WINMARK CORP - Quarter Report: 2015 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 26, 2015

 

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)

 

 

 

(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, 4,128,031 shares outstanding as of October 12, 2015.

 

 

Table of Contents

 

WINMARK CORPORATION AND SUBSIDIARIES

 

INDEX

 

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	CONSOLIDATED CONDENSED BALANCE SHEETS: September 26, 2015 and December 27, 2014	3
	CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS: Three Months Ended September 26, 2015 and September 27, 2014 Nine Months Ended September 26, 2015 and September 27, 2014	4
	CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME: Three Months Ended September 26, 2015 and September 27, 2014 Nine Months Ended September 26, 2015 and September 27, 2014	5
	CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS: Nine Months Ended September 26, 2015 and September 27, 2014	6
	NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS	7 – 14
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15 – 24
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	26
Item 3.	Defaults Upon Senior Securities	26
Item 4.	Mine Safety Disclosures	26
Item 5.	Other Information	26
Item 6.	Exhibits	27
	SIGNATURES	28

 

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PART I.                                                    FINANCIAL INFORMATION

ITEM 1:   Financial Statements

 

WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

		September 26, 2015			December 27, 2014
ASSETS
Current Assets:
Cash and cash equivalents		$	1,060,700		$	2,089,700
Marketable securities		226,500			466,800
Receivables, less allowance for doubtful accounts of $600 and $1,600		1,314,200			1,328,200
Net investment in leases - current		18,260,700			19,831,600
Income tax receivable		855,000			4,163,900
Inventories		59,600			93,500
Prepaid expenses		757,500			467,400
Total current assets		22,534,200			28,441,100
Net investment in leases - long-term		21,994,700			24,188,900
Property and equipment, net		1,218,800			1,420,300
Other assets		607,500			677,500
Deferred income taxes		419,400			—
		$	46,774,600		$	54,727,800
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Line of credit		$	—		$	18,500,000
Notes payable, net of unamortized debt issuance costs of $11,300		1,988,700			—
Accounts payable		1,208,400			1,955,500
Accrued liabilities		3,139,800			1,759,200
Discounted lease rentals		75,800			227,300
Deferred revenue		2,139,200			2,142,600
Deferred income taxes		2,846,400			4,412,600
Total current liabilities		11,398,300			28,997,200
Long-Term Liabilities:
Line of credit		46,200,000			—
Notes payable, net of unamortized debt issuance costs of $96,800		22,403,200			—
Discounted lease rentals		—			25,800
Deferred revenue		1,536,100			1,347,800
Other liabilities		1,248,800			1,403,200
Deferred income taxes		—			1,344,300
Total long-term liabilities		71,388,100			4,121,100
Shareholders’ Equity (Deficit):
Common stock, no par value, 10,000,000 shares authorized, 4,128,031 and 4,998,512 shares issued and outstanding		434,700			422,400
Accumulated other comprehensive loss		(33,700		)	(37,100		)
Retained earnings (accumulated deficit)		(36,412,800		)	21,224,200
Total shareholders’ equity (deficit)		(36,011,800		)	21,609,500
		$	46,774,600		$	54,727,800

 

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 26, 2015			September 27, 2014			September 26, 2015			September 27, 2014
REVENUE:
Royalties		$	11,286,100		$	10,725,000		$	31,226,700		$	28,735,800
Leasing income		3,247,000			4,121,800			16,919,900			11,655,000
Merchandise sales		762,300			786,100			2,182,300			2,259,900
Franchise fees		483,200			558,200			1,253,500			1,514,700
Other		220,900			213,300			917,900			830,500
Total revenue		15,999,500			16,404,400			52,500,300			44,995,900
COST OF MERCHANDISE SOLD		711,600			742,300			2,055,600			2,156,300
LEASING EXPENSE		173,400			808,500			4,941,300			1,234,200
PROVISION FOR CREDIT LOSSES		38,800			(1,700		)	(123,400		)	26,100
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		5,733,900			5,677,600			18,226,700			17,874,500
Income from operations		9,341,800			9,177,700			27,400,100			23,704,800
INTEREST EXPENSE		(687,700		)	(150,500		)	(1,142,900		)	(356,700		)
INTEREST AND OTHER INCOME (EXPENSE)		(12,400		)	27,200			(61,800		)	28,200
Income before income taxes		8,641,700			9,054,400			26,195,400			23,376,300
PROVISION FOR INCOME TAXES		(3,302,100		)	(3,431,400		)	(10,050,100		)	(8,920,600		)
NET INCOME		$	5,339,600		$	5,623,000		$	16,145,300		$	14,455,700
EARNINGS PER SHARE — BASIC		$	1.29		$	1.12		$	3.53		$	2.84
EARNINGS PER SHARE — DILUTED		$	1.23		$	1.09		$	3.39		$	2.76
WEIGHTED AVERAGE SHARES OUTSTANDING — BASIC		4,128,031			5,022,166			4,568,813			5,093,243
WEIGHTED AVERAGE SHARES OUTSTANDING — DILUTED		4,338,230			5,156,785			4,758,158			5,235,949

