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Article by DailyStocks_admin    (03-12-12 01:58 AM)

Description

Winmark Corp. Chairman & CEO, 10% Owner JOHN L MORGAN bought 5000 shares on 3-01-2012 at $ 57

BUSINESS OVERVIEW

Background



We are a franchisor of four value-oriented retail store concepts that buy, sell, trade and consign merchandise. Each of our retail store brands emphasizes consumer value by offering high-quality used merchandise at substantial savings from the price of new merchandise and by purchasing customers’ used goods that have been outgrown or are no longer used. The retail brands also offer new merchandise to customers.



We operate a middle-market equipment leasing business through our wholly owned subsidiary, Winmark Capital Corporation. Our middle-market leasing business serves large and medium-sized businesses and focuses on technology-based assets which typically cost more than $250,000. The businesses we target generally have annual revenue of between $50 million and several billion dollars. We generate middle-market equipment leases primarily through business alliances, equipment vendors and directly from customers.



We also operate a small-ticket financing business through our wholly owned subsidiary, Wirth Business Credit®, Inc. Our small-ticket financing business serves small businesses and focuses on assets which generally have a cost of $5,000 to $100,000.



The Company also provides management services to Tomsten, Inc. (d/b/a Archiver’s) for an annual fee. In connection with these services, John L. Morgan, our Chairman and Chief Executive Officer serves as Chairman and Chief Executive Officer of Tomsten, Inc.



Our significant assets are located within the United States, and we generate all revenues from United States operations other than franchising revenues from Canadian operations of approximately $2.2 million, $1.8 million and $2.0 million for 2010, 2009 and 2008, respectively. For additional financial information, please see Item 6 — Selected Financial Data and Item 8 — Financial Statements and Supplementary Data. We were incorporated in Minnesota in 1988.



Franchise Operations



Our four retail brands with their fiscal year 2010 system-wide sales, defined as estimated revenues generated by all franchise owned locations, are summarized as follows:



Plato’s Closet ® - $241 million.



We began franchising the Plato’s Closet brand in 1999. Plato’s Closet franchises sell and buy used clothing and accessories geared toward the teenage and young adult market. Customers have the opportunity to sell their used items to a Plato’s Closet franchise when gently-used or outgrown and to purchase quality used clothing and accessories at prices lower than new merchandise. For the years ended 2010, 2009 and 2008, Plato’s Closet contributed royalties and franchise fees of $10.3 million, $8.5 million and $6.9 million , respectively. As a percentage of consolidated revenues for 2010, 2009 and 2008, these amounts equaled 25.1%, 22.8% and 19.5%, respectively.

Play It Again Sports ® - $236 million.



We began franchising the Play It Again Sports brand in 1988. Play It Again Sports franchises sell, buy, trade and consign used and new sporting goods, equipment and accessories for a variety of athletic activities including hockey, wheeled sports (in-line skating, skateboards, etc.), fitness, ski/snowboard, golf and baseball/softball. The franchises offer a flexible mix of merchandise that is adjusted to adapt to seasonal and regional differences. Play It Again Sports is known for providing high value to the customer by offering a mix of new and used sporting goods. For the years ended 2010, 2009 and 2008, Play It Again Sports contributed royalties and franchise fees of $9.7 million, $9.1 million and $9.8 million, respectively. As a percentage of consolidated revenues for 2010, 2009 and 2008, these amounts equaled 23.7%, 24.3% and 27.6% respectively.



Once Upon A Child ® - $168 million.



We began franchising the Once Upon A Child brand in 1993. Once Upon A Child franchises sell and buy used and new children’s clothing, toys, furniture, equipment and accessories. This brand primarily targets cost-conscious parents of children ages infant to 10 years with emphasis on children ages seven years old and under. These customers have the opportunity to sell their used children’s items to a Once Upon A Child franchise when outgrown and to purchase quality used children’s clothing, toys, furniture and equipment at prices lower than new merchandise. New merchandise is offered to supplement the used merchandise. For the years ended 2010, 2009 and 2008, Once Upon A Child contributed royalties and franchise fees of $7.0 million, $6.4 million and $5.7 million, respectively. As a percentage of consolidated revenues for 2010, 2009 and 2008, these amounts equaled 17.0%, 17.1% and 16.0% respectively.



Music Go Round ® - $25 million.



We began franchising the Music Go Round brand in 1994. Music Go Round franchises sell, buy, trade and consign used and new musical instruments, speakers, amplifiers, music-related electronics and related accessories for parents of children who play musical instruments, as well as professional and amateur musicians. For the years ended 2010, 2009 and 2008, Music Go Round contributed royalties and franchise fees of $0.8 million each year, respectively. As a percentage of consolidated revenues for 2010, 2009 and 2008, these amounts equaled 1.9%, 2.0% and 2.2% respectively.

