Winmark Corp. CEO JOHN L MORGAN bought 21000 shares on10-10-2008 at $15.93
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 customersā used goods that have been outgrown or are no longer used. The retail brands also offer new merchandise to customers. We also franchise a concept that provides leasing and financing services to small businesses.
We also 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 generally cost of more than $250,000. The businesses we target generally have annual revenue of $25,000,000 or more. 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. (formerly known as Winmark Business Solutions, Inc.). Our small-ticket financing business serves small businesses and focuses on assets which generally have a cost of $5,000 to $250,000. We primarily generate financing business through our Wirth Business CreditĀ® franchisees.
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 $2.0 million, $1.8 million and $1.7 million for 2007, 2006 and 2005, respectively. For additional financial information, please see Item 6 ā Selected Financial Data and Item 8 ā Financial Statements and Supplementary Data. We were incorporated in Minnesota in 1988.
Our four retail brands with their fiscal year 2007 system-wide sales, defined as estimated revenues generated by all franchise owned locations, are summarized as follows:
Play It Again Sports Ā® - $250 million.
We began franchising the Play It Again SportsĀ® brand in 1988. Play It Again SportsĀ® 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 SportsĀ® is known for providing the highest value to the customer by offering a mix of used and new sporting goods. For the years ended 2007, 2006 and 2005, Play It Again SportsĀ® contributed royalties and franchise fees of $10.4 million, $10.4 million and $10.2 million, respectively. As a percentage of consolidated revenues for 2007, 2006 and 2005, these amounts equaled 33.3%, 38.1% and 38.4%, respectively.
Once Upon A Child Ā® - $125 million.
We began franchising the Once Upon A ChildĀ® brand in 1993. Once Upon A ChildĀ® franchises sell and buy used and new childrenās 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 childrenās items to a Once Upon A ChildĀ® franchise when outgrown and to purchase quality used childrenās clothing, toys, furniture and equipment at prices lower than new merchandise. New merchandise is offered to supplement the used merchandise. For the years ended 2007, 2006 and 2005, Once Upon A ChildĀ® contributed royalties and franchise fees of $5.4 million, $4.9 million and $4.3 million, respectively. As a percentage of consolidated revenues for 2007, 2006 and 2005, these amounts equaled 17.3%, 17.7% and 16.2%, respectively.
Platoās Closet Ā® - $126 million.
We began franchising the Platoās ClosetĀ® brand in 1999. Platoās ClosetĀ® 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 Platoās ClosetĀ® franchise when gently-used or outgrown and to purchase quality used clothing and accessories at prices lower than new merchandise. For the years ended 2007, 2006 and 2005, Platoās ClosetĀ® contributed royalties and franchise fees of $5.4 million, $4.2 million and $3.5 million, respectively. As a percentage of consolidated revenues for 2007, 2006 and 2005, these amounts equaled 17.2%, 15.2% and 13.3%, respectively.
Music Go Round Ā® - $25 million.
We began franchising the Music Go RoundĀ® brand in 1994. Music Go RoundĀ® 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 2007, 2006 and 2005, Music Go RoundĀ® contributed royalties and franchise fees of $0.8 million, $0.8 million and $0.9 million, respectively. As a percentage of consolidated revenues for 2007, 2006 and 2005, these amounts equaled 2.4%, 2.8% and 3.3%, respectively.
Wirth Business CreditĀ®
We began franchising the Wirth Business CreditĀ® business in 2006. The Wirth Business CreditĀ® brand franchises leasing and financing services businesses that provide franchisees an array of small-ticket equipment leasing and financing options funded through Winmark or its affiliates to offer to customers for business essential equipment and assets. Wirth Business CreditĀ® franchisees are paid a transaction fee for each leasing or financing transaction funded through Winmark or its affiliates, and as such Winmark Corporation does not receive royalties from Wirth Business CreditĀ® franchisees.