 

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 26, 2015			September 27, 2014			September 26, 2015			September 27, 2014
NET INCOME		$	5,339,600		$	5,623,000		$	16,145,300		$	14,455,700
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX:
Unrealized net gains (losses) on marketable securities:
Unrealized holding net gains (losses) arising during period		(30,700		)	(61,400		)	8,000			(56,200		)
Reclassification adjustment for net gains included in net income		—			—			(2,300		)	(3,800		)
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX		(30,700		)	(61,400		)	5,700			(60,000		)
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		11,600			23,300			(3,200		)	21,400
Reclassification adjustment for net gains included in net income		—			—			900			1,400
INCOME TAX (EXPENSE) BENEFIT RELATED TO ITEMS OF OTHER COMPREHENSIVE INCOME		11,600			23,300			(2,300		)	22,800
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX		(19,100		)	(38,100		)	3,400			(37,200		)
COMPREHENSIVE INCOME		$	5,320,500		$	5,584,900		$	16,148,700		$	14,418,500

 

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 26, 2015			September 27, 2014
OPERATING ACTIVITIES:
Net income		$	16,145,300		$	14,455,700
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		322,800			304,600
Provision for credit losses		(123,400		)	26,100
Compensation expense related to stock options		1,255,100			1,037,200
Deferred income taxes		(3,329,900		)	(2,858,000		)
(Gain) loss on sale of marketable securities		22,800			(12,700		)
Deferred initial direct costs		(332,900		)	(757,100		)
Amortization of deferred initial direct costs		491,700			576,000
Tax benefits on exercised stock options		(16,600		)	(74,700		)
Change in operating assets and liabilities:
Receivables		14,000			98,900
Income tax receivable / payable		3,323,200			290,900
Inventories		33,900			500
Prepaid expenses		(290,100		)	(66,900		)
Other assets		70,000			—
Accounts payable		(747,100		)	668,000
Accrued and other liabilities		1,133,300			1,522,600
Rents received in advance and security deposits		6,600			114,200
Deferred revenue		184,900			100,400
Net cash provided by operating activities		18,163,600			15,425,700
INVESTING ACTIVITIES:
Proceeds from sale of marketable securities		299,000			603,200
Purchase of marketable securities		(75,800		)	(629,800		)
Purchase of property and equipment		(121,300		)	(423,700		)
Purchase of equipment for lease contracts		(18,516,900		)	(21,394,100		)
Principal collections on lease receivables		22,047,500			15,519,800
Net cash provided by (used for) investing activities		3,632,500			(6,324,600		)
FINANCING ACTIVITIES:
Proceeds from borrowings on line of credit		56,500,000			28,400,000
Payments on line of credit		(28,800,000		)	(8,400,000		)
Proceeds from borrowings on notes payable		25,000,000			—
Payments on notes payable		(500,000		)	—
Repurchases of common stock		(74,261,500		)	(11,564,800		)
Proceeds from exercises of stock options		159,000			392,000
Dividends paid		(939,200		)	(26,630,400		)
Tax benefits on exercised stock options		16,600			74,700
Net cash used for financing activities		(22,825,100		)	(17,728,500		)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(1,029,000		)	(8,627,400		)
Cash and cash equivalents, beginning of period		2,089,700			10,642,600
Cash and cash equivalents, end of period		$	1,060,700		$	2,015,200
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest		$	830,400		$	301,000
Cash paid for income taxes		$	10,056,800		$	11,487,700

 

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 26, 2015 are not necessarily indicative of the results to be expected for the full year.

