Winmark Corp. 10-K Summary: Fiscal Year Ended December 29, 2007
Business Context and Reporting Period
Winmark Corporation (WINA) is a franchisor of four value-oriented retail store concepts (Play It Again Sports, Once Upon A Child, Plato's Closet, and Music Go Round) that buy, sell, trade, and consign merchandise. The company also operates two equipment leasing businesses: Winmark Capital Corporation (middle-market) and Wirth Business Credit (small-ticket financing). This report covers the fiscal year ended December 29, 2007.
Key Financial Metrics
| Metric | 2007 | 2006 |
|---|---|---|
| Total Revenue | $31.17 million | $27.37 million |
| Net Income | $3.04 million | $3.34 million |
| Operating Income | $6.43 million | $5.36 million |
| Cash from Operations | $6.25 million | $5.09 million |
| Total Debt | $37.26 million | $15.98 million |
| Working Capital | ($1.81 million) | $2.30 million |
| Shares Outstanding | 5.42 million | 5.66 million |
Revenue Breakdown: Royalties ($20.45M), Leasing Income ($4.42M), Merchandise Sales ($4.00M), Franchise Fees ($1.72M).
Profitability: Net income margin was 9.8% in 2007, down from 12.2% in 2006. Operating margin improved to 20.6% from 19.6%.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 13.9% year-over-year, driven primarily by a 138.4% increase in leasing income and a 6.4% increase in royalties.
- Net Income Decline: Despite higher revenue, net income decreased 8.8% due to increased interest expense (up 99.9% to $1.46M), higher selling, general, and administrative (SG&A) expenses (up 12.3%), and a $360k loss from equity investments.
- Debt Expansion: Total debt more than doubled to $37.3 million from $16.0 million to fund the rapid expansion of the leasing portfolio, which grew to $41.9 million.
- Liquidity Shift: Working capital turned negative ($1.81M deficit) compared to a positive $2.30M in 2006, reflecting increased current liabilities related to debt and lease originations.
- Franchise Count: Total franchises/territories increased to 892 from 844. However, Play It Again Sports continued a net decline, closing 28 stores and opening 14 (net loss of 14).
Guidance, Outlook, and Risks
Management Commentary: Management views the leasing segment as a growth driver, with leasing income doubling. The franchising segment remains the primary profit center, with operating income increasing 5.9%. The company plans to use its credit facility and subordinated notes to fund further leasing expansion and stock repurchases.
Risks and Contingencies:
- Franchise Decline: Play It Again Sports has experienced a net loss of stores for nine consecutive years. Failure to reverse this trend could materially harm financial results.
- Investment Losses: The company holds illiquid investments in Tomsten, Inc. (Archiver's) and BridgeFunds. Tomsten has sustained significant losses, resulting in a $360k charge in 2007 and a carrying value reduction to $5.5 million.
- Interest Rate Risk: A significant portion of debt is variable rate. A 1% increase in rates would reduce annual pre-tax earnings by approximately $32,000.
- Concentration Risk: One customer accounted for approximately 13% of total assets in the leasing portfolio as of year-end.
Investor Verification Checklist
- Verify the sustainability of the leasing segment's growth given the significant increase in debt and interest expense.
- Monitor the trend of Play It Again Sports store closures and the company's ability to reverse the net loss.
- Review the valuation and potential impairment risks associated with the $7.5 million investment in Tomsten, Inc.
- Assess the company's ability to maintain liquidity given the negative working capital position and upcoming debt maturities.
- Confirm the renewal rates of franchise agreements, noting that 100% of expiring agreements were renewed in 2007.