Retail Brands Franchising Overview
We use franchising as a business method of distributing goods and services through our retail brands to consumers. We also use franchising as a method to originate small-ticket leasing transactions with our Wirth Business CreditĀ® franchises. We discuss our Wirth Business CreditĀ® franchise system in the Wirth Business CreditĀ® Franchise System Subsection of this Business Section. 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:
ā¢ franchising the rights to operate retail stores offering value-oriented merchandise;
ā¢ attracting new, qualified franchisees; and
ā¢ providing initial and continuing support to franchisees.
We have and we intend to reinvest operating cash flow generated from our business into:
ā¢ supporting the current franchise systems;
ā¢ making investments in infrastructure to support our corporate needs;
ā¢ supporting Wirth Business Credit, Inc. and Winmark Capital Corporation; and
ā¢ 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. We 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.
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:
ā¢ have a sufficient net worth,
ā¢ have prior business experience, and
ā¢ intend to be integrally involved with the management of the business.
At December 29, 2007, we had 53 signed retail franchise agreements that are expected to open in 2008.
We began franchising in Canada in 1991 and, as of December 29, 2007, had 63 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.
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.
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.
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 ā as i s ā basis. We have developed specialized computer point-of-sale systems for Once Upon A ChildĀ® and Platoās ClosetĀ® stores that provide the franchisee with standardized pricing information to assist in the purchasing of used items. Play It Again SportsĀ®, Once Upon A ChildĀ® and Music Go RoundĀ® also use buying guides and the point-of-sale system to assist franchisees in pricing used items.
We provide centralized buying services including credit and billing for the Play It Again SportsĀ® franchisees. Upon credit approval, Play It Again SportsĀ® 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 SportsĀ® franchise system uses several major vendors including Keys Fitness, Horizon Fitness, Nautilus, Easton Sporting Goods, The Hockey Company and Nike Bauer Hockey. The loss of any of the above vendors would change the vendor mix, but not significantly change our products offered.
To provide the franchisees of our Once Upon A ChildĀ® and Music Go RoundĀ® 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 ChildĀ® franchised store purchases approximately 30% of its new product from Graco, Million Dollar Baby and Dorel Juvenile Group. While we believe that there are several other vendors that could adequately replace the loss of any of these three major vendors, it would alter the selection of product offered.
There are no significant vendors to our typical Platoās ClosetĀ® franchised store.
Retail Advertising and Marketing
We encourage our franchisees to implement a marketing program that includes one or more of the following: television, radio, direct mail, point-of-purchase materials, in store signage and local store marketing programs. Through these mediums, we advertise that we buy, sell and trade used and new items. Franchisees of the respective retail brands are required to spend the following minimum percentage of their gross sales on approved advertising and marketing: Play It Again SportsĀ® - 5%, Once Upon A ChildĀ® - 5%, Platoās ClosetĀ® - 5% and Music Go RoundĀ® - 3%. Beginning in March 2008, the percentage for new and renewing Music Go RoundĀ® stores will increase to 5%. In addition, Play It Again SportsĀ®, Once Upon A ChildĀ®, Platoās ClosetĀ® and Music Go RoundĀ® are required to pay us an annual marketing fee. Franchisees may be required to participate in regional cooperative advertising groups.
Computerized Point-Of-Sale Systems
We require our retail brand franchisees to use a retail information management computer system in each store, which has evolved with the development of new technology. This computerized point-of-sale system is designed specifically for use in our franchise retail stores. The current system includes our proprietary Data Recycling System software, a dedicated server, two or more work station registers, a receipt printer, a report printer and a bar code scanner, together with software modules for inventory management, cash management and customer information management. We require franchisees to purchase their computer hardware from us. We charge a fee of approximately 4% for handling and configuration of systems sold through us. The Data Recycling System software is designed to accommodate buying and consigning of used merchandise. This system provides franchisees with an important management tool that reduces errors, increases efficiencies and enhances inventory control. We provide both computer software and hardware support for the system through our Computer Support Center located at our Company headquarters.