Retail Brands Franchising Overview



We use franchising as a business method of distributing goods and services through our retail brands to consumers. We, as franchisor, own a retail business brand, represented by a service mark or similar right, and an operating system for the franchised business. We then enter into franchise agreements with franchisees and grant the franchisee the right to use our business brand, service marks and operating system to manage a retail business. Franchisees are required to operate their retail businesses according to the systems, specifications, standards and formats we develop for the business brand. We train the franchisees how to operate the franchised business. We also provide continuing support and service to our franchisees.



We have developed value-oriented retail brands based on a mix of used and new merchandise. We franchise rights to franchisees who open franchised locations under such brands. The key elements of our franchise strategy include:



• franchising the rights to operate retail stores offering value-oriented merchandise;

• attracting new, qualified franchisees; and

• providing initial and continuing support to franchisees.



We have and will continue to reinvest operating cash flow generated from our business into:



• supporting the current franchise systems;

• making investments in infrastructure to support our corporate needs;

• supporting Winmark Capital and Wirth Business Credit; and

• pursuing new business opportunities.



Offering Value-Oriented Merchandise



Our retail brands provide value to consumers by purchasing and reselling used merchandise that consumers have outgrown or no longer use at substantial savings from the price of new merchandise. Our retail brands also offer value-priced new merchandise. By offering a combination of high-quality used and value-priced new merchandise, we benefit from consumer demand for value-oriented retailing. In addition, we believe that among national retail operations our retail store brands provide a unique source of value to consumers by purchasing used merchandise. We also believe that the strategy of buying used merchandise increases consumer awareness of our retail brands.



Attracting Franchisees



Our franchise marketing program for retail brands seeks to attract prospective franchisees with experience in management and operations and an interest in being the owner and operator of their own business. We seek franchisees who:



• have a sufficient net worth;

• have prior business experience; and

• intend to be integrally involved with the management of the business.



At December 25, 2010, we had 34 signed retail franchise agreements that are expected to open in 2011.



We began franchising in Canada in 1991 and, as of December 25, 2010, had 62 franchised retail stores open in Canada. The Canadian retail stores are operated by franchisees under agreements substantially similar to those used in the United States.

Retail Brand Franchise Support



As a franchisor, our success depends upon our ability to develop and support competitive and successful franchise brands. We emphasize the following areas of franchise support and assistance.



Training



Each franchisee must attend our training program regardless of prior experience. Soon after signing a franchise agreement, the franchisee of one of our retail brands is required to attend new owner orientation training. This course covers basic management issues, such as preparing a business plan, lease evaluation, evaluating insurance needs and obtaining financing. Our training staff assists each franchisee in developing a business plan for their retail store with financial and cash flow projections. The second training session is centered on store operations. It covers, among other things, point-of-sale computer training, inventory selection and acquisition, sales, marketing and other topics. We provide the franchisee with operations manuals that we periodically update.



Field Support



We provide operations personnel to assist the franchisee in the opening of a new business. We also have an ongoing field support program designed to assist franchisees in operating their retail stores. Our franchise support personnel visit each retail store periodically and, in most cases, a business assessment is made to determine whether the franchisee is operating in accordance with our standards. The visit is also designed to assist franchisees with operational issues.



Purchasing



During training each franchisee is taught how to evaluate, purchase and price used goods. In addition to purchasing used products from customers who bring merchandise to the store, the franchisee is also encouraged to develop sources for purchasing used merchandise in the community. Franchisees typically do not repair or recondition used products, but rather, purchase quality used merchandise that may be put directly on display for resale on an ‘ as i s ’ basis. We have developed specialized computer point-of-sale systems for Once Upon A Child and Plato’s Closet stores that provide the franchisee with standardized pricing information to assist in the purchasing of used items. Play It Again Sports, Once Upon A Child and Music Go Round also use buying guides and the point-of-sale system to assist franchisees in pricing used items.



We provide centralized buying services, which on a limited basis include credit and billing for the Play It Again Sports franchisees. Upon credit approval, Play It Again Sports franchisees may order through the buying group, in which case, product is shipped directly to the store by the vendor. We are invoiced by the vendor, and in turn, we invoice the franchisee adding a 4% service fee to cover our costs of operating the buying group. Our Play It Again Sports franchise system uses several major vendors including Horizon Fitness, Nautilus, Wilson Sporting Goods, Champro Sporting Goods, Easton-Bell Sports, RBK CCM Hockey and Bauer Hockey. The loss of any of the above vendors would change the vendor mix, but not significantly change our products offered. The amount of product being sold through the buying group has significantly decreased over the past few years as a result of our strategic decision to have more franchisees purchase merchandise directly from vendors.



