Winmark Corporation 10-Q Summary
Business Context and Reporting Period
Winmark Corporation operates a franchise system for retail stores under the brands Play It Again Sports, Once Upon A Child, Plato's Closet, and Music Go Round. As of June 26, 2004, the company had 784 franchised stores. This filing covers the quarterly period ended June 26, 2004, and the six-month period ended on that date.
Key Financial Metrics
| Metric | Six Months Ended June 26, 2004 | Six Months Ended June 28, 2003 |
|---|---|---|
| Total Revenue | $14,224,200 | $15,782,700 |
| Net Income | $2,086,600 | $1,878,600 |
| Earnings Per Share (Diluted) | $0.32 | $0.30 |
| Operating Cash Flow | $2,252,100 | $2,184,800 |
| Cash and Cash Equivalents (End of Period) | $7,167,600 | $4,071,100 |
| Current Ratio | 4.2 to 1.0 | 2.9 to 1.0 |
| Long-Term Debt | $0 | $0 |
Revenue Composition (Six Months 2004): Royalties ($8.6M), Merchandise Sales ($4.9M), Franchise Fees ($0.4M), and Other ($0.3M).
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 9.9% year-over-year. This was driven by a 19.6% drop in Direct Franchisee Sales and a 48.6% drop in Company-owned retail sales.
- Profitability Increase: Despite lower revenue, Net Income increased 11.1% to $2.1 million. Operating income rose 20.5% to $3.35 million.
- Expense Reduction: Selling, General, and Administrative (SG&A) expenses decreased 8.0% to $6.8 million. This reduction is primarily attributed to the sale of five Company-owned stores in late 2003 and early 2004, eliminating associated rent and salary costs.
- Franchise Growth: Franchise fees increased 45.4% due to 19 new store openings in the first six months of 2004 compared to 14 in the prior year. Royalties increased 5.7% due to higher franchisee retail sales.
- Investment Losses: The company recorded an $82,400 loss from its equity investment in eFrame, LLC, representing its pro-rata share of losses.
Outlook, Risks, and Management Commentary
- Strategic Shift: Management is strategically shifting Play It Again Sports franchisees to purchase merchandise directly from vendors rather than through the company's buying group, reducing merchandise sales revenue but lowering operational overhead.
- Liquidity: The company maintains strong liquidity with $8.6 million in cash and current marketable securities. Management believes cash generated from operations and existing investments are adequate to meet current obligations and fund leasing operations.
- Investments: The company holds a 19% stake in Tomsten, Inc. (Archiver's) and a 27.2% stake in eFrame, LLC. The eFrame investment is currently generating losses.
- Risks: Key risks include the collectability of receivables, inventory valuation, and the impact of franchisee sales estimates on royalty revenue. The company also faces market risk regarding interest rate fluctuations on its fixed income securities.
- Subsequent Events: On June 28, 2004, stock options were granted to non-employee directors. Stephen M. Briggs resigned from the board of managers of eFrame, LLC on July 30, 2004.
Investor Verification Checklist
- Verify the sustainability of the SG&A expense reduction following the sale of Company-owned stores.
- Monitor the performance of the eFrame, LLC investment, which is currently contributing to losses.
- Assess the long-term impact of the strategic decision to reduce Direct Franchisee Sales volume on overall revenue stability.
- Review the renewal rate of franchise agreements (35 of 44 available renewed in the first half of 2004) as an indicator of franchisee health.
- Confirm the company's ability to maintain its high current ratio (4.2:1) as it continues to fund leasing operations.