WINMARK CORP - Quarter Report: 2014 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the quarterly period ended September 27, 2014

 

or

 

 

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, 4,997,512 shares outstanding as of October 15, 2014.

 

 

Table of Contents

 

WINMARK CORPORATION AND SUBSIDIARIES

 

INDEX

 

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	CONSOLIDATED CONDENSED BALANCE SHEETS: September 27, 2014 and December 28, 2013	3
	CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS: Three Months Ended September 27, 2014 and September 28, 2013 Nine Months Ended September 27, 2014 and September 28, 2013	4
	CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME: Three Months Ended September 27, 2014 and September 28, 2013 Nine Months Ended September 27, 2014 and September 28, 2013	5
	CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS: Nine Months Ended September 27, 2014 and September 28, 2013	6
	NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS	7 – 13
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14 – 22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22
Item 4.	Controls and Procedures	23
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.	Defaults Upon Senior Securities	24
Item 4.	Mine Safety Disclosures	24
Item 5.	Other Information	24
Item 6.	Exhibits	25
	SIGNATURES	26

 

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PART I.                            FINANCIAL INFORMATION

ITEM 1:    Financial Statements

 

WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

		September 27, 2014			December 28, 2013
ASSETS
Current Assets:
Cash and cash equivalents		$	2,015,200		$	10,642,600
Marketable securities		715,800			736,500
Receivables, less allowance for doubtful accounts of $2,500 and $4,300		1,106,600			1,205,500
Net investment in leases - current		20,036,200			17,239,900
Income tax receivable		—			166,500
Inventories		96,200			96,700
Prepaid expenses		654,200			587,300
Total current assets		24,624,200			30,675,000
Net investment in leases - long-term		23,114,800			20,301,400
Property and equipment, net		1,501,300			1,382,200
Other assets		677,500			677,500
Deferred income taxes		23,500			—
		$	49,941,300		$	53,036,100
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Line of credit		$	20,000,000		$	—
Accounts payable		3,109,400			2,441,400
Income tax payable		26,900			—
Accrued liabilities		2,874,000			1,233,100
Discounted lease rentals		288,300			424,900
Deferred revenue		2,225,200			2,199,900
Deferred income taxes		2,810,500			4,208,200
Total current liabilities		31,334,300			10,507,500
Long-Term Liabilities:
Discounted lease rentals		94,300			277,400
Deferred revenue		1,255,800			1,180,700
Other liabilities		1,385,000			1,489,000
Deferred income taxes		—			1,436,800
Total long-term liabilities		2,735,100			4,383,900
Shareholders’ Equity:
Common stock, no par value, 10,000,000 shares authorized, 4,997,512 and 5,143,530 shares issued and outstanding		—			2,949,500
Accumulated other comprehensive loss		(41,300		)	(4,100		)
Retained earnings		15,913,200			35,199,300
Total shareholders’ equity		15,871,900			38,144,700
		$	49,941,300		$	53,036,100

 

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 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
REVENUE:
Royalties		$	10,725,000		$	9,853,900		$	28,735,800		$	26,937,000
Leasing income		4,121,800			3,810,100			11,655,000			11,348,100
Merchandise sales		786,100			598,000			2,259,900			1,821,100
Franchise fees		558,200			340,000			1,514,700			1,144,200
Other		213,300			189,900			830,500			713,400
Total revenue		16,404,400			14,791,900			44,995,900			41,963,800
COST OF MERCHANDISE SOLD		742,300			569,200			2,156,300			1,734,700
LEASING EXPENSE		808,500			399,300			1,234,200			1,289,500
PROVISION FOR CREDIT LOSSES		(1,700		)	(29,800		)	26,100			(67,700		)
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		5,677,600			5,311,900			17,874,500			16,728,900
Income from operations		9,177,700			8,541,300			23,704,800			22,278,400
INTEREST EXPENSE		(150,500		)	(35,500		)	(356,700		)	(180,100		)
INTEREST AND OTHER INCOME (EXPENSE)		27,200			5,500			28,200			(4,800		)
Income before income taxes		9,054,400			8,511,300			23,376,300			22,093,500
PROVISION FOR INCOME TAXES		(3,431,400		)	(3,259,800		)	(8,920,600		)	(8,447,700		)
NET INCOME		$	5,623,000		$	5,251,500		$	14,455,700		$	13,645,800
EARNINGS PER SHARE — BASIC		$	1.12		$	1.03		$	2.84		$	2.70
EARNINGS PER SHARE — DILUTED		$	1.09		$	1.00		$	2.76		$	2.61
WEIGHTED AVERAGE SHARES OUTSTANDING — BASIC		5,022,166			5,116,872			5,093,243			5,046,156
WEIGHTED AVERAGE SHARES OUTSTANDING — DILUTED		5,156,785			5,263,311			5,235,949			5,222,196

