Winmark Corp. 10-K Summary: Fiscal Year Ended December 28, 2002
Business Context and Reporting Period
Winmark Corporation is a franchisor of four retail brands (Play It Again Sports, Once Upon A Child, Music Go Round, and Plato's Closet) that buy, sell, trade, and consign used and new merchandise. The company operates primarily in the United States with minor Canadian operations. The reporting period covers the fiscal year ended December 28, 2002. As of year-end, the system comprised 828 total stores (down from 844 in 2001), with a net decrease of 16 stores due to 46 openings and 62 closures/sales.
Key Financial Metrics
| Metric | Fiscal 2002 | Fiscal 2001 |
|---|---|---|
| Total Revenue | $33.43 million | $36.09 million |
| Net Income | $3.83 million | $3.20 million |
| Diluted EPS | $0.63 | $0.55 |
| Operating Cash Flow | $5.39 million | $7.44 million |
| Cash & Short-term Investments | $6.60 million | $3.20 million |
| Total Debt | $0 | $0.20 million |
| Working Capital | $7.47 million | $4.64 million |
| Current Ratio | 2.78:1 | 1.89:1 |
Revenue Composition: Royalties accounted for 49.2% of total revenue ($16.45 million), while merchandise sales (direct franchisee sales and company-owned retail) accounted for 46.3% ($15.47 million).
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 7.4% to $33.43 million. This was driven by a 18.8% drop in merchandise sales, primarily due to a strategic decision to have Play It Again Sports franchisees purchase directly from vendors rather than through the company's buying group, and a reduction in the number of Play It Again Sports stores.
- Profitability Increase: Despite lower revenue, Net Income increased 19.8% to $3.83 million. Operating income rose 5.7% to $6.32 million, aided by a 22.1% decrease in the cost of merchandise sold (as a percentage of revenue) and a 4.0% reduction in selling, general, and administrative expenses.
- Debt Elimination: The company paid off its remaining long-term debt and terminated the Rush River credit facility in 2002, resulting in zero outstanding debt at year-end.
- Store Count: The total number of stores declined by 16 units. Play It Again Sports saw a net loss of 28 stores, while Plato's Closet grew significantly with 31 new openings.
Outlook, Risks, and Unusual Items
- Investment in Tomsten, Inc.: The company committed to a $6.0 million investment in Tomsten, Inc. (parent of "Archiver's" photo retail chain). $2.0 million was paid in 2002, with subsequent payments due in 2003. This investment is illiquid and carries the risk of total loss.
- Franchise Renewals: A significant risk factor is the dependence on franchise renewals. In 2002, 102 of 114 expiring Play It Again Sports agreements were renewed. However, 68, 42, and 30 agreements are scheduled to expire in 2003, 2004, and 2005, respectively.
- Store Closures: Management acknowledges a historical trend of net store closures in the Play It Again Sports brand (net loss of 28 stores in 2002) and emphasizes the need to reverse this trend to sustain growth.
- Accounting Changes: The company adopted SFAS No. 142 (Goodwill) and SFAS No. 123 (Stock-Based Compensation) in 2002. Goodwill is no longer amortized, and stock-based compensation is now expensed using the fair value method.
- Legal Proceedings: No material litigation is currently pending.
Investor Verification Checklist
- Franchise Renewal Rates: Verify the renewal rate for the 68 Play It Again Sports agreements expiring in 2003 to assess future royalty stability.
- Tomsten Investment Status: Monitor the performance and liquidity of the $6.0 million investment in Tomsten, Inc., as it represents a significant portion of the company's cash reserves.
- Play It Again Sports Turnaround: Track whether the net loss of Play It Again Sports stores can be halted or reversed, as this brand generates the majority of system-wide sales.
- Buying Group Margins: Confirm the long-term impact of shifting Play It Again Sports franchisees to direct vendor purchasing on the company's merchandise sales revenue stream.
- Contingent Lease Liabilities: Review the adequacy of reserves for contingent liabilities related to closed or sold company-owned stores where the company remains a guarantor.