Winmark Business Solutions
We established Winmark Business Solutions to provide business support services to franchisees and other small businesses. We provide a web site that:
ā¢ aggregates the purchasing power of small businesses, including our franchisees, which allows us to more effectively negotiate arrangements for products and services critical to most small businesses;
ā¢ provides an easy point of contact between vendors and small businesses;
ā¢ provides small business owners information and tools that will help them be successful at every stage of their small business;
ā¢ provides equipment leasing options for small businesses; and
ā¢ provides advertising and promotional opportunities for small businesses.
We have established preferred provider relationships with high quality vendors that provide small businesses a host of critical services. Included in the array of services available through the web site are accounting, tax and payroll services, copying and printing services, purchase of office supplies, credit card processing, loss prevention, business insurance, computer/POS equipment, and more. A small business becomes a member of Winmark Business Solutions by registration, which is free.
Other Support Services
We assist each new franchisee with retail store site location by providing demographic data and general site selection information. Third party vendors provide design layouts and opening materials including pricing materials, stationary, signage, fixtures, slat wall and carpeting. Additional communication with retail brand franchisees is made through periodic updates, emails, broadcast faxes, extranet and semi-annual or annual conferences which generally include trade shows.
The Retail Franchise Agreement
We enter into franchise agreements with our franchisees. The following is a summary of certain key provisions of our current standard retail brand franchise agreement. Except as noted, the franchise agreements used for each of our retail brands are generally the same. The Franchise Agreement signed by Wirth Business CreditĀ® franchisees is described in the Wirth Business CreditĀ® Franchise System subsection of this Business Section.
Each franchisee must execute our franchise agreement and pay an initial franchise fee. At December 29, 2007, the franchise fee for all brands was $20,000 for an initial store in the U.S. and $23,300CAD for an initial store in Canada. Once a franchisee opens its initial store, it can open additional stores, in any brand, by paying a $15,000 franchise fee for a store in the U.S. and $17,500CAD for a store in Canada, provided an acceptable territory is available and the franchisee meets the brandās additional store standards. The franchise fees for our initial retail store and additional retail store in Canada is based upon the exchange rate applied to the United States fee on the last business day of the preceding fiscal year. The franchise fee in 2008 for an initial retail store will be $20,000CAD, and an additional retail store $15,000CAD. Typically, the franchiseeās initial store is open for business within 270 days from the date the franchise agreement is signed. The franchise agreement has an initial term of 10 years, with subsequent 10-year renewal periods, and grants the franchisee an exclusive geographic area, which will vary in size depending upon population, demographics and other factors. A renewal fee equal to $5,000 is payable to us as part of any franchise renewal. As an incentive, we generally refund the renewal fee if a franchisee modernizes its store to meet our standards. Under current franchise agreements, franchisees of the respective brands are required to pay us weekly continuing fees (royalties) equal to the percentage of gross sales outlined in their Franchise Agreements, generally ranging from 4% to 5% for Play It Again SportsĀ® and Once Upon A ChildĀ® and 3% for Music Go RoundĀ®. Beginning in March 2008, the royalty rate for new Platoās Closet franchisees will increase from 4% to 5%, and beginning in March 2009 the royalty rate for additional Platoās ClosetĀ® stores for all franchisees will increase from 4% to 5%. Also beginning in March 2009, the royalty rate for Play It Again SportsĀ® franchisees opening their second or additional store will increase from 4% to 5%.