 

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 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
NET INCOME		$	5,623,000		$	5,251,500		$	14,455,700		$	13,645,800
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX:
Unrealized net gains (losses) on marketable securities:
Unrealized holding net gains (losses) arising during period		(61,400		)	(8,100		)	(56,200		)	(9,500		)
Reclassification adjustment for net gains included in net income		—			—			(3,800		)	—
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX		(61,400		)	(8,100		)	(60,000		)	(9,500		)
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		23,300			3,100			21,400			3,600
Reclassification adjustment for net gains included in net income		—			—			1,400			—
INCOME TAX (EXPENSE) BENEFIT RELATED TO ITEMS OF OTHER COMPREHENSIVE INCOME		23,300			3,100			22,800			3,600
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX		(38,100		)	(5,000		)	(37,200		)	(5,900		)
COMPREHENSIVE INCOME		$	5,584,900		$	5,246,500		$	14,418,500		$	13,639,900

 

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 27, 2014			September 28, 2013
OPERATING ACTIVITIES:
Net income		$	14,455,700		$	13,645,800
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		304,600			321,400
Provision for credit losses		26,100			(67,700		)
Compensation expense related to stock options		1,037,200			842,900
Deferred income taxes		(2,858,000		)	294,700
Gain on sale of marketable securities		(12,700		)	—
Deferred initial direct costs		(757,100		)	(374,100		)
Amortization of deferred initial direct costs		576,000			418,700
Tax benefits on exercised stock options		(74,700		)	(310,900		)
Change in operating assets and liabilities:
Receivables		98,900			120,200
Income tax receivable / payable		290,900			1,348,500
Inventories		500			1,800
Prepaid expenses		(66,900		)	(173,400		)
Accounts payable		668,000			(479,400		)
Accrued and other liabilities		1,522,600			967,000
Rents received in advance and security deposits		114,200			160,800
Deferred revenue		100,400			321,400
Net cash provided by operating activities		15,425,700			17,037,700
INVESTING ACTIVITIES:
Proceeds from sale of marketable securities		603,200			—
Purchase of marketable securities		(629,800		)	(324,600		)
Purchase of property and equipment		(423,700		)	(165,600		)
Purchase of equipment for lease contracts		(21,394,100		)	(14,979,300		)
Principal collections on lease receivables		15,519,800			13,654,700
Net cash used for investing activities		(6,324,600		)	(1,814,800		)
FINANCING ACTIVITIES:
Proceeds from borrowings on line of credit		28,400,000			2,000,000
Payments on line of credit		(8,400,000		)	(12,800,000		)
Repurchases of common stock		(11,564,800		)	(1,854,900		)
Proceeds from exercises of stock options		392,000			3,121,400
Dividends paid		(26,630,400		)	(707,500		)
Proceeds from discounted lease rentals		—			721,800
Tax benefits on exercised stock options		74,700			310,900
Net cash used for financing activities		(17,728,500		)	(9,208,300		)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(8,627,400		)	6,014,600
Cash and cash equivalents, beginning of period		10,642,600			2,233,400
Cash and cash equivalents, end of period		$	2,015,200		$	8,248,000
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest		$	301,000		$	195,200
Cash paid for income taxes		$	11,487,700		$	6,787,800

 

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 27, 2014 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®, Once Upon A Child®, Play It Again Sports®, Music Go Round® and Style Encore®.  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 27, 2014						December 28, 2013
		Cost			Fair Value			Cost			Fair Value
Equity securities		$	782,400		$	715,800		$	743,100		$	736,500

 

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

 

		September 27, 2014			December 28, 2013
Unrealized gains		$	800		$	6,800
Unrealized losses		(67,400		)	(13,400		)
Net unrealized losses		$	(66,600	)	$	(6,600	)

 

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 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Realized gains		$	12,200		$	—		$	39,000		$	—
Realized losses		—			—			(26,300		)	—
Net realized gains/(losses)		$	12,200		$	—		$	12,700		$	—

 

Amounts reclassified out of accumulated other comprehensive loss into earnings is determined by using the average cost of the security when sold.  Gross realized gains (losses) reclassified out of accumulated other comprehensive loss into earnings are included in Interest and Other Income (Expense) and the related tax benefits (expenses) are included in the Provision for Income Taxes lines of the Consolidated Condensed Statements of Operations.