To provide the franchisees of our Once Upon A Child and Music Go Round systems a source of affordable new product, we have developed relationships with our significant vendors and negotiated prices for our franchisees to take advantage of the buying power a franchise system brings.



Our typical Once Upon A Child franchised store purchases approximately 30% of its new product from Graco, Million Dollar Baby, Dorel Juvenile Group and North Gates. The loss of any of the above vendors would change the vendor mix, but not significantly change our products offered.



There are no significant vendors to our typical Plato’s Closet franchised store.

CEO BACKGROUND

John L. Morgan Age: 69

Mr. Morgan was elected Chairman of the Board and Chief Executive Officer of Winmark in March 2000. In addition, Mr. Morgan currently serves as Chairman and Chief Executive Officer of Tomsten, Inc. (d/b/a Archiver’s) pursuant to a management agreement entered into in December 2009 between Winmark and Tomsten, Inc. He was an independent investor/business consultant from April 1999 to February 2000. He was the founder of Winthrop Resources Corporation, a business equipment leasing company, and served as its President from March 1982 through March 1999. In addition, Mr. Morgan is currently a private investor and serves as a member of Rush River Group, LLC. Mr. Morgan brings experience in executive management and over 40 years of equipment leasing experience to our Board. In his current capacity as Chairman and Chief Executive Officer of Winmark, Mr. Morgan provides an intimate knowledge of our business and operations and provides the Board with company-specific experience and expertise. In addition, his significant ownership stake in Winmark provides the Board with a unique perspective regarding the long-term strategy of the company.

Jenele C. Grassle Age: 51

Ms. Grassle was elected a director of Winmark in January 2001. She has served as Vice President, Merchandising for Carlson Marketing Worldwide, a division of Groupe Aeroplan, Inc., since May 2008. Ms. Grassle served as the Vice President/General Merchandise Manager at Value Vision Media, Inc. from July 2007 to April 2008, as Vice President, Jewelry from July 2006 to July 2007 and as Divisional Merchandise Manager, Ready-to-Wear, Accessories and Cosmetics from February 2005 to July 2006. Ms. Grassle’s background as an executive officer and her expertise in retail management including merchandising, operations and marketing provides expertise as well as leadership skills to our Board.

Kirk A. MacKenzie Age: 72

Mr. MacKenzie was elected a director of Winmark in May 2000 and served as its Vice Chairman from that time until February 2011. In addition, he is currently a private investor, serves as a member of Rush River Group, LLC and is a Director of Geronimo Wind Energy, LLC. From January 1982 to March 1999, Mr. MacKenzie was Executive Vice President of Winthrop Resources Corporation, a business equipment leasing company. Mr. MacKenzie’s experience in equipment leasing, as well as his previous public company executive experience provides significant insight and expertise to our Board, particularly as we continue to build our equipment leasing operations.


Dean B. Phillips Age: 42

Mr. Phillips was elected a director of Winmark in 2007. He currently serves as President and Chief Executive Officer of Phillips Distilling Company, a position he has held since 2000. From 1993 to 2000, Mr. Phillips held a variety of sales and marketing positions in both the US and Canada at Phillips Distilling Company and Millennium Import, LLC — the marketer of Belvedere and Chopin luxury vodkas. Mr. Phillips is Chairman of the Board of Directors of Allina Health System, a member of the Advisory Board of the Center for the Study of Politics and Governance at the University of Minnesota’s Humphrey Institute and a Trustee of The Jay & Rose Phillips Family Foundation. Through his background as an existing chief executive officer, as well as his other board service, Mr. Phillips brings, leadership, corporate governance and risk assessment skills to our Board.

Paul C. Reyelts Age: 64

Mr. Reyelts was elected a director of Winmark in May 2000 and serves as Lead Director. He served as the Executive Vice President of Finance and Chief Financial Officer of The Valspar Corporation, a global leader in the coatings industry, from April 1982 until February 2008. He remained an Executive Vice President of Valspar Corporation until his retirement in May 2009. In addition, Mr. Reyelts serves on the Board of Trustees of Minnesota Public Radio, the Advisory Board of the University of Minnesota College of Design and the Minneapolis Parks Foundation Board. As the former Chief Financial Officer of a NYSE-listed public company, Mr. Reyelts brings experience in financial and executive management, corporate governance and risk management to our Board. In addition, he has an extensive knowledge of the capital markets due to his prior experience that has proven useful to the Board.