Each franchisee is required to pay us an annual marketing fee of $500 ($1,000 for each new Platoās ClosetĀ® franchisee). Beginning in March 2008, Play It Again SportsĀ®, Once Upon A ChildĀ® and Music Go RoundĀ® marketing fees for new and renewing stores will increase to $1,000. Each Play It Again SportsĀ® and Once Upon A ChildĀ® franchisee is required to spend 5% of its gross sales for advertising and promoting its franchised store. We have the option to increase the minimum advertising expenditure requirement for these franchises to 6% of the franchiseeās gross sales, of which up to 2% would be paid to us as an advertising fee for deposit in an advertising fund. This fund, if initiated, would be managed by us and would be used for advertising and promotion of the franchise system. Beginning in March 2008, new and renewing Music Go RoundĀ® franchisees will have the same advertising and promoting requirements as Play It Again SportsĀ® and Once Upon A ChildĀ® franchisees. In 2007, Platoās ClosetĀ® adopted the advertising and promotional requirements of Play It Again SportsĀ® and Once Upon A ChildĀ® for new and renewing franchisees. Existing Music Go RoundĀ® franchisees are currently required to spend 3% of their gross sales for advertising and promoting their franchised stores, and Winmark has the option to increase the minimum advertising expenditure requirement for these franchisees to 4% of the franchiseeās gross sales, 1 Ā½% of which would be paid to us as an advertising fee for deposit in an advertising fund. Existing Platoās ClosetĀ® franchisees prior to 2007 are required to spend at least 4% of gross sales for approved advertising, and Winmark has the same option to increase minimum advertising expenditures to 6% of the franchiseeās gross sales described above.
During the term of a franchise agreement, franchisees agree not to operate directly or indirectly any competitive business. In addition, franchisees agree that after the end of the term or termination of the franchise agreement, franchisees will not operate any competitive business for a period of one year and within a reasonable geographic area. We will pursue enforcement of our noncompetition clause vigorously; however, these noncompetition clauses are not enforceable in certain states or in all circumstances.
Although our franchise agreements contain provisions designed to assure the quality of a franchiseeās operations, we have less control over a franchiseeās operations than we would if we owned and operated a retail store. Under the franchise agreement, we have a right of first refusal on the sale of any franchised store, but we are not obligated to repurchase any franchise.
Renewal of the Franchise Relationship
At the end of the 10-year term of each franchise agreement, each franchisee has the option to ārenewā the franchise relationship by signing a new 10-year franchise agreement. If a franchisee chooses not to sign a new franchise agreement, a franchisee must comply with all post termination obligations including the franchiseeās noncompetition clause discussed above. This noncompetition clause may not be enforceable in certain states or in all circumstances. We may choose not to renew the franchise relationship only when permitted by the franchise agreement and applicable state law.
In 2007, 20 Play It Again SportsĀ® franchise agreements expired. Of those franchise relationships, 20 were ārenewedā with the signing of a new 10-year franchise agreement. In 2008, 2009 and 2010, 9, 15 and 29 Play It Again SportsĀ® franchise agreements will expire, respectively.
In 2007, 13 Once Upon A ChildĀ® franchise agreements expired. Of those franchise relationships, 13 were ārenewedā with the signing of a new 10-year franchise agreement. In 2008, 2009 and 2010, 8, 24 and 22 Once Upon A ChildĀ® franchise agreements will expire, respectively.
In 2007, 7 Music Go RoundĀ® franchise agreements expired. Of those franchise agreements, 7 were ārenewedā with the signing of a new 10-year franchise agreement. In 2008, 2009 and 2010, 4, 4, and 1 Music Go RoundĀ® franchise agreements will expire, respectively.
None of our Platoās ClosetĀ® franchise agreements will expire in 2008. In 2009 and 2010, 11 and 22 Platoās ClosetĀ® franchise agreements will expire, respectively.
None of our Wirth Business CreditĀ® franchise agreements will expire in 2008, 2009 or 2010.
We believe that renewing a significant number of these franchise relationships is important to the success of the Company.
Retail Franchising Competition
Retailing, including the sale of sporting goods, childrenās and teenage apparel, and musical instruments, is highly competitive. Many retailers have substantially greater financial and other resources than we do. Our franchisees compete with established, locally owned retail stores, discount chains and traditional retail stores for sales of new merchandise. Full line retailers generally carry little or no used merchandise. Resale, thrift and consignment shops and garage and rummage sales offer some competition to our franchisees for the sale of used merchandise. Also, our franchisees increasingly compete with online used and new goods retailers such as eBay, Harmony Central and many others. We are aware of, and compete with, one franchisor of stores which sells new and used sporting equipment, two franchisors of stores which sell used and new childrenās clothing, toys and accessories and one franchisor of teen apparel stores.
