WINA

Winmark Corp. 2005 Annual Report (10-K) Summary

Business Context and Reporting Period

Company: Winmark Corporation
Reporting Period: Fiscal year ended December 31, 2005 (53-week year)
Business Model: Winmark is a franchisor of value-oriented retail concepts (Play It Again Sports, Once Upon A Child, Plato's Closet, Music Go Round) that buy, sell, trade, and consign used and new merchandise. The company also operates an equipment leasing business (Winmark Capital Corporation) and a small-ticket financing business (Wirth Business Credit, Inc.).
Store Count: As of December 31, 2005, the company had 803 franchised stores. The company sold its remaining three company-owned retail stores during 2005 and no longer owns any retail locations.

Key Financial Metrics

Revenue Breakdown (2005): Royalties ($17.9M), Merchandise Sales ($6.7M), Franchise Fees ($1.1M), Leasing Income ($0.4M), Other ($0.6M).

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 2.2% to $26.6 million. This was driven by a 23.8% drop in merchandise sales due to a strategic shift encouraging franchisees to buy directly from vendors and the sale of all company-owned retail stores.
• Profitability Drop: Net income fell 48.6% to $2.1 million. Operating income decreased 32.2% to $4.5 million.
• Expense Increase: Selling, general, and administrative (SG&A) expenses rose 24.3% to $16.6 million. Increases were attributed to stock-based compensation ($1.05M), new hires, and infrastructure costs for the leasing division.
• Investment Losses: The company recorded a $937,600 impairment charge on its investment in eFrame, LLC, contributing to a $1.17 million loss from equity investments.
• Leasing Segment Loss: The new leasing segment reported an operating loss of $1.8 million in 2005, up from $0.6 million in 2004, due to startup costs.

Guidance, Outlook, and Risks

Outlook: Management expects cash generated from operations and existing investments to be adequate for 2006 needs. The company plans to amend its $15 million line of credit with LaSalle Bank by the end of Q2 2006. No dividends are anticipated in the foreseeable future.

Key Risks and Contingencies:

• Franchise Renewals: The company is dependent on renewing 10-year franchise agreements. While the 2005 renewal rate was 93%, failure to renew a significant number of agreements would materially harm financial performance.
• Play It Again Sports Decline: The number of Play It Again Sports franchises has declined for seven consecutive years (net loss of 16 stores in 2005). Management aims to reverse this trend but offers no assurance of success.
• Investment Risk: The company holds $11 million in illiquid long-term investments (Tomsten, Commercial Credit Group, BridgeFunds). These investments are in unproven businesses, and the company has no control over their operations.
• Regulatory Risk: Investment securities exceeded 40% of total assets at year-end, creating a risk of being classified as an "investment company" under the 1940 Act, which would impose significant regulatory burdens.

Investor Verification Checklist

• Franchise Renewal Rates: Verify the renewal rate for 2006, particularly for Play It Again Sports and Once Upon A Child, where significant numbers of agreements expire.
• Leasing Segment Viability: Assess the timeline for the leasing division to reach profitability given the $1.8M operating loss and heavy startup costs.
• Investment Valuation: Review the status of the $11M in private equity investments (specifically eFrame, which was written down, and BridgeFunds) to ensure no further impairments are likely.
• Stock Repurchase Activity: Note that the company repurchased 210,565 shares in 2005; verify if this buyback program continues to support share price.
• Regulatory Status: Confirm the company's stance on the 40% investment asset threshold and any correspondence with the SEC regarding Investment Company Act classification.