Mark L. Wilson Age: 62

Mr. Wilson was elected a director of Winmark in May 2000. He currently serves as Of Counsel at the law firm of Henson & Efron, P.A. In 2006, Mr. Wilson served as President of Kettle River Company, LLC, a business consulting firm. From 1999 to 2006, he served as President of Weisman Enterprises, Inc. and its affiliates, a vending and small transaction management company . In addition, Mr. Wilson currently serves on the Board of Directors of the Minnesota Community Foundation as its Vice-Chairman, The St. Paul Foundation as its Vice-Chairman, Intergenerational Living and Health Care, Inc., GiveMN.org and Minnesota Real Estate Foundation. Mr. Wilson’s background in legal matters and executive management provides significant insight and expertise to our Board. He provides valuable guidance on the issues of corporate governance, risk management and general management.

Steven C. Zola Age: 49

Mr. Zola has served as the President of Winmark Capital Corporation since December 2005 and as a director of Winmark Corporation since February 2011. Mr. Zola also served as an advisor to Winmark from January 2005 to December 2005. From September 2002 until January 2007, Mr. Zola served in a number of positions, including President and Chief Executive Officer, of CrystalVoice Communications, Inc, a VoIP software company. From March 1990 to January 2002 he was employed by Winthrop Resources Corporation, a technology equipment leasing company, where he served as Senior Vice President of Sales and Marketing prior to his departure. Mr. Zola brings over twenty years of equipment leasing experience to our Board. In his current capacity as President of Winmark Capital Corporation, Mr. Zola provides an intimate knowledge of our leasing operations and provides the Board with insight into these activities.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview



As of December 25, 2010, we had 918 franchises operating under the Plato’s Closet, Play it Again Sports, Once Upon a Child, Music Go Round and Wirth Business Credit brands and had a leasing portfolio of $30.7 million. Management closely tracks the following financial criteria to evaluate current business operations and future prospects: royalties, leasing activity, and selling, general and administrative expenses.



Our most profitable source of franchising revenue is royalties received from our franchise partners. During 2010, our royalties increased $2,873,100 or 12.2% compared to 2009.



During 2010, we purchased $15.3 million in equipment for lease contracts compared to $15.5 million in 2009. Overall, our leasing portfolio (net investment in leases — current and long-term) decreased to $30.7 million at December 25, 2010 from $37.0 million at December 26, 2009. Leasing income in 2010 was $9.9 million compared to $9.5 million in the same period last year, an increase of 3.8%. (See Note 12 — “Segment Reporting”). Our earnings are also impacted by credit losses. During 2010, our provision for credit losses decreased to $0.2 million from $2.8 million in 2009, as we experienced a lower level of net write-offs and delinquencies, primarily in the small-ticket financing business portion of our leasing segment.



Management continually monitors the level and timing of selling, general and administrative expenses. The major components of selling, general and administrative expenses include salaries, wages and benefits, advertising, travel, occupancy, legal and professional fees. During 2010, selling, general and administrative expense decreased $521,400, or 2.7%, compared to the same period last year.

Renewal activity is a key focus area for management. Our franchisees sign 10-year agreements with us. The renewal of existing franchise agreements as they approach their expiration is an indicator that management monitors to determine the health of our business and the preservation of future royalties. In 2010, we renewed 100% of franchise agreements up for renewal. This percentage of renewal has ranged between 96% and 100% during the last three years.



Our ability to grow our profits is dependent on our ability to: (i) effectively support our franchise partners so that they produce higher revenues, (ii) open new franchises, (iii) increase lease originations and minimize write-offs in our leasing portfolios, and (iv) control our selling, general and administrative expenses. A detailed description of the risks to our business along with other risk factors can be found in Item 1A “Risk Factors”.

Revenue



Revenues for the year ended December 25, 2010 totaled $41.2 million compared to $37.3 million for the comparable period in 2009.



Royalties and Franchise Fees



Royalties increased to $26.5 million for 2010 from $23.6 million for the same period in 2009, a 12.2% increase. The increase was due to higher Plato’s Closet, Play It Again Sports and Once Upon A Child royalties of $1,645,000, $660,000 and $564,000, respectively. The increase in royalties for these brands is primarily due to higher franchisee retail sales in these brands as well as having 34 additional Plato’s Closet franchise stores in 2010 compared to the same period last year.

Franchise fees include initial franchise fees from the sale of new franchises and transfer fees related to the transfer of existing franchises. Franchise fee revenue is recognized when the franchise opens or when the franchise agreement is assigned to a buyer of a franchise. An overview of retail brand franchise fees is presented in the Franchising subsection of the Business section. Franchise fees increased to $1,366,400 for 2010 from $1,072,900 for 2009 primarily as a result of opening seven more franchises in 2010 compared to 2009 and an increase in the franchise fee for an initial store.



Leasing Income



Leasing income increased to $9,896,300 in 2010 compared to $9,536,900 for the same period in 2009, a 3.8% increase. The increase is due to an increase in leasing income from the middle-market equipment leasing business portion of our leasing segment, partially offset by a decrease in leasing income from the small-ticket financing business portion of our leasing segment.