Our Play It Again SportsĀ® franchisees compete with large retailers such as Dickās Sporting Goods, The Sports AuthorityĀ® as well as regional and local sporting goods stores. We also compete with TargetĀ® and Wal-MartĀ® .
Our Once Upon A ChildĀ® franchisees compete primarily with large retailers such as Babies āRā UsĀ®, Wal-MartĀ®, TargetĀ® Stores and various specialty childrenās retail stores such as GapĀ® Kids. We compete with one other franchisor in the specialty childrenās retail market.
Our Platoās ClosetĀ® franchise stores primarily compete with specialty apparel stores such as GapĀ®, Abercrombie & FitchĀ®, Old NavyĀ®, Banana RepublicĀ® and The LimitedĀ®. We compete with one other franchisor in the teenage clothing retail market.
Our Music Go RoundĀ® franchise stores compete with large musical instrument retailers such as Guitar CenterĀ® and Sam Ash MusicĀ®. We do not believe we compete with any other franchisor directly in the used and new musical instrument market.
Our retail franchises may face additional competition in the future. This could include additional competitors that may enter the used merchandise market. We believe that our franchisees will continue to be able to compete with other retailers based on the strength of our value-oriented brands and the name recognition associated with our service marks.
We also face competition in connection with the sale of franchises. Our prospective franchisees frequently evaluate other franchise opportunities before purchasing a franchise from us. We compete with other franchise companies for franchisees based on the following factors, among others: amount of initial investment, franchise fee, royalty rate, profitability, franchisor services and industry. We believe that our franchise brands are competitive with other franchises based on the fees we charge, our franchise support services and the performance of our existing franchise brands.
Wirth Business CreditĀ® Franchise System
We franchise the right to operate a small business equipment leasing and finance business under the brand Wirth Business CreditĀ®. Franchisees in the Wirth Business CreditĀ® franchise system market and sell small business equipment leasing and financing services offered by us.
Our franchise marketing program for Wirth Business CreditĀ® seeks to attract prospective franchisees with a desire to operate their own sales and marketing business who:
ā¢ have a sufficient net worth;
ā¢ have prior sales or small business experience; and
ā¢ intend to be integrally involved in the operation of the franchise.
As a franchisor of Wirth Business CreditĀ®, our lease originations volume depends heavily on our ability to support competitive and successful Wirth Business CreditĀ® franchisees. We emphasize the following areas of franchise support and assistance in our Wirth Business CreditĀ® franchise system:
ā¢ Marketing; and
ā¢ Ongoing Support.
Each franchisee, along with any hired salespersons, must attend our training program prior to commencing operations. Soon after signing the franchise agreement, a Wirth Business CreditĀ® franchisee is required to participate in our training program. We begin with pre-training. At pre-training, we cover, among other topics, sales basics, owning your own business and valuation. Our franchisees next come to our headquarters for a week-long training session. This week-long training session covers the basics of leasing, market orientation, lead generation, selling to vendors, owning your own business, business planning, credit basics, marketing, computer and software training and the nature of our franchise relationship.
After the initial week of training, we continue to support our Wirth Business CreditĀ® franchisees. We provide sales support to our franchisees through our territory managers in Minneapolis. Franchisees have the ability to regularly interact with our territory managers. Our territory managers provide the opportunity to each franchisee to work together on monthly sales planning and analysis. In addition, we deliver new tools and programs to our franchisees periodically.
We have an annual conference for our franchise system. At the conference, our franchisees have the opportunity to learn from each other and from us new information about how to operate more effectively.
John L. Morgan
Mr. Morgan was elected Chairman of the Board and Chief Executive Officer of Winmark in March 2000. 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.
William D. Dunlap
Mr. Dunlap was elected a director of Winmark in May 2000. He has served as the Chairman of Petters Media and Marketing Group since January 2007. He served as Chairman of Campbell Mithun, LLC from May 1995 to June 2003, and served as its Chairman and Chief Executive Officer from 1982 through 1995.