 

5.              Investment in Leasing Operations:

 

Investment in leasing operations consists of the following:

 

		September 27, 2014			December 28, 2013
Direct financing and sales-type leases:
Minimum lease payments receivable		$	42,205,400		$	35,450,900
Estimated residual value of equipment		4,796,800			4,348,800
Unearned lease income net of initial direct costs deferred		(6,513,400		)	(4,963,400		)
Security deposits		(3,425,500		)	(3,325,600		)
Equipment installed on leases not yet commenced		6,831,900			6,718,000
Total investment in direct financing and sales-type leases		43,895,200			38,228,700
Allowance for credit losses		(927,200		)	(822,700		)
Net investment in direct financing and sales-type leases		42,968,000			37,406,000
Operating leases:
Operating lease assets		685,800			1,353,500
Less accumulated depreciation and amortization		(502,800		)	(1,218,200		)
Net investment in operating leases		183,000			135,300
Total net investment in leasing operations		$	43,151,000		$	37,541,300

 

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As of September 27, 2014, the $43.2 million total net investment in leases consists of $20.1 million classified as current and $23.1 million classified as long-term.  As of December 28, 2013, the $37.5 million total net investment in leases consists of $17.2 million classified as current and $20.3 million classified as long-term.

 

As of September 27, 2014, leased assets with one customer approximated 16% 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 2014 and the full fiscal years thereafter as of September 27, 2014:

 

		Direct Financing and Sales-Type Leases						Operating Leases
		Minimum Lease Payments Receivable			Income Amortization			Minimum Lease Payments Receivable
2014		$	7,128,600		$	1,658,700		$	76,800
2015		21,679,100			3,801,600			76,800
2016		11,167,200			1,002,500			—
2017		2,210,200			49,600			—
2018		20,300			1,000			—
Thereafter		—			—			—
		$	42,205,400		$	6,513,400		$	153,600

 

The activity in the allowance for credit losses for leasing operations during the first nine months of 2014 and 2013, respectively, is as follows:

 

		September 27, 2014			September 28, 2013
Balance at beginning of period		$	822,700		$	775,800
Provisions charged to expense		26,100			(67,700		)
Recoveries		98,500			114,700
Deductions for amounts written-off		(20,100		)	(17,300		)
Balance at end of period		$	927,200		$	805,500

 

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 27, 2014						December 28, 2013
		Investment In Leases			Allowance for Credit Losses			Investment In Leases			Allowance for Credit Losses
Collectively evaluated for loss potential		$	43,895,200		$	927,200		$	38,228,700		$	822,700
Individually evaluated for loss potential		—			—			—			—
Total		$	43,895,200		$	927,200		$	38,228,700		$	822,700

 

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-accrual.  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.

 

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		September 27, 2014
		0-60 Days Delinquent and Accruing			61-90 Days Delinquent and Accruing			Over 90 Days Delinquent and Accruing			Non-Accrual			Total
Middle-Market		$	42,677,200		$	—		$	—		$	—		$	42,677,200
Small-Ticket		1,218,000			—			—			—			1,218,000
Total Investment in Leases		$	43,895,200		$	—		$	—		$	—		$	43,895,200

 

		December 28, 2013
		0-60 Days Delinquent and Accruing			61-90 Days Delinquent and Accruing			Over 90 Days Delinquent and Accruing			Non-Accrual			Total
Middle-Market		$	36,716,100		$	—		$	—		$	416,400		$	37,132,500
Small-Ticket		1,096,200			—			—			—			1,096,200
Total Investment in Leases		$	37,812,300		$	—		$	—		$	416,400		$	38,228,700

 

6.              Recent Accounting Pronouncements:

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition that supersedes existing revenue recognition guidance (but does not apply to nor supersede accounting guidance for lease contracts).  The ASU’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The ASU also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.  The ASU is effective for reporting periods beginning after December 15, 2016, and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application.  The Company is currently in the process of evaluating the impact of the adoption of this ASU on the Company’s consolidated results.