Merchandise Sales



Merchandise sales include the sale of product to franchisees either through the Play It Again Sports buying group, or through our Computer Support Center (together, “Direct Franchisee Sales”). Direct Franchisee Sales decreased 1.8% to $2,344,800 in 2010 from $2,386,700 in 2009. This is a result of lower franchisee purchases through the Play It Again Sports buying group, partially offset by increased technology purchases by our franchisees.



Other Revenue



Other revenue includes marketing and software license fees received from franchisees as well as management fees received for management services that we provide Tomsten, Inc. (“Tomsten”). Other revenue increased to $1,106,800 for 2010 from $683,300 for 2009 due to the management fees received from Tomsten.



Cost of Merchandise Sold



Cost of merchandise sold includes in-bound freight and the cost of merchandise associated with Direct Franchisee Sales. Cost of merchandise sold decreased 2.6% to $2,231,100 in 2010 from $2,290,200 in 2009. The decrease was primarily due to a decrease in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for 2010 and 2009 was 95.2% and 96.0%, respectively.



Leasing Expense



Leasing expense decreased to $1,624,200 in 2010 compared to $2,288,200 in 2009. The decrease is primarily due to lower borrowing costs in connection with the lease portfolio.



Provision for Credit Losses



Provision for credit losses decreased to $189,000 in 2010 compared to $2,795,500 in 2009. The decrease is primarily due to a lower level of net write-offs and delinquencies, primarily in the small-ticket financing business portion of our leasing segment. During 2010, we had total net write-offs of $620,600 compared to $2,995,000 in 2009.



Selling, General and Administrative Expenses



The $521,400, or 2.7%, decrease in selling, general and administrative expenses in 2010 compared to the same period in 2009 is primarily due to a decrease in outside services.

Loss from Equity Investments



During 2010 and 2009, we recorded losses of $259,100 and $100,500, respectively, from our investment in Tomsten (representing our pro-rata share of losses for the periods). (See Item 1A “Risk Factors” as well as Note 3 — “Investments”).



Interest Expense



Interest expense decreased to $980,200 in 2010 compared to $1,309,000 in 2009. The decrease is primarily due to lower corporate borrowings.



Interest and Other Income



During 2010, we had interest and other income of $257,800 compared to $459,300 of interest and other income in 2009. The decrease is primarily due to a decrease in income from our marketable securities.



Income Taxes



The provision for income taxes was calculated at an effective rate of 41.2% and 40.5% for 2010 and 2009, respectively. The higher effective rate in 2010 compared to 2009 reflects our recording of a deferred tax asset valuation allowance for losses from our equity investments.

Franchising segment operating income



The franchising segment’s 2010 operating income increased by $3.2 million, or 26.5%, to $15.4 million from $12.2 million for 2009. The increase in segment contribution was primarily due to increased royalty and franchise fee revenues.



Leasing segment operating income (loss)



The leasing segment generated operating income of $3.1 million for 2010 compared to a loss of ($1.4 million) during 2009. This improvement was primarily due to a decrease in the provision for credit losses which resulted from a lower level of net write-offs and delinquencies in our leasing portfolio.



Liquidity and Capital Resources



Our primary sources of liquidity have historically been cash flow from operations and borrowings. The components of the consolidated statement of operations that affect our liquidity include non-cash items for depreciation, compensation expense related to stock options and loss from equity investments. The most significant component of the consolidated balance sheet that affects liquidity is investments. Investments include $4.0 million of illiquid investments in two private companies: Tomsten, Inc. and BridgeFunds LLC.



We ended 2010 with $2.3 million in cash and cash equivalents and a current ratio (current assets divided by current liabilities) of 1.2 to 1.0 compared to $9.5 million in cash and cash equivalents and a current ratio of 1.6 to 1.0 at the end of 2009.



Operating activities provided $12.4 million of cash during 2010 compared to $13.7 million during 2009. Cash provided by operating assets and liabilities include an increase in deferred and current income taxes of $0.8 million, primarily due to tax depreciation on lease equipment purchases. Cash utilized by operating assets and liabilities include a $0.5 million decrease in advance rents and security deposits due to a decrease in activity levels in our small-ticket financing business.



Investing activities provided $5.4 million of cash during 2010 compared to $2.4 million provided during 2009. The 2010 activities consisted primarily of the purchase of equipment for lease contracts of $15.3 million and collections on lease receivables of $20.0 million.



Financing activities used $25.0 million of cash during 2010 compared to $8.7 million used during 2009. The 2010 activities consisted primarily of net proceeds from exercises of stock options of $0.9 million, net payments of $21.2 million on our subordinated notes, net payments on our line of credit of $0.5 million, $4.0 million used to purchase 165,590 shares of our common stock and $0.3 million for the payment of dividends.



