Winmark Corp. 10-K Summary: Fiscal Year Ended December 27, 2008
Business Context and Reporting Period
Winmark Corporation (WINA) is a franchisor of four value-oriented retail brands (Play It Again Sports, Once Upon A Child, Plato's Closet, and Music Go Round) and operates equipment leasing businesses through subsidiaries Winmark Capital Corporation (middle-market) and Wirth Business Credit (small-ticket). The reporting period covers the fiscal year ended December 27, 2008. As of year-end, the company operated 924 total franchises/territories and held a leasing portfolio of $45.4 million.
Key Financial Metrics
| Metric | 2008 | 2007 |
|---|---|---|
| Total Revenue | $35.4 million | $31.2 million |
| Net Income | $1.1 million | $3.0 million |
| Earnings Per Share (Diluted) | $0.21 | $0.54 |
| Operating Income | $8.1 million | $6.4 million |
| Provision for Credit Losses | $2.6 million | $0.6 million |
| Cash and Equivalents | $2.1 million | $1.3 million |
| Total Debt | $34.4 million | $37.3 million |
| Working Capital | $6.2 million | ($0.6 million) |
Segment Performance: The Franchising segment generated $10.0 million in operating income, while the Leasing segment reported an operating loss of $1.9 million.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 13.7% to $35.4 million, driven primarily by a 6.6% increase in royalties and an 83.3% surge in leasing income.
- Profitability Decline: Net income dropped 62.6% to $1.1 million. This was primarily due to a $2.8 million impairment charge on the investment in Tomsten, Inc. (Archiver's) and a significant increase in the provision for credit losses.
- Leasing Segment: While leasing income grew to $8.1 million due to a larger portfolio, the segment's operating loss narrowed by 28.9% to $1.9 million. However, net charge-offs in the small-ticket financing business rose to $1.6 million from $0.4 million in 2007.
- Franchise Activity: The company opened 80 new franchises/territories and closed 48, ending the year with 924 locations. Renewal rates remained strong at 96%.
Guidance, Outlook, and Risks
Management Commentary: Management attributes the decline in net income to the impairment of the Tomsten investment and worsening economic trends affecting credit quality in the leasing portfolio. The company tightened credit standards in 2008 in response to the economic environment.
Liquidity and Capital: The company maintains a $55.0 million credit facility with $41.4 million available. It also has $20.8 million outstanding in unsecured subordinated notes. Management believes current cash, operating cash flow, and credit facilities are adequate to fund 2009 operations.
Risks and Contingencies:
- Credit Risk: Deteriorating economic conditions have increased delinquencies in the small-ticket leasing portfolio. Continued charge-offs could materially impact profitability.
- Investment Impairment: The company holds illiquid investments in Tomsten, Inc. and BridgeFunds LLC. Further losses or inability to raise capital by these entities could lead to additional impairments.
- Franchise Renewals: A significant number of franchise agreements expire in 2009-2011. Failure to renew these could materially impact future royalties.
- Regulatory: New Consumer Product Safety Improvement Act requirements regarding lead and phthalates in children's products may limit the supply of used merchandise for Once Upon A Child franchisees.
Investor Verification Checklist
- Credit Loss Trends: Verify the trajectory of net charge-offs and the adequacy of the allowance for credit losses in the small-ticket leasing segment given the economic downturn.
- Tomsten Investment: Assess the recoverability of the remaining $2.3 million carrying value of the Tomsten, Inc. investment and the likelihood of further impairments.
- Franchise Renewals: Monitor the renewal rate for the 12 Play It Again Sports and 20 Once Upon A Child agreements expiring in 2009.
- Liquidity Covenants: Confirm continued compliance with debt covenants (debt service coverage, tangible net worth) under the $55 million credit facility.
- Leasing Portfolio Growth: Evaluate whether the company can sustain leasing income growth while maintaining strict credit standards to prevent further charge-offs.