET OF TAX		(3,400		)	(72,000		)	(18,200		)	(72,600		)
COMPREHENSIVE INCOME		$	4,256,100		$	3,411,500		$	11,161,700		$	9.837,400

 

The accompanying notes are an integral part of these financial statements.

 

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended
		September 29,  2012			September 24,  2011
OPERATING ACTIVITIES:
Net income		$	11,179,900		$	9,910,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		326,600			361,600
Provision for credit losses		(69,600		)	8,200
Compensation expense related to stock options		683,000			552,800
Deferred income taxes		214,200			—
Loss (gain) on sale of marketable securities		(34,600		)	600
Loss from equity investments		650,400			444,600
Impairment of investment in notes		660,700			546,100
Deferred initial direct costs		(484,100		)	(269,000		)
Amortization of deferred initial direct costs		421,800			440,800
Tax benefits on exercised stock options		(353,300		)	(137,600		)
Change in operating assets and liabilities:
Receivables		151,700			303,500
Income tax receivable / payable		53,800			2,742,600
Inventories		(16,800		)	17,900
Prepaid expenses		(211,300		)	(126,300		)
Accounts payable		51,000			415,000
Accrued and other liabilities		998,400			51,500
Rents received in advance and security deposits		(100		)	25,800
Other assets		—			(14,500		)
Deferred revenue		450,500			152,700
Net cash provided by operating activities		14,672,200			15,426,300
INVESTING ACTIVITIES:
Purchase of long term investments		—			(1,000,000		)
Proceeds from sale of marketable securities		1,424,700			161,300
Purchase of marketable securities		(466,700		)	(451,500		)
Purchase of property and equipment		(81,500		)	(138,200		)
Purchase of equipment for lease contracts		(17,372,400		)	(15,578,600		)
Principal collections on lease receivables		12,802,200			15,069,800
Net cash used for investing activities		(3,693,700		)	(1,937,200		)
FINANCING ACTIVITIES:
Proceeds from borrowings on line of credit		20,300,000			3,000,000
Payments on line of credit		(9,600,000		)	(11,800,000		)
Repurchases of common stock		(4,893,600		)	(3,527,200		)
Proceeds from exercises of stock options		594,900			738,300
Dividends paid		(25,922,600		)	(398,400		)
Proceeds from discounted lease rentals		1,418,600			—
Tax benefits on exercised stock options		353,300			137,600
Net cash used for financing activities		(17,749,400		)	(11,849,700		)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(6,770,900		)	1,639,400
Cash and cash equivalents, beginning of period		9,020,100			2,257,100
Cash and cash equivalents, end of period		$	2,249,200		$	3,896,500
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest		$	266,400		$	142,600
Cash paid for income taxes		$	7,325,500		$	4,085,000

 

The accompanying notes are an integral part of these financial statements.

 

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WINMARK CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

1.              Management’s Interim Financial Statement Representation:

 

The accompanying consolidated condensed financial statements have been prepared by Winmark Corporation and subsidiaries (the Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.  The Company has a 52/53 week year which ends on the last Saturday in December.  The information in the consolidated condensed financial statements includes normal recurring adjustments and reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of such financial statements.  The consolidated condensed financial statements and notes are presented in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q, and therefore do not contain certain information included in the Company’s annual consolidated financial statements and notes.  This report should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K.

 

Revenues and operating results for the nine months ended September 29, 2012 are not necessarily indicative of the results to be expected for the full year.

 

Reclassifications

 

Certain reclassifications of previously reported amounts have been made to conform to the current year presentation.  Such reclassifications did not impact net income or shareholders’ equity as previously reported.

 

2.              Organization and Business:

 

The Company offers licenses to operate franchises using the service marks Plato’s Closet®, Play It Again Sports®, Once Upon A Child® and Music Go Round®.  The Company also operates both middle market and small-ticket equipment leasing businesses under the Winmark Capital® and Wirth Business Credit® marks.

 

3.              Fair Value Measurements:

 

The Company defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  The Company uses three levels of inputs to measure fair value:

 

·                  Level 1 — quoted prices in active markets for identical assets and liabilities.

·                  Level 2 — observable inputs other than quoted prices in active markets for identical assets and liabilities.

·                  Level 3 — unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.

 

The Company’s marketable securities were valued based on Level 1 inputs using quoted prices.

 

Due to their nature, the carrying value of cash equivalents, receivables, payables and debt obligations approximates fair value.