We have future operating lease commitments for our corporate headquarters. As of December 25, 2010, we had no other material outstanding commitments. See Note 11 to the consolidated financial statements.



As of December 25, 2010, we had no off balance sheet arrangements.

On July 13, 2010, we terminated our $40.0 million Amended and Restated Revolving Credit Agreement (the “Credit Facility”) with Bank of America, N.A. and the PrivateBank and Trust Company and entered into a new credit agreement with the PrivateBank and Trust Company (the “Line of Credit”). We repaid the borrowings under the Credit Facility on the termination date with existing cash balances and have completed our obligations under this agreement.



The Line of Credit, which provides for an aggregate commitment over its four year term of $30.0 million subject to certain borrowing base limitations, allows us to choose between three interest rate options in connection with our borrowings. The interest rate options are the Base Rate, LIBOR and Fixed Rate (all as defined within the Line of Credit) plus an applicable margin of 0.50%, 2.75% and 2.75%, respectively. Interest periods for LIBOR borrowings can be one, two or three months, and interest periods for Fixed Rate borrowings can be one, two, three or four years as selected by us. The Line of Credit also provides for non-utilization fees of 0.25% per annum on the daily average of the unused commitment.



As of December 25, 2010, our borrowing availability under the Line of Credit was $30.0 million (the lesser of the borrowing base or the aggregate commitment). There were $8.8 million in borrowings outstanding under the Line of Credit bearing interest ranging from 3.04% to 3.75%, leaving $21.2 million available for additional borrowings.



The Line of Credit was used to complete the redemption of the Renewable Unsecured Subordinated Notes (as indicated below) and has been and will continue to be used for general corporate purposes. The Line of Credit is secured by a lien against substantially all of our assets, contains customary financial conditions and covenants, and requires maintenance of minimum levels of debt service coverage and tangible net worth and maximum levels of leverage (all as defined within the Line of Credit). As of December 25, 2010, we were in compliance with all of our financial covenants.



On April 19, 2006, we announced the filing of a “shelf registration” on Form S-1 registration statement with the Securities and Exchange Commission for the sale of up to $50 million of Renewable Subordinated Unsecured Notes with maturities from three months to ten years. In June 2006, the Form S-1 registration became effective. Every year since the S-1 registration became effective, we have filed Post-Effective Amendments to keep the registration statement effective. On July 30, 2010, we redeemed all of our outstanding Renewable Unsecured Subordinated Notes and subsequently deregistered all securities pursuant to the registration. The redemption price equaled 100% of the principal amount, plus accrued and unpaid interest up to the redemption date. We borrowed $16.0 million on our Line of Credit to finance the redemption.



We may utilize discounted lease financing to provide funds for a portion of our leasing activities. Rates for discounted lease financing reflect prevailing market interest rates and the credit standing of the lessees for which the payment stream of the leases are discounted. We believe that discounted lease financing will continue to be available to us at competitive rates of interest through the relationships we have established with financial institutions.



We believe that the combination of our cash on hand, the cash generated from our franchising business, cash generated from discounting sources and our Line of Credit will be adequate to fund our planned operations, including leasing activity, through 2011.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview



As of September 24, 2011, we had 923 franchises operating under the Plato’s Closet, Play It Again Sports, Once Upon A Child and Music Go Round brands and had a leasing portfolio of $30.2 million. Management closely tracks the following financial criteria to evaluate current business operations and future prospects: royalties, leasing activity, and selling, general and administrative expenses.



Our most profitable source of franchising revenue is royalties received from our franchise partners. During the first nine months of 2011, our royalties increased $2.2 million or 10.9% compared to the first nine months of 2010.

During the first nine months of 2011, we purchased $15.6 million in equipment for lease customers compared to $12.6 million in the first nine months of 2010. Overall, our leasing portfolio (net investment in leases — current and long-term) decreased to $30.2 million at September 24, 2011 from $30.7 million at December 25, 2010. Leasing income net of leasing expense during the first nine months of 2011 was $8.4 million compared to $5.9 million in the same period last year. Fluctuations in period-to-period leasing income and leasing expense result primarily from the manner and timing in which leasing income and leasing expense is recognized over the term of each particular lease in accordance with accounting guidance applicable to leasing. For this reason, we believe that more meaningful levels of leasing activity are the purchases of equipment for lease customers and the medium- to long-term trend in the size of the leasing portfolio. Our earnings are also impacted by credit losses. During the first nine months of 2011, our provision for credit losses decreased to $8,200 from $142,400 in the first nine months of 2010.



Management continually monitors the level and timing of selling, general and administrative expenses. The major components of selling, general and administrative expenses include salaries, wages and benefits, advertising, travel, occupancy, legal and professional fees. During the first nine months of 2011, selling, general and administrative expense was comparable to the first nine months of 2010.