 

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 26, 2015						December 27, 2014
		Cost			Fair Value			Cost			Fair Value
Equity securities		$	280,600		$	226,500		$	526,600		$	466,800

 

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 26, 2015			December 27, 2014
Unrealized gains		$	—		$	3,300
Unrealized losses		(54,100		)	(63,100		)
Net unrealized losses		$	(54,100	)	$	(59,800	)

 

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 26, 2015			September 27, 2014			September 26, 2015			September 27, 2014
Realized gains		$	—		$	12,200		$	13,400		$	39,000
Realized losses		—			—			(36,200		)	(26,300		)
Net realized gains/(losses)		$	—		$	12,200		$	(22,800	)	$	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 26, 2015			December 27, 2014
Direct financing and sales-type leases:
Minimum lease payments receivable		$	36,246,600		$	40,739,900
Estimated residual value of equipment		4,811,200			4,347,100
Unearned lease income net of initial direct costs deferred		(4,983,200		)	(6,061,100		)
Security deposits		(3,274,900		)	(3,253,200		)
Equipment installed on leases not yet commenced		8,326,000			8,364,100
Total investment in direct financing and sales-type leases		41,125,700			44,136,800
Allowance for credit losses		(882,000		)	(386,000		)
Net investment in direct financing and sales-type leases		40,243,700			43,750,800
Operating leases:
Operating lease assets		1,362,100			806,100
Less accumulated depreciation and amortization		(1,350,400		)	(536,400		)
Net investment in operating leases		11,700			269,700
Total net investment in leasing operations		$	40,255,400		$	44,020,500

 

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As of September 26, 2015, the $40.3 million total net investment in leases consists of $18.3 million classified as current and $22.0 million classified as long-term.  As of December 27, 2014, the $44.0 million total net investment in leases consists of $19.8 million classified as current and $24.2 million classified as long-term.

 

As of September 26, 2015, leased assets with three customers approximated 18%, 13% and 12%, respectively, 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 2015 and the full fiscal years thereafter as of September 26, 2015:

 

		Direct Financing and Sales-Type Leases						Operating Leases
		Minimum Lease Payments Receivable			Income Amortization			Minimum Lease Payments Receivable
2015		$	6,320,200		$	1,228,500		$	7,600
2016		18,984,100			2,939,300			—
2017		9,748,000			789,800			—
2018		1,192,300			25,600			—
2019		2,000			—			—
Thereafter		—			—			—
		$	36,246,600		$	4,983,200		$	7,600

 

The activity in the allowance for credit losses for leasing operations during the first nine months of 2015 and 2014, respectively, is as follows:

 

		September 26, 2015			September 27, 2014
Balance at beginning of period		$	386,000		$	822,700
Provisions charged to expense		(123,400		)	26,100
Recoveries		628,700			98,500
Deductions for amounts written-off		(9,300		)	(20,100		)
Balance at end of period		$	882,000		$	927,200

 

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 26, 2015						December 27, 2014
		Investment In Leases			Allowance for Credit Losses			Investment In Leases			Allowance for Credit Losses
Collectively evaluated for loss potential		$	41,125,700		$	882,000		$	44,136,800		$	386,000
Individually evaluated for loss potential		—			—			—			—
Total		$	41,125,700		$	882,000		$	44,136,800		$	386,000

 

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 26, 2015
		0-60 Days Delinquent and Accruing			61-90 Days Delinquent and Accruing			Over 90 Days Delinquent and Accruing			Non-Accrual			Total
Middle-Market		$	39,972,700		$	—		$	—		$	—		$	39,972,700
Small-Ticket		1,153,000			—			—			—			1,153,000
Total Investment in Leases		$	41,125,700		$	—		$	—		$	—		$	41,125,700

 

		December 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		$	42,948,000		$	—		$	—		$	—		$	42,948,000
Small-Ticket		1,188,800			—			—			—			1,188,800
Total Investment in Leases		$	44,136,800		$	—		$	—		$	—		$	44,136,800

 

6.              Recent Accounting Pronouncements:

 

In May 2014, the Financial Accounting Standards Board (“FASB”) 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.  As a result of the FASB’s issuance of ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 for all entities by one year, such ASU is effective for reporting periods beginning after December 15, 2017, 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 new standard will become effective for the Company beginning with the first quarter of fiscal 2018.  The Company is currently in the process of evaluating the impact of the adoption of this ASU on the Company’s consolidated results.

 

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which amends existing guidance to require the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge (as an asset).  The ASU is effective for reporting periods beginning after December 15, 2015, but early adoption is permitted.  The Company early adopted the ASU for the fiscal year ending December 26, 2015, and applied its provision retrospectively.  The adoption of this ASU resulted in the classification of $108,100 of unamortized debt issuance costs related to Notes Payable as long-term debt within the Company’s Consolidated Condensed Balance Sheet as of September 26, 2015.  As the ASU is only applicable to debt issuance costs incurred by the Company for its Note Payable in fiscal 2015, no prior period information has been retrospectively adjusted.  Other than this classification, the adoption of this ASU did not have an impact on the Company’s consolidated condensed financial statements.