 

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4.              Investments:

 

Marketable Securities

 

The following is a summary of marketable securities classified as available-for-sale securities:

 

		September 29, 2012						December 31, 2011
		Cost			Fair Value			Cost			Fair Value
Equity securities		$	92,400		$	90,400		$	1,015,800		$	1,043,800

 

The Company’s unrealized gains and losses for marketable securities classified as available-for-sale securities in accumulated other comprehensive income are as follows:

 

		September 29, 2012			December 31, 2011
Unrealized gains		$	—		$	32,900
Unrealized losses		(2,000		)	(4,900		)
Net unrealized gains (losses)		$	(2,000	)	$	28,000

 

The Company’s realized gains and losses recognized on sales of available-for-sale marketable securities are as follows:

 

		Three Months Ended						Nine Months Ended
		September 29,  2012			September 24, 2011			September 29,  2012			September 24,  2011
Realized gains		$	4,600		$	—		$	46,900		$	—
Realized losses		—			—			(12,300		)	(600		)
Net realized gains (losses)		$	4,600		$	—		$	34,600		$	(600	)

 

Amounts reclassified out of accumulated other comprehensive income into earnings is determined by using the average cost of the security when sold.

 

Long-Term Investments

 

The Company has an investment in Tomsten, Inc. (“Tomsten”), the parent company of “Archiver’s” retail chain.  The Company has invested a total of $8.5 million in the purchase of common stock of Tomsten.  The Company’s investment currently represents 22.0% of the outstanding common stock of Tomsten.  As of September 29, 2012, $0.3 million of the Company’s investment, with a current carrying value of $1.8 million, is attributable to goodwill.  The amount of goodwill was determined by calculating the difference between the Company’s net investment in Tomsten less its pro rata share of Tomsten’s net worth.  During the third quarter of 2012, the Company ceased providing management services to Tomsten and the Company’s Chairman and Chief Executive Officer resigned from Tomsten’s Board of Directors.

 

The Company has a $2.0 million investment in senior subordinated promissory notes with warrants in BridgeFunds Limited (“BridgeFunds”).  BridgeFunds advances funds to claimants involved in civil litigation to cover litigation expenses.  Monthly prepayment of the principal of such notes in an amount equal to Available Cash Flow (as defined within the agreements governing the notes) is required.  In July 2012, the Company entered into an amendment to the agreement governing the notes whereby the maturity date of all of the outstanding notes was changed to June 30, 2013.  During the nine months ended September 29, 2012, the Company did not receive any payments of principal or interest on the notes.  The Company stopped accruing interest on this investment as of September 30, 2010.  The Company has deemed this investment to be impaired, and in evaluating the investment for impairment has determined that its present value of expected future cash flows, discounted at the effective interest rate on the notes of 15%, is less than the recorded investment in the notes.  In developing its estimate of expected future cash flows, the Company used certain information obtained from BridgeFunds

 

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concerning existing liabilities, claimant cases outstanding and historical default rates on claimant advances, and made certain assumptions regarding the timing of case settlements, the payment of future liabilities and future default rates.  The Company recognized $883,100 in impairment charges during 2011 and established a corresponding valuation allowance accordingly.  The Company recognized an additional $660,700 charge to increase the valuation allowance in the third quarter of 2012, primarily as a result of a decrease in the BridgeFunds portfolio of receivables with no improvement in portfolio performance.  As of September 29, 2012, the $0.7 million net investment balance inclusive of $0.2 million of related interest receivable is classified as long-term based on expected payments from Available Cash Flow.

 

5.              Investment in Leasing Operations:

 

Investment in leasing operations consists of the following:

 

		September 29, 2012			December 31, 2011
Direct financing and sales-type leases:
Minimum lease payments receivable		$	26,733,300		$	27,413,300
Estimated residual value of equipment		2,501,900			2,764,400
Unearned lease income net of initial direct costs deferred		(4,647,100		)	(4,217,000		)
Security deposits		(2,651,000		)	(2,448,800		)
Equipment installed on leases not yet commenced		12,438,500			6,489,200
Total investment in direct financing and sales-type leases		34,375,600			30,001,100
Allowance for credit losses		(802,000		)	(803,800		)
Net investment in direct financing and sales-type leases		33,573,600			29,197,300
Operating leases:
Operating lease assets		1,349,400			1,218,900
Less accumulated depreciation and amortization		(785,000		)	(567,300		)
Net investment in operating leases		564,400			651,600
Total net investment in leasing operations		$	34,138,000		$	29,848,900

 

As of September 29, 2012, the $34.1 million total net investment in leases consists of $10.7 million classified as current and $23.4 million classified as long-term.  As of December 31, 2011, the $29.8 million total net investment in leases consists of $11.7 million classified as current and $18.1 million classified as long-term.