Revenue



Revenues for the quarter ended September 24, 2011 totaled $11.8 million compared to $11.0 million for the comparable period in 2010.



Royalties and Franchise Fees



Royalties increased to $8.0 million for the third quarter of 2011 from $7.0 million for the third quarter of 2010, a 14.5% increase. The increase was due to higher Plato’s Closet and Once Upon A Child royalties of $683,600 and $340,100, respectively. The increase in royalties for Plato’s Closet and Once Upon A Child is primarily due to higher franchisee retail sales in these brands as well as having 29 additional Plato’s Closet franchises in the third quarter of 2011 compared to the same period last year.

Franchise fees increased to $516,200 for the third quarter of 2011 compared to $357,100 for the third quarter of 2010, primarily as a result of opening eight more franchises in the 2011 period compared to the same period in 2010.



Leasing Income



Leasing income of $2.4 million for the third quarter of 2011 was comparable to $2.4 million for the same period in 2010.



Merchandise Sales



Merchandise sales include the sale of product to franchisees either through the Play It Again Sports buying group, or through our Computer Support Center (together, “Direct Franchisee Sales”). Direct Franchisee Sales decreased to $664,300 for the third quarter 2011 from $964,000 in the same period of 2010. The decrease is primarily due to a decrease in franchisee purchases through the buying group.



Cost of Merchandise Sold



Cost of merchandise sold includes in-bound freight and the cost of merchandise associated with Direct Franchisee Sales. Cost of merchandise sold decreased to $631,500 for the third quarter of 2011 from $920,600 in the same period of 2010. The decrease was primarily due to a decrease in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the third quarter of 2011 and 2010 was 95.1% and 95.5%, respectively.



Leasing Expense



Leasing expense decreased to $290,400 for the third quarter of 2011 compared to $387,600 for the third quarter of 2010. The decrease is due to lower borrowing costs in connection with the lease portfolio.



Provision for Credit Losses



Provision for credit losses was $(13,100) for the third quarter of 2011 compared to $130,500 for the third quarter of 2010. Provision levels for the periods presented were impacted by net recoveries/write-offs as well as a lower level of delinquencies, primarily in the small-ticket financing business portion of our leasing segment. During the third quarter of 2011, we had total net recoveries of $44,100 compared to total net write-offs of $277,800 in the third quarter of 2010.



Selling, General and Administrative



Selling, general and administrative expenses decreased 3.2% to $4.2 million in the third quarter of 2011 from $4.4 million in the same period of 2010. The decrease was primarily due to decreases in sales-related compensation expense and outside services.



Loss from Equity Investments



During the third quarter of 2011 and 2010, we recorded losses of $(224,700) and $(200,200), respectively, from our investment in Tomsten (representing our pro-rata share of losses for the periods).



Impairment of Investment in Notes



During the third quarter of 2011, we recorded a $293,200 impairment charge for our investment in BridgeFunds notes. (See Note 4 — “Investments”).

Interest Expense



Interest expense decreased to $26,200 for the third quarter of 2011 compared to $363,900 for the third quarter of 2010. The decrease is due to lower corporate borrowings.



Interest and Other Income (Expense)



During the third quarter of 2011, we had interest and other income (expense) of $(9,000) compared to $96,100 of interest and other income in the third quarter of 2010. Interest and other income during the third quarter of 2010 included interest accrued on the Company’s investment in BridgeFunds and realized gains on sales of marketable securities that did not recur during the third quarter of 2011. (See Note 4 — “Investments”).



Income Taxes



The provision for income taxes was calculated at an effective rate of 42.8% and 43.3% for the third quarter of 2011 and 2010, respectively.



Comparison of Nine Months Ended September 24, 2011 to Nine Months Ended September 25, 2010



Revenue



Revenues for the first nine months of 2011 totaled $38.1 million compared to $30.7 million for the comparable period in 2010.



Royalties and Franchise Fees



Royalties increased to $21.9 million for the first nine months of 2011 from $19.8 million for the first nine months of 2010, a 10.9% increase. The increase was due to higher Plato’s Closet and Once Upon A Child royalties of $1,538,600 and $658,500, respectively. The increase in royalties for these brands is primarily due to higher franchisee retail sales in these brands as well as having 29 additional Plato’s Closet franchises in the first nine months of 2011 compared to the same period last year.



Franchise fees decreased to $836,200 for the first nine months of 2011 compared to $885,600 for the first nine months of 2010, primarily as a result of opening four fewer franchises in the 2011 period compared to the same period in 2010.



Leasing Income



Leasing income increased to $12.6 million for the first nine months of 2011 compared to $7.3 million in the same period in 2010. The increase is due to a higher level of equipment sales to customers.