Jenele C. Grassle
Ms. Grassle was elected a director of Winmark in January 2001. She has served as the Vice President/General Merchandise Manager at Value Vision Media, Inc. since July 2007. From July 2006 to July 2007, Ms. Grassle served as Vice President, Jewelry for ValueVision Media, Inc. From March 2005 to July 2006, Ms. Grassle served as Divisional Merchandise Manager, Ready-to-Wear, Accessories and Cosmetics for ValueVision Media, Inc. From July 2000 to June 2004, Ms. Grassle served as the Vice President/General Merchandise Manager of Merchandising at Wilsons Leather, a leading specialty retailer of menās and womenās leather apparel and accessories. From September 1988 to March 2000, Ms. Grassle served as Divisional Merchandise Manager for the Target Corporation.
Kirk A. MacKenzie
Mr. MacKenzie was elected Vice Chairman and a director of Winmark in May 2000. In addition, he is currently a private investor and serves as a member of Rush River Group, LLC. From January 1982 to March 1999, Mr. MacKenzie was Executive Vice President of Winthrop Resources Corporation, a business equipment leasing company.
Dean B. Phillips
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 ā the marketer of Belvedere and Chopin luxury vodkas. Mr. Phillips is Vice-Chairman of the Board of Directors of Allina Health System, serving as Chair of its Investment and Philanthropy Committees, a member of the Advisory Board of the Center for the Study of Politics and Governance at the University of Minnesotaās Humphrey Institute and a Trustee of The Jay & Rose Phillips Family Foundation.
Paul C. Reyelts
Mr. Reyelts was elected a director of Winmark in May 2000. 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. In February 2008, Mr. Reyelts stepped down as Chief Financial Officer of Valspar and announced his intention to retire as an officer of Valspar at the end of 2009. Mr. Reyelts remains a member of Valsparās executive committee. In addition, Mr. Reyelts serves on the Board of Trustees of Minnesota Public Radio.
Mark L. Wilson
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. From November 1974 to December 1998, he was a corporate law, business planning and mergers and acquisitions attorney. In addition, Mr. Wilson currently serves on the Board of Directors of the Minnesota Community Foundation and The St. Paul Foundation and as the chairman of the Board of Directors of the Minnesota Center for Photography.
MANAGEMENT DISCUSSION FROM LATEST 10K
As of December 29, 2007, we had 892 franchises operating under the following brands: Play it Again SportsĀ®, Once Upon a ChildĀ®, Platoās ClosetĀ®, Music Go RoundĀ® and Wirth Business CreditĀ®. Management tracks closely the following criteria to evaluate current business operations and future prospects: royalties, franchise fees, leasing activity, selling, general and administrative expenses, franchise openings and closings and franchise renewals.
Our most profitable sources of franchising revenue are royalties earned from our franchise partners and franchise fees for new openings and transfers.
During 2007, our royalties increased $1,234,700 or 6.4% compared to 2006. Franchise fees increased $478,400 or 38.4% compared to last year and primarily reflect consistent new openings in established brands and the addition of the new Wirth Business CreditĀ® franchise system. During 2007, revenue generated from the Companyās leasing activities was $4,416,200 compared to $1,852,700 in the same period last year. (See Note 13 ā āSegment Reporting.ā) The Companyās leasing portfolio was $41.9 million at December 29, 2007. (Net investment in leases ā current plus net investment in leases ā long-term.)
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 2007, the Company renewed 100% of franchise agreements up for renewal. This percentage of renewal has ranged between 93% and 100% during the last three years.
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.
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 āRisk Factorsā.
Results of Operations
Royalties and Franchise Fees
Revenues for the year ended December 29, 2007 totaled $31.2 million compared to $27.4 million for the comparable period in 2006
Royalties increased to $20.4 million for 2007 from $19.2 million for the same period in 2006, a 6.4% increase. The increase was due to higher Platoās ClosetĀ® and Once Upon A ChildĀ® royalties of $1,039,600 and $349,100, respectively. The increase in Platoās ClosetĀ® and Once Upon A ChildĀ® royalties is primarily due to having 30 additional Platoās ClosetĀ® and 14 additional Once Upon A ChildĀ® franchise stores in 2007 compared to the same period last year and higher franchisee retail sales in both brands.
