WINA

Winmark Corporation 10-K Summary: Fiscal Year Ended December 27, 2003

Business Context and Reporting Period

Winmark Corporation is a franchisor of value-oriented retail store concepts that buy, sell, trade, and consign used and new merchandise. The company operates four primary brands: Play It Again Sports (sporting goods), Once Upon A Child (children's items), Plato's Closet (teen apparel), and Music Go Round (musical instruments). The reporting period covers the fiscal year ended December 27, 2003. As of year-end, the system operated 784 franchised stores and 7 company-owned stores.

Key Financial Metrics

Revenue Composition: Royalties accounted for 52.3% of total revenue ($16.33 million), while merchandise sales (direct franchisee sales and company-owned retail) accounted for 43.0% ($13.43 million). Franchise fees contributed 2.7% ($0.86 million).

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 6.5% to $31.24 million. This was driven by a 13.2% drop in merchandise sales and a 0.7% decline in royalties.
• Store Count: The total number of franchised stores decreased by 13 (from 797 to 784). Play It Again Sports saw a net loss of 27 stores, while Plato's Closet added 30 stores.
• Profitability: Despite lower revenue, Net Income increased 4.8% to $4.01 million, aided by a 4.0% reduction in Selling, General, and Administrative (SG&A) expenses and a gain on the sale of investments ($101,500).
• Debt Elimination: The company terminated its credit agreement with Rush River Group, LLC, resulting in zero outstanding debt as of December 27, 2003.
• Investments: The company increased its long-term investments significantly, purchasing $5.5 million in equity interests in Tomsten, Inc. and eFrame, LLC during the year.

Outlook, Risks, and Management Commentary

Management Commentary: Management emphasized a focus on profitability and cost management. The decline in royalties was attributed to a weak economic environment and a reduced number of stores, partially offset by growth in Plato's Closet. The company renewed 92% of franchise agreements up for renewal in 2003.

Winmark Business Solutions: Launched in late 2002, this initiative provides business support services to franchisees and other small businesses via a website. Currently, it generates no revenue as all services are provided by third-party vendors.

Risk Factors:

• Franchise Renewals: The business model relies heavily on the renewal of 10-year franchise agreements. A significant failure to renew could materially impact future royalties.
• Store Closures: Play It Again Sports has experienced a net loss of stores for six consecutive years. Management aims to reverse this trend through improved support services.
• Investment Risk: The company holds significant illiquid investments in private companies (Tomsten, Inc. and eFrame, LLC). Loss of these investments would materially impact financial performance.
• Competition: Franchisees face competition from large retailers (e.g., Wal-Mart, Target) and online used goods retailers (e.g., eBay).

Investor Verification Checklist

• Franchise Renewal Rates: Verify the renewal percentages for Play It Again Sports and Once Upon A Child in upcoming years, as these brands have significant expirations scheduled for 2004-2006.
• Store Count Trends: Monitor whether the net loss of Play It Again Sports stores stabilizes or reverses, as this is a primary revenue driver.
• Investment Valuation: Assess the financial health of Tomsten, Inc. and eFrame, LLC, given Winmark's $7.5 million total exposure to these illiquid private equity investments.
• Merchandise Sales Strategy: Review the strategic shift regarding the Play It Again Sports buying group, which has reduced direct franchisee sales revenue but may improve franchisee margins.
• Winmark Business Solutions: Track the development of this new revenue stream to determine if it will transition from a cost center to a profit generator.