 

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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 26, 2015		September 27, 2014		September 26, 2015		September 27, 2014
Denominator for basic EPS — weighted average common shares		4,128,031		5,022,166		4,568,813		5,093,243
Dilutive shares associated with option plans		210,199		134,619		189,345		142,706
Denominator for diluted EPS — weighted average common shares and dilutive potential common shares		4,338,230		5,156,785		4,758,158		5,235,949
Options excluded from EPS calculation — anti-dilutive		5,309		32,169		16,961		25,676

 

8.     Shareholders’ Equity (Deficit):

 

Dividends

 

On January 28, 2015, 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 February 11, 2015, which was paid on March 2, 2015.

 

On April 29, 2015, the Company’s Board of Directors approved the payment of a $0.07 per share quarterly cash dividend to shareholders of record at the close of business on May 13, 2015, which was paid on June 1, 2015.

 

On July 29, 2015, the Company’s Board of Directors approved the payment of a $0.07 per share quarterly cash dividend to shareholders of record at the close of business on August 12, 2015, which was paid on September 1, 2015.

 

Repurchase of Common Stock

 

In April 2015, the Company’s Board of Directors authorized the repurchase of up to 875,000 shares of our common stock for a price of $84.72 per share through a tender offer (the “Tender Offer”).  The Tender Offer began on the date of the announcement, April 15, 2015 and expired on May 13, 2015.  Upon expiration, the Company accepted for payment 875,000 shares for a total purchase price of approximately $74.3 million, including fees and expenses related to the Tender Offer.

 

Under a previous Board of Directors’ authorization, as of September 26, 2015, 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.  The Company has authorized up to 500,000 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”).

 

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The Company also sponsors a Stock Option Plan for Nonemployee Directors (the “Nonemployee Directors Plan”) and has reserved a total of 350,000 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 26, 2015 was as follows:

 

		Number of Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (years)		Intrinsic Value
Outstanding at December 27, 2014		597,700		$	48.50		6.93		$	20,973,700
Granted		39,700		91.93
Exercised		(5,106	)	40.52
Outstanding at September 26, 2015		632,294		$	51.29		6.41		$	30,798,700
Exercisable at September 26, 2015		397,392		$	38.58		5.28		$	24,405,900

 

The fair value of options granted under the Option Plans during the first nine months of 2015 and 2014 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 26, 2015			September 27, 2014
Risk free interest rate		1.68		%	1.80		%
Expected life (years)		6			6
Expected volatility		30.8		%	34.1		%
Dividend yield		1.34		%	1.80		%
Option fair value		$	25.48		$	19.23

 

During the nine months ended September 26, 2015, option holders surrendered 587 shares of previously owned common stock as payment for option shares exercised as provided for by the Option Plans.  All unexercised options at September 26, 2015 have an exercise price equal to the fair market value on the date of the grant.

 

Compensation expense of $1,255,100 and $1,037,200 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 2015 and 2014, respectively.  As of September 26, 2015, the Company had $3.6 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 2.3 years.

 

A reconciliation of common shares outstanding and total equity (deficit) from December 27, 2014 to September 26, 2015 is as follows:

 

		Common Shares		Total Equity (Deficit)
BALANCE, December 27, 2014		4,998,512		$	21,609,500
Repurchase of common stock		(875,000	)	(74,261,500		)
Stock options exercised and related tax benefits		4,519		175,600
Compensation expense relating to stock options		—		1,255,100
Cash dividends		—		(939,200		)
Comprehensive income		—		16,148,700
BALANCE, September 26, 2015		4,128,031		$	(36,011,800	)

 

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9.  Debt:

 

Line of Credit

 

In April 2015, 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 Tender Offer;

·                  Increase the aggregate commitments from $35.0 million to $60.0 million to partially fund the Tender Offer;

·                  Extend the termination date from February 28, 2018 to May 14, 2019;

·                  Amend the tangible net worth covenant calculation to remove the effect of the Tender Offer and amend the leverage ratio to allow for an increase in the maximum of such ratio for a period of approximately two years from the effective date of the amendment;

·                  Provide for a change in the applicable margin on the interest rate options based upon the leverage ratio;

·                  Provide for additional LIBOR interest periods of six months and twelve months and remove the fixed rate interest options; and

·                  Permit the Company to sell up to $30 million in term notes to Prudential Investment Management, Inc., its affiliates and managed accounts (“Prudential”) to partially fund the Tender Offer.