 

As of September 29, 2012, leased assets with one customer approximated 10% of the Company’s total assets.

 

Future minimum lease payments receivable under lease contracts and the amortization of unearned lease income, net of initial direct costs deferred, is as follows for the remainder of fiscal 2012 and the full fiscal years thereafter as of September 29, 2012:

 

		Direct Financing and Sales-Type Leases						Operating Leases
		Minimum Lease Payments Receivable			Income  Amortization			Minimum Lease Payments Receivable
2012		$	4,239,300		$	1,263,800		$	262,600
2013		13,224,200			2,576,000			1,552,100
2014		6,813,400			692,300			132,400
2015		1,957,100			108,300			—
2016		499,300			6,700			—
Thereafter		—			—			—
		$	26,733,300		$	4,647,100		$	1,947,100

 

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The activity in the allowance for credit losses for leasing operations during the first nine months of 2012 and 2011, respectively, is as follows:

 

		September 29, 2012			September 24, 2011
Balance at beginning of period		$	803,800		$	907,800
Provisions charged to expense		(69,600		)	8,200
Recoveries		195,900			248,500
Deductions for amounts written-off		(128,100		)	(288,100		)
Balance at end of period		$	802,000		$	876,400

 

The Company’s investment in direct financing and sales-type leases (“Investment In Leases”) and allowance for credit losses by loss evaluation methodology are as follows:

 

		September 29, 2012						December 31, 2011
		Investment In Leases			Allowance for  Credit Losses			Investment In Leases			Allowance for  Credit Losses
Collectively evaluated for loss potential		$	34,375,600		$	802,000		$	30,001,100		$	803,800
Individually evaluated for loss potential		—			—			—			—
Total		$	34,375,600		$	802,000		$	30,001,100		$	803,800

 

The Company’s key credit quality indicator for its investment in direct financing and sales-type leases is the status of the lease, defined as accruing or non-accruing.  Leases that are accruing income are considered to have a lower risk of loss.  Non-accrual leases are those that the Company believes have a higher risk of loss.  The following table sets forth information regarding the Company’s accruing and non-accrual leases.  Delinquent balances are determined based on the contractual terms of the lease.

 

		September 29, 2012
		0-60 Days  Delinquent and Accruing			61-90 Days  Delinquent and Accruing			Over 90 Days Delinquent and  Accruing			Non-Accrual			Total
Middle-Market		$	32,469,600		$	—		$	—		$	—		$	32,469,600
Small-Ticket		1,899,100			6,900			—			—			1,906,000
Total Investment in Leases		$	34,368,700		$	6,900		$	—		$	—		$	34,375,600

 

		December 31, 2011
		0-60 Days  Delinquent and Accruing			61-90 Days  Delinquent and Accruing			Over 90 Days Delinquent and  Accruing			Non-Accrual			Total
Middle-Market		$	25,650,500		$	932,100		$	—		$	—		$	26,582,600
Small-Ticket		3,351,400			48,300			—			18,800			3,418,500
Total Investment in Leases		$	29,001,900		$	980,400		$	—		$	18,800		$	30,001,100

 

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6.              New Accounting Pronouncements:

 

In June 2011, the Financial Accounting Standards Board (“FASB”) amended its accounting guidance on the presentation of other comprehensive income (“OCI”) in an entity’s financial statements.  The amended guidance eliminates the option to present the components of OCI as part of the statement of changes in shareholders’ equity and provides two options for presenting OCI: in a statement included in the income statement or in a separate statement immediately following the income statement.  The amendments do not change the guidance for the items that have to be reported in OCI or when an item of OCI has to be moved into net income.  For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  The Company adopted the amended presentation guidance in its quarterly report on Form 10-Q for the fiscal period ended March 31, 2012 (see Consolidated Condensed Statements of Comprehensive Income) and such adoption has not impacted the consolidated results of the Company.

 

In September 2011, the FASB amended its accounting guidance on testing goodwill for impairment by providing entities an option to perform a qualitative assessment to determine whether further impairment testing is necessary.  The amendments do not change the guidance for how goodwill is calculated or when goodwill is tested for impairment.  The amendments are effective for fiscal years beginning after December 15, 2011.  The Company adopted the new guidance on January 1, 2012 and such adoption has not impacted the consolidated results of the Company.