 

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 27, 2014		September 28, 2013		September 27, 2014		September 28, 2013
Denominator for basic EPS — weighted average common shares		5,022,166		5,116,872		5,093,243		5,046,156
Dilutive shares associated with option plans		134,619		146,439		142,706		176,040
Denominator for diluted EPS — weighted average common shares and dilutive potential common shares		5,156,785		5,263,311		5,235,949		5,222,196
Options excluded from EPS calculation — anti-dilutive		32,169		1,267		25,676		9,403

 

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8.              Shareholders’ Equity:

 

Dividends

 

On January 29, 2014, the Company’s Board of Directors approved the payment of a $0.05 per share quarterly cash dividend to shareholders of record at the close of business on February 12, 2014, which was paid on March 3, 2014.

 

On February 4, 2014, the Company’s Board of Directors approved the payment of a $5.00 per share special cash dividend (the “2014 Special Dividend”) to shareholders of record at the close of business February 17, 2014, which was paid on March 3, 2014.  The 2014 Special Dividend totaled $25.8 million and was financed by a combination of cash on hand as well as net borrowings under the Line of Credit of $13.0 million (see Note 9 — “Line of Credit”).

 

On April 30, 2014, the Company’s Board of Directors approved the payment of a $0.06 per share quarterly cash dividend to shareholders of record at the close of business on May 14, 2014, which was paid on June 2, 2014.

 

On July 30, 2014, the Company’s Board of Directors approved the payment of a $0.06 per share quarterly cash dividend to shareholders of record at the close of business on August 13, 2014, which was paid on September 2, 2014.

 

Repurchase of Common Stock

 

In the first nine months of 2014, the Company repurchased 166,030 shares of its common stock for an aggregate purchase price of $11.6 million or $69.65 per share.  Under the Board of Directors’ authorization, as of September 27, 2014, the Company has the ability to repurchase an additional 166,700 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.  At the April 30, 2014 Annual Shareholders Meeting, the Company’s shareholders approved an increase in the shares of common stock available for granting either nonqualified or incentive stock options to officers and key employees under the Company’s 2010 Stock Option Plan (the “2010 Plan”) from 250,000 to 500,000.

 

The Company also sponsors a Stock Option Plan for Nonemployee Directors (the “Nonemployee Directors Plan”), and at the April 30, 2014 Annual Shareholders Meeting, the Company’s shareholders approved an increase in the shares of common stock available for granting options to directors of the Company who are not employees from 300,000 to 350,000.

 

Stock option activity under the 2001 Plan, 2010 Plan and Nonemployee Directors Plan (collectively, the “Option Plans”) as of September 27, 2014 was as follows:

 

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		Number of Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (years)		Intrinsic Value
Outstanding at December 28, 2013		526,712		$	42.87		7.33		$	26,446,700
Granted		48,500		66.29
Exercised		(20,012	)	19.59
Forfeited		(5,000	)	56.85
Outstanding at September 27, 2014		550,200		$	45.65		6.91		$	16,500,100
Exercisable at September 27, 2014		305,748		$	33.17		5.76		$	12,781,100

 

The fair value of options granted under the Option Plans during the first nine months of 2014 and 2013 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 27, 2014			September 28, 2013
Risk free interest rate		1.80		%	1.30		%
Expected life (years)		6			6
Expected volatility		34.1		%	32.5		%
Dividend yield		1.80		%	1.90		%
Option fair value		$	19.23		$	15.84

 

All unexercised options at September 27, 2014 have an exercise price equal to the fair market value on the date of the grant.

 

Compensation expense of $1,037,200 and $842,900 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 2014 and 2013, respectively.  As of September 27, 2014, the Company had $3.2 million of total unrecognized compensation expense related to stock options that is expected to be recognized over the remaining weighted average vesting period of approximately 2.4 years.

 

9.  Line of Credit:

 

On February 21, 2014, the Company’s Line of Credit with The PrivateBank and Trust Company and BMO Harris Bank N.A. was amended to, among other things, amend certain financial covenant calculations to remove the effect of the 2014 Special Dividend in such calculations, to reduce the applicable margin on the interest rate options, and to extend the termination date from February 29, 2016 to February 28, 2018.

 

The Line of Credit provides for an aggregate commitment of $35.0 million, subject to certain borrowing base limitations.  During the first nine months of 2014, the Line of Credit was used to finance in part the 2014 Special Dividend (as indicated above) and 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 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 27, 2014, the Company was in compliance with all of its financial covenants.  There were $20.0 million in borrowings outstanding under the Line of Credit bearing interest ranging from 2.40% to 3.25%, leaving $15.0 million available for additional borrowings.