 

During the first nine months of 2015, the Line of Credit was used to finance in part the Tender Offer 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 26, 2015, the Company was in compliance with all of its financial covenants.  There were $46.2 million in borrowings outstanding under the line of credit bearing interest ranging from 2.46% to 3.25%, leaving $13.8 million available for additional borrowings.

 

Notes Payable

 

In May 2015, the Company entered into a $25.0 million Note Agreement (the “Note Agreement”) with Prudential.  Proceeds from the Note Agreement of $25.0 million were used to fund in part the Tender Offer.

 

The final maturity of the notes is 10 years.  Interest at a rate of 5.50% per annum on the outstanding principal balance is payable quarterly, along with required prepayments of the principal of $500,000 quarterly for the first five years, and $750,000 quarterly thereafter until the principal is paid in full.  The notes may be prepaid, at the option of the Company, in whole or in part (in a minimum amount of $1.0 million), but prepayments require payment of a Yield Maintenance Amount, as defined in the Note Agreement.

 

The Company’s obligations under the Note Agreement are secured by a lien against substantially all of the Company’s assets (as the notes rank pari passu with the Line of Credit), and the Note Agreement contains customary financial conditions and covenants, and requires maintenance of minimum levels of fixed charge coverage and tangible net worth and maximum levels of leverage (all as defined within the Note Agreement).  As of September 26, 2015, the Company was in compliance with all of its financial covenants.

 

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In connection with the Note Agreement, the Company incurred $112,800 in debt issuance costs, of which unamortized amounts are presented as a direct deduction from the carrying amount of the related liability.

 

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 3.25% at September 26, 2015 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 26, 2015			September 27, 2014			September 26, 2015			September 27, 2014
Revenue:
Franchising		$	12,752,500		$	12,282,600		$	35,580,400		$	33,340,900
Leasing		3,247,000			4,121,800			16,919,900			11,655,000
Total revenue		$	15,999,500		$	16,404,400		$	52,500,300		$	44,995,900
Reconciliation to operating income:
Franchising segment contribution		$	7,827,500		$	7,132,700		$	19,679,000		$	17,145,100
Leasing segment contribution		1,514,300			2,045,000			7,721,100			6,559,700
Total operating income		$	9,341,800		$	9,177,700		$	27,400,100		$	23,704,800
Depreciation:
Franchising		$	85,900		$	80,700		$	255,800		$	240,400
Leasing		22,700			21,500			67,000			64,200
Total depreciation		$	108,600		$	102,200		$	322,800		$	304,600

 

		As of
		September 26, 2015			December 27, 2014
Identifiable assets:
Franchising		$	3,336,100		$	3,258,300
Leasing		40,739,800			44,870,800
Unallocated		2,698,700			6,598,700
Total		$	46,774,600		$	54,727,800

 

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

 

Overview

 

As of September 26, 2015, we had 1,133 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 $40.3 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 2015, our royalties increased $2.5 million or 8.7% compared to the first nine months of 2014.

 

During the first nine months of 2015, we purchased $18.5 million in equipment for lease customers compared to $21.4 million in the first nine months of 2014.  Overall, our leasing portfolio (net investment in leases — current and long-term) decreased to $40.3 million at September 26, 2015 from $44.0 million at December 27, 2014.  Leasing income net of leasing expense during the first nine months of 2015 was $12.0 million compared to $10.4 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.

 

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 2015, selling, general and administrative expense increased $0.4 million, or 2.0%, compared to the first nine months of 2014.

 

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 26, 2015:

 

										NINE MONTHS ENDED 9/26/15
		TOTAL 12/27/14		OPENED		CLOSED		TOTAL 9/26/15		AVAILABLE FOR RENEWAL		COMPLETED RENEWALS
Plato’s Closet
Franchises - US and Canada		426		24		0		450		18		18
Once Upon A Child
Franchises - US and Canada		308		13		1		320		17		17
Play It Again Sports
Franchises - US and Canada		301		4		10		295		20		20
Music Go Round
Franchises - US		33		1		1		33		3		3
Style Encore
Franchises - US		24		11		0		35		0		0
Total Franchised Stores		1,092		53		12		1,133		58		58

 

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