WINA

Winmark Corp. 10-K Summary: Fiscal Year Ended December 26, 2009

Business Context and Reporting Period

Winmark Corporation (WINA) is a franchisor of four value-oriented retail brands (Play It Again Sports, Plato's Closet, Once Upon A Child, and Music Go Round) and operates two equipment leasing businesses (Winmark Capital and Wirth Business Credit). The reporting period covers the fiscal year ended December 26, 2009. As of year-end, the company operated 914 franchises/territories and maintained a leasing portfolio of $37.0 million.

Key Financial Metrics

Segment Performance: The Franchising segment generated $12.2 million in operating income (up 21.8% from 2008). The Leasing segment reported an operating loss of $1.4 million, an improvement of 26.1% from the $1.9 million loss in 2008.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 5.3% to $37.3 million, driven by an 8.3% increase in royalties and a 17.8% increase in leasing income.
• Profitability Surge: Net income increased 413.3% to $5.8 million. This was primarily due to a significant reduction in losses from equity investments (down from a $3.2 million loss in 2008 to $0.1 million in 2009) and improved operating margins.
• Franchise Activity: The company opened 49 new franchises but closed 59, resulting in a net decrease of 10 locations. However, the renewal rate for expiring agreements was 96%.
• Leasing Portfolio: The net investment in leases decreased 18.5% to $37.0 million due to tightened credit standards and the economic environment, though leasing income rose due to accounting classification changes (sales-type leases).
• Stock Repurchases: The company repurchased 313,585 shares of common stock for $5.3 million during the year.

Outlook, Risks, and Contingencies

• Outlook: Management expects cash from operations, the $40 million credit facility, and subordinated notes to be adequate to fund 2010 operations. The company plans to continue supporting franchisees and managing leasing credit risk.
• Credit Risk: The provision for credit losses increased to $2.8 million (from $2.6 million in 2008) due to higher net charge-offs in the small-ticket financing business. Management notes that continued charge-offs at current levels could materially impact results.
• Investment Risks: The company holds illiquid investments in Tomsten, Inc. (Archiver's) and BridgeFunds, LLC. Tomsten has incurred significant losses, and BridgeFunds is in a run-off phase. Further impairments are possible.
• Franchise Renewals: A significant number of franchise agreements expire in 2010, 2011, and 2012. Failure to renew these could materially impact future royalties.
• Liquidity: The company has a $40 million revolving credit facility with $30.7 million available as of year-end. It also has $21.2 million outstanding in renewable subordinated notes.

Key Facts for Investor Verification

• Franchise Renewal Rates: Verify the 96% renewal rate for 2009 and monitor upcoming expirations (25 Play It Again Sports, 22 Plato's Closet, and 20 Once Upon A Child agreements expire in 2010).
• Leasing Credit Quality: Monitor the provision for credit losses and net charge-offs, which rose to $3.0 million in 2009, to assess the impact of the economic downturn on the leasing portfolio.
• Equity Investment Valuation: Review the carrying value of the $2.2 million investment in Tomsten, Inc., which has a history of losses, for potential future impairment charges.
• Debt Covenants: Confirm continued compliance with financial covenants on the $40 million credit facility and subordinated notes, specifically regarding debt service coverage and tangible net worth.
• Franchise Openings: Assess the pipeline of 46 signed franchise agreements expected to open in 2010 to gauge future royalty growth.