Winmark Corp. 10-K Summary: Fiscal Year Ended December 30, 2006
Business Context and Reporting Period
Winmark Corporation is a franchisor of value-oriented retail store concepts (Play It Again Sports, Once Upon A Child, Plato's Closet, Music Go Round) and operates equipment leasing businesses (Winmark Capital Corporation and Wirth Business Credit). The reporting period covers the fiscal year ended December 30, 2006. The company operates primarily in the United States with limited Canadian franchising revenue.
Key Financial Metrics
| Metric | 2006 | 2005 |
|---|---|---|
| Total Revenue | $27.37 million | $26.60 million |
| Net Income | $3.42 million | $2.10 million |
| Diluted EPS | $0.57 | $0.33 |
| Operating Income | $5.36 million | $4.49 million |
| Cash and Equivalents (Year End) | $1.04 million | $2.95 million |
| Total Debt | $15.98 million | $0 |
| Working Capital | $2.30 million | $4.78 million |
| Franchises Opened | 62 | 52 |
| Franchises Closed | 29 | 26 |
Segment Performance: Franchising revenue was $25.52 million (up slightly from prior year), while Leasing revenue grew significantly to $1.85 million from $0.44 million. However, the Leasing segment reported an operating loss of $2.11 million due to startup costs.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 2.9% to $27.37 million, driven by a 7.5% increase in royalties and a 323.9% surge in leasing income.
- Profitability: Net income increased 62.9% to $3.42 million, aided by a $250,000 gain on the sale of an equity investment (eFrame) and higher interest income.
- Debt Structure: The company incurred significant new debt in 2006, issuing $15.38 million in renewable unsecured subordinated notes and utilizing a $20 million line of credit (with $600,000 outstanding at year-end), compared to zero debt in 2005.
- Store Count: Total franchise count increased to 836. Notably, Play It Again Sports continued a net decline in store count (closed 22, opened 14), while Plato's Closet added 22 net stores.
- Stock Repurchases: The company repurchased 524,000 shares of common stock for approximately $12.28 million.
Guidance, Outlook, and Risks
Outlook: Management expects cash generated from operations and existing credit facilities to be adequate for 2007 operations. The company plans to continue expanding its leasing portfolio and opening new franchises, particularly in established brands.
Risks and Contingencies:
- Franchise Renewals: The company is dependent on franchise renewals; 34 agreements were up for renewal in 2006, all of which were renewed (100%).
- Play It Again Sports Decline: The company explicitly notes a continued decline in Play It Again Sports franchise locations and the risk that this trend may not be reversed.
- Leasing Segment Losses: The leasing business is in early stages and currently operates at a loss. Future profitability depends on controlling costs and growing the portfolio.
- Investment Risk: The company holds $11.5 million in illiquid long-term investments in private companies (Tomsten, BridgeFunds, Commercial Credit Group), which carry risks of impairment or inability to liquidate.
- Key Person Risk: The business is heavily dependent on Chairman and CEO John L. Morgan.
Investor Verification Checklist
- Verify the sustainability of the 100% franchise renewal rate in upcoming years, particularly for Play It Again Sports.
- Monitor the trajectory of the Leasing segment's operating losses versus revenue growth to assess path to profitability.
- Review the liquidity position given the drop in cash equivalents from $2.95M to $1.04M and the increase in debt obligations.
- Assess the valuation and liquidity of the $11.5 million in long-term private equity investments.
- Confirm the status of the $20 million line of credit and compliance with financial covenants (tangible net worth, interest coverage).