WINA

Winmark Corp. 10-Q Summary: Quarter Ended September 24, 2005

Business Context and Reporting Period

Winmark Corporation operates a franchising business model for value-oriented retail concepts (Play It Again Sports, Once Upon A Child, Plato's Closet, and Music Go Round) and a growing equipment leasing segment. This report covers the three and nine-month periods ended September 24, 2005. As of the reporting date, the company operated 803 franchised stores.

Key Financial Metrics

Debt and Liquidity: The company reported no material outstanding debt as of September 24, 2005. It maintains a $15.0 million line of credit with LaSalle Bank, of which $10.0 million is available for leasing operations; no funds had been drawn as of the filing date.

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 4.6% year-over-year for the nine-month period. This was driven by a 23.0% drop in merchandise sales due to a strategic shift encouraging franchisees to buy directly from vendors and the sale of a company-owned Music Go Round store.
• Profitability Pressure: Net income declined 30.1% for the nine-month period. Operating income margins compressed from 24.2% to 18.5% due to increased Selling, General, and Administrative (SG&A) expenses.
• SG&A Increase: SG&A expenses rose 16.7% year-over-year, primarily due to startup costs for the new leasing segment ($1.51 million in the first nine months of 2005 vs. $0.37 million in 2004), higher salaries, and stock-based compensation.
• Leasing Segment Loss: The leasing segment reported an operating loss of $1.23 million for the nine months ended September 24, 2005, compared to a loss of $0.35 million in the prior year, reflecting significant investment in equipment and personnel.
• Franchising Growth: Despite the overall revenue decline, the franchising segment contribution increased 4.0% to $8.36 million, driven by a 1.8% increase in royalties from 26 additional Plato's Closet stores.

Outlook, Risks, and Unusual Items

• Guidance: Management believes cash generated from operations and existing investments will be adequate to meet obligations and fund planned leasing activities for the remainder of 2005. No specific numerical guidance was provided.
• Stock Repurchases: The company repurchased 138,215 shares of common stock in the third quarter for approximately $2.60 million. As of September 24, 2005, authorization remained to repurchase an additional 539,458 shares.
• Investment Portfolio: The company holds significant illiquid investments in private companies (Tomsten, eFrame, CCG, and BridgeFunds). Losses from equity investments totaled $188,800 for the nine-month period.
• Unusual Items: The company recorded a $70,800 gain from the closing of a company-owned Music Go Round store, which partially offset SG&A increases. Additionally, the company sold inventory from this store at a loss of $64,100.
• Risks: Future results depend on franchisee performance, the success of the new leasing franchise system (Wirth Business Credit), and the financial health of minority investments.

Investor Verification Checklist

• Leasing Segment Viability: Verify the timeline for the leasing segment to reach profitability given the $1.23 million loss in the first nine months.
• Franchisee Direct Purchasing: Assess the long-term impact of the strategic shift reducing merchandise sales revenue on overall royalty growth.
• Investment Valuation: Review the financial health of minority investments (eFrame, CCG, Tomsten) to assess potential impairment risks.
• Store Count Dynamics: Monitor the net change in franchise store openings versus closings, particularly for Play It Again Sports which saw a net decrease in store count.
• Cash Flow Sustainability: Confirm that operating cash flow remains sufficient to fund the $2.26 million used in investing activities without drawing on the credit line.