 

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10.       Discounted Lease Rentals:

 

The Company utilized certain lease receivables and underlying equipment as collateral to borrow from financial institutions at a weighted average interest rate of 3.26% at September 27, 2014 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 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:

 

		Three Months Ended						Nine Months Ended
		September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Revenue:
Franchising		$	12,282,600		$	10,981,800		$	33,340,900		$	30,615,700
Leasing		4,121,800			3,810,100			11,655,000			11,348,100
Total revenue		$	16,404,400		$	14,791,900		$	44,995,900		$	41,963,800
Reconciliation to operating income:
Franchising segment contribution		$	7,132,700		$	6,306,800		$	17,145,100		$	15,981,700
Leasing segment contribution		2,045,000			2,234,500			6,559,700			6,296,700
Total operating income		$	9,177,700		$	8,541,300		$	23,704,800		$	22,278,400
Depreciation:
Franchising		$	80,700		$	86,100		$	240,400		$	252,900
Leasing		21,500			23,300			64,200			68,500
Total depreciation		$	102,200		$	109,400		$	304,600		$	321,400

 

		As of
		September 27, 2014			December 28, 2013
Identifiable assets:
Franchising		$	3,291,500		$	7,407,400
Leasing		44,197,000			42,490,800
Unallocated		2,452,800			3,137,900
Total		$	49,941,300		$	53,036,100

 

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

 

Overview

 

As of September 27, 2014, we had 1,070 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 $43.2 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 2014, our royalties increased $1.8 million or 6.7% compared to the first nine months of 2013.

 

During the first nine months of 2014, we purchased $21.4 million in equipment for lease customers compared to $15.0 million in the first nine months of 2013.  Overall, our leasing portfolio (net investment in leases — current and long-term) increased to $43.2 million at September 27, 2014 from $37.5 million at December 28, 2013.  Leasing income net of leasing expense during the first nine months of 2014 was $10.4 million compared to $10.1 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 nine months of 2014, selling, general and administrative expense increased $1.1 million, or 6.8%, compared to the first nine 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 nine months ended September 27, 2014:

 

										NINE MONTHS ENDED 9/27/14
		TOTAL 12/28/13		OPENED		CLOSED		TOTAL 9/27/14		AVAILABLE FOR RENEWAL		COMPLETED RENEWALS
Plato’s Closet Franchises - US and Canada		391		30		(2	)	419		21		21
Once Upon A Child Franchises - US and Canada		282		24		(2	)	304		29		29
Play It Again Sports Franchises - US and Canada		300		2		(4	)	298		20		19
Music Go Round Franchises - US		29		3		0		32		1		1
Style Encore Franchises - US		3		14		0		17		—		—
Total Franchised Stores		1,005		73		(8	)	1,070		71		70

 

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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 nine months of 2014, we renewed 70 of the 71 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				Nine Months Ended
		September 27, 2014		September 28, 2013		September 27, 2014		September 28, 2013
Revenue:
Royalties		65.4	%	66.6	%	63.9	%	64.2	%
Leasing income		25.1		25.8		25.9		27.1
Merchandise sales		4.8		4.0		5.0		4.3
Franchise fees		3.4		2.3		3.4		2.7
Other		1.3		1.3		1.8		1.7
Total revenue		100.0		100.0		100.0		100.0
Cost of merchandise sold		(4.5	)	(3.9	)	(4.8	)	(4.1	)
Leasing expense		(4.9	)	(2.7	)	(2.8	)	(3.1	)
Provision for credit losses		—		0.2		—		0.1
Selling, general and administrative expenses		(34.6	)	(35.9	)	(39.7	)	(39.9	)
Income from operations		56.0		57.7		52.7		53.0
Interest expense		(0.9	)	(0.2	)	(0.8	)	(0.4	)
Interest and other income (expense)		0.1		—		—		—
Income before income taxes		55.2		57.5		51.9		52.6
Provision for income taxes		(20.9	)	(22.0	)	(19.8	)	(20.1	)
Net income		34.3	%	35.5	%	32.1	%	32.5	%

 

Comparison of Three Months Ended September 27, 2014 to Three Months Ended September 28, 2013

 

Revenue

 

Revenues for the quarter ended September 27, 2014 totaled $16.4 million compared to $14.8 million for the comparable period in 2013.

 

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