 

7.              Earnings Per Share:

 

The following table sets forth the presentation of shares outstanding used in the calculation of basic and diluted earnings per share (“EPS”):

 

		Three Months Ended				Nine Months Ended
		September 29,  2012		September 24,  2011		September 29,  2012		September 24,  2011
Denominator for basic EPS — weighted average common shares		5,013,822		4,970,046		5,041,023		4,980,160
Dilutive shares associated with option plans		208,897		293,297		216,034		259,264
Denominator for diluted EPS — weighted average common shares and dilutive potential common shares		5,222,719		5,263,343		5,257,057		5,239,424
Options excluded from EPS calculation — anti-dilutive		23,270		2,614		18,863		10,640

 

8.              Shareholders’ Equity:

 

Dividends

 

On January 18, 2012, the Company’s Board of Directors approved the payment of a $0.03 per share quarterly cash dividend and $5.00 per share special cash dividend (the “Special Dividend”) to shareholders of record at the close of business on February 8, 2012, both of which were paid on March 1, 2012.  The Special Dividend totaled $25.4 million and was financed by a combination of cash on hand as well as net borrowings under the Line of Credit of $12.8 million.  (See Note 9 — “Line of Credit”).

 

On April 25, 2012, the Company’s Board of Directors approved the payment of a $0.04 per share quarterly cash dividend to shareholders of record at the close of business on May 9, 2012, which was paid on June 1, 2012.

 

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On July 25, 2012, the Company’s Board of Directors approved the payment of a $0.04 per share quarterly cash dividend to shareholders of record at the close of business on August 8, 2012, which was paid on September 4, 2012.

 

Repurchase of Common Stock

 

In the first nine months of 2012, the Company repurchased 92,652 shares of its common stock for an aggregate purchase price of $4.9 million or $52.82 per share.  These repurchase transactions reduced the dollar amount of common stock on the balance sheet to zero, with the remainder recorded to retained earnings.  Under the Board of Directors’ authorization, as of September 29, 2012, the Company has the ability to repurchase an additional 403,220 shares of its common stock.  Repurchases may be made from time to time at prevailing prices, subject to certain restrictions on volume, pricing and timing.

 

Stock Option Plans and Stock-Based Compensation

 

The Company had authorized up to 750,000 shares of common stock be reserved for granting either nonqualified or incentive stock options to officers and key employees under the Company’s 2001 Stock Option Plan (the “2001 Plan”).  The 2001 Plan expired on February 20, 2011.  The Company has authorized up to 250,000 shares of common stock to be reserved for granting either nonqualified or incentive stock options to officers and key employees under the Company’s 2010 Stock Option Plan (the “2010 Plan”).

 

The Company also sponsors a Stock Option Plan for Nonemployee Directors (the “Nonemployee Directors Plan”) and has reserved a total of 300,000 shares for issuance to directors of the Company who are not employees.

 

Stock option activity under the 2001 Plan, 2010 Plan and Nonemployee Directors Plan (collectively, the “Option Plans”) as of September 29, 2012 was as follows:

 

		Number of  Shares		Weighted  Average  Exercise Price			Weighted Average Remaining  Contractual Life (years)		Intrinsic Value
Outstanding at December 31, 2011		668,614		$	24.31		6.62		$	22,101,800
Granted		72,500		53.30
Exercised		(130,287	)	20.12
Outstanding at September 29, 2012		610,827		$	28.65		6.85		$	15,616,100
Exercisable at September 29, 2012		341,938		$	18.79		5.63		$	11,528,500

 

During the nine months ended September 29, 2012, option holders surrendered 31,351 shares of previously owned common stock as payment for option shares exercised as provided for by the Option Plans.  All unexercised options at September 29, 2012 have an exercise price equal to the fair market value on the date of the grant.

 

The fair value of options granted under the Option Plans during the first nine months of 2012 and 2011 were estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions and results:

 

		Nine Months Ended
		September 29, 2012			September 24, 2011
Risk free interest interest rate		0.88		%	1.94		%
Expected life (years)		6			6
Expected volatility		31.4		%	28.0		%
Dividend yield		2.06		%	.32		%
Option fair value		$	12.95		$	11.28

 

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Compensation expense of $683,000 and $552,800 relating to the vested portion of the fair value of stock options granted was expensed to “Selling, General and Administrative Expenses” in the first nine months of 2012 and 2011, respectively.  As of September 29, 2012, the Company had $2.3 million of total unrecognized compensation expense related to stock options that is expected to be recognized over the remaining weighted average period of approximately 2.4 years.