Merchandise Sales



Merchandise sales include the sale of product to franchisees either through the Play It Again Sports buying group, or through our Computer Support Center (together, “Direct Franchisee Sales”). Direct Franchisee Sales of $2.0 million for the first nine months of 2011 was comparable to $2.0 million for the same period last year .

Cost of Merchandise Sold



Cost of merchandise sold includes in-bound freight and the cost of merchandise associated with Direct Franchisee Sales. Cost of merchandise sold of $1.9 million for the first nine months of 2011 was comparable to $1.9 million for the same period last year. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the first nine months of 2011 and 2010 was 95.5% and 95.2%, respectively.



Leasing Expense



Leasing expense increased to $4.1 million for the first nine months of 2011 compared to $1.4 million for the first nine months of 2010. The increase is primarily due to an increase in the associated cost of equipment sales to customers discussed above.



Provision for Credit Losses



Provision for credit losses was $8,200 for the first nine months of 2011 compared to $142,400 for the first nine months of 2010. Provision levels for the periods presented were impacted by net write-offs as well as a lower level of delinquencies, primarily in the small-ticket financing business portion of our leasing segment. During the first nine months of 2011, we had total net write-offs of $39,600 compared to $482,700 in the first nine months of 2010.



Selling, General and Administrative



Selling, general and administrative expense of $14.1 million in the first nine months of 2011 was comparable to $14.1 million in the first nine months of 2010.



Loss from Equity Investments



During the first nine months of 2011 and 2010, we recorded losses of $(444,600) and $(322,400), respectively, from our investment in Tomsten (representing our pro-rata share of losses for the periods).



Impairment of Investment in Notes



During the first nine months of 2011, we recorded $546,100 in impairments charge for our investment in BridgeFunds notes. (See Note 4 — “Investments”).



Interest Expense



Interest expense decreased to $84,200 for the first nine months of 2011 compared to $925,200 for the first nine months of 2010. The decrease is due to lower corporate borrowings.



Interest and Other Income



During the first nine months of 2011, we had interest and other income of $22,100 compared to $376,800 of interest and other income in the first nine months of 2010. Interest and other income during the first nine months of 2010 included interest accrued on the Company’s investment in BridgeFunds and realized gains on sales of marketable securities that did not recur during the first nine months of 2011. (See Note 4 — “Investments”).

Income Taxes



The provision for income taxes was calculated at an effective rate of 41.3% and 41.6% for the first nine months of 2011 and 2010, respectively.



Segment Comparison of Three Months Ended September 24, 2011 to Three Months Ended September 25, 2010



Franchising Segment Operating Income



The franchising segment’s operating income for the third quarter of 2011 increased by $1.1 million, or 25.6%, to $5.6 million from $4.5 million for the third quarter of 2010. The increase in segment contribution was primarily due to increased royalty revenue.



Leasing Segment Operating Income



The leasing segment’s operating income for the third quarter of 2011 increased to $1,008,300 from $719,300 for the third quarter of 2010. The increase in segment contribution was primarily due to a decrease in provision for credit losses and a decrease in selling, general and administrative expenses.



Segment Comparison of Nine Months Ended September 24, 2011 to Nine Months Ended September 25, 2010



Franchising Segment Operating Income



The franchising segment’s operating income for the first nine months of 2011 increased by $1.8 million, or 16.2%, to $13.1 million from $11.3 million for the first nine months of 2010. The increase in segment contribution was primarily due to increased royalty revenue.



Leasing Segment Operating Income



The leasing segment’s operating income for the first nine months of 2011 increased to $4.9 million from $1.9 million during the first nine months of 2010. The increase in segment contribution was primarily due to an increase in leasing income net of leasing expense.



Liquidity and Capital Resources



Our primary sources of liquidity have historically been cash flow from operations and borrowings. The components of the consolidated statement of operations that affect our liquidity include non-cash items for depreciation, compensation expense related to stock options and loss from equity investments. The most significant component of the consolidated balance sheet that affects liquidity is investments. Investments include $4.2 million of illiquid investments in two private companies: Tomsten, Inc. and BridgeFunds, LLC (see Note 4 — “Investments”).



We ended the third quarter of 2011 with $3.9 million in cash and cash equivalents and a current ratio (current assets divided by current liabilities) of 2.1 to 1.0 compared to $2.2 million in cash and cash equivalents and a current ratio of 1.1 to 1.0 at the end of the third quarter of 2010.



Operating activities provided $15.4 million of cash during the first nine months of 2011 compared to $7.8 million during the same period last year. Cash provided by operating assets and liabilities include an increase in income taxes payable of $2.6 million, primarily due to tax depreciation on lease equipment purchases.

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