 

9.  Line of Credit:

 

On January 30, 2012, the Company’s Line of Credit with The PrivateBank and Trust Company and BMO Harris Bank N.A. was amended to, among other things, provide the consent of the lenders for the payment of the Special Dividend and to amend certain financial covenant calculations to remove the effect of the Special Dividend in such calculations.

 

On February 29, 2012, the Line of Credit was amended to, among other things, increase the aggregate commitments from $30.0 million to $35.0 million and extend the termination date from July 31, 2014 to February 29, 2016.

 

During the nine months ended September 29, 2012, the Line of Credit was used to finance in part the Special Dividend (as indicated above) and has been and will continue to be used for general corporate purposes.  Borrowings under the Line of Credit are subject to certain borrowing base limitations, and the Line of Credit is secured by a lien against substantially all of the Company’s 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 September 29, 2012, the Company was in compliance with all of its financial covenants and the Company’s borrowing availability under the Line of Credit was $35.0 million (the lesser of the borrowing base or the aggregate commitments).  There were $10.7 million in borrowings outstanding under the Line of Credit bearing interest ranging from 2.97% to 3.75%, leaving $24.3 million available for additional borrowings.

 

10.       Discounted Lease Rentals:

 

The Company utilized certain lease receivables and underlying equipment as collateral to borrow from financial institutions at a weighted average rate of 2.98% at September 29, 2012 on a non-recourse basis.

 

11.       Segment Reporting:

 

The Company currently has two reportable business segments, franchising and leasing.  The franchising segment franchises value-oriented retail store concepts that buy, sell, trade and consign merchandise.  The leasing segment includes (i) Winmark Capital Corporation, a middle-market equipment leasing business and (ii) Wirth Business Credit, Inc., a small ticket financing business.  Segment reporting is intended to give financial statement users a better view of how the Company manages and evaluates its businesses. The Company’s internal management reporting is the basis for the information disclosed for its business segments and includes allocation of shared-service costs.  Segment assets are those that are directly used in or identified with segment operations, including cash, accounts receivable, prepaids, inventory, property and equipment and investment in leasing operations. Unallocated assets include corporate cash and cash equivalents, marketable securities, current and long-term investments, deferred tax amounts and other corporate assets.  Inter-segment balances and transactions have been eliminated.  The following tables summarize financial information by segment and provide a reconciliation of segment contribution to operating income:

 

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		Three Months Ended						Nine Months Ended
		September 29,  2012			September 24,  2011			September 29,  2012			September 24,  2011
Revenue:
Franchising		$	10,486,400		$	9,400,700		$	28,835,100		$	25,475,200
Leasing		4,312,700			2,372,800			9,989,800			12,628,000
Total revenue		$	14,799,100		$	11,773,500		$	38,824,900		$	38,103,200
Reconciliation to operating income:
Franchising segment contribution		$	6,235,900		$	5,637,400		$	15,335,700		$	13,090,500
Leasing segment contribution		2,227,600			1,008,300			5,000,500			4,851,300
Total operating income		$	8,463,500		$	6,645,700		$	20,336,200		$	17,941,800
Depreciation:
Franchising		$	83,400		$	92,200		$	253,600		$	280,700
Leasing		23,800			26,700			73,000			80,900
Total depreciation		$	107,200		$	118,900		$	326,600		$	361,600

 

		As of
		September 29,  2012			December 31, 2011
Identifiable assets:
Franchising		$	3,131,600		$	7,753,200
Leasing		35,480,300			33,374,000
Unallocated		4,530,100			6,618,500
Total		$	43,142,000		$	47,745,700

 

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

 

Overview

 

As of September 29, 2012, we had 958 franchises operating under the Plato’s Closet, Play it Again Sports, Once Upon a Child and Music Go Round brands and had a leasing portfolio of $34.1 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 nine months of 2012, our royalties increased $3.2 million or 14.8% compared to the first nine months of 2011.

 

During the first nine months of 2012, we purchased $17.4 million in equipment for lease customers compared to $15.6 million in the first nine months of 2011.  Overall, our leasing portfolio (net investment in leases — current and long-term) increased to $34.1 million at September 29, 2012 from $29.8 million at December 31, 2011.  Leasing income net of leasing expense during the first nine months of 2012 was $8.7 million compared to $8.4 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.  Our earnings are also impacted by credit losses.  During the first nine months of 2012, our provision for credit losses decreased to $(69,600) from $8,200 in the first nine months of 2011.

 

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