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. Franchisees of the retail brands are required to pay an initial franchise fee of $20,000 for each initial franchise ($23,300CAD in Canada) and $15,000 for each additional franchise ($17,500CAD in Canada). The franchise fees for Wirth Business CreditĀ® are $35,000, but are reduced by the Pioneer Program as described in the Franchising subsection of the Business Section. Franchise fees increased to $1,724,100 for 2007 compared to $1,245,700 for 2006. Eighty-three franchise territories were opened in 2007 compared to 70 franchise territories opened during 2006.
Leasing income increased to $4,416,200 in 2007 compared to $1,852,700 for the same period in 2006. The increase is due to a larger lease portfolio in 2007 compared to 2006.
Direct Franchisee Sales revenues decreased $469,800, or 10.5%, for the year ended December 29, 2007 compared to the same period last year. This is a result of managementās strategic decision to have more franchisees purchase merchandise directly from vendors and having 14 fewer Play It Again SportsĀ® stores open than one year ago.
Cost of Merchandise Sold
Cost of merchandise sold decreased $446,100 or 10.4% in 2007 compared to the same period last year. The decrease was primarily due to a decrease in Direct Franchisee Sales discussed in the revenue section.
Leasing expense increased to $1,031,000 in 2007 compared to $227,100 in 2006. The increase is due to interest on increased borrowing in connection with the growth of the Companyās lease portfolio.
Selling, General and Administrative Expenses
The $2,109,500, or 12.3%, increase in selling, general and administrative expenses in 2007 compared to the same period in 2006 is primarily due to increases in salaries, outside services, amortization of initial direct costs and development advertising of $845,000, $369,000, $297,000 and $144,000, respectively. The increase in salaries includes $619,200 of additional expenses related to the departure of leasing sales staff.
Gain (Loss) from Equity Investments
During 2007, the Company recorded a loss of $359,600 from our investment in Tomsten. During 2006, the Company sold its investment in eFrame, LLC (āeFrameā) resulting in a gain of $250,000 and recorded a loss of $133,400 from our investment in Tomsten. This represents our pro rata share of Tomsten losses for the periods. See the section in this Form 10-K entitled āRisk Factorsā. (See Note 3.)
Interest expense increased to $1,456,800 in 2007 compared to $728,700 in 2006. The increase is due to interest on borrowings on the line of credit and renewable subordinated notes.
Interest and Other Income
During 2007, the Company had interest and other income of $539,100 compared to $867,300 of interest and other income in 2006. The decrease is primarily due to the $360,000 transaction fee recognized in 2006 on the Commercial Credit Group redemption and investment agreement. (See Note 3.)
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations
Comparison of Three Months Ended June 28, 2008 to Three Months Ended June 30, 2007
Revenue for the quarter ended June 28, 2008 totaled $8.7 million compared to $7.6 million for the comparable period in 2007.
Royalties increased to $5.3 million for the second quarter of 2008 from $4.8 million for the same period in 2007, a 9.4% increase. The increase was due to higher Platoās ClosetĀ® and Once Upon A ChildĀ® royalties of $301,000 and $120,000, respectively. The increase in Platoās ClosetĀ® and Once Upon A ChildĀ® royalties is primarily due to having 27 additional Platoās ClosetĀ® and 11 additional Once Upon A ChildĀ® franchise stores in the second quarter of 2008 compared to the same period last year and higher franchisee retail sales in both brands.
Merchandise sales include the sale of product to franchisees either through the Play It Again SportsĀ® buying group, or through our Computer Support Center (āDirect Franchisee Salesā).
Direct Franchisee Sales revenues decreased $218,600, or 18.3%, for the six months ended June 28, 2008 compared to the same period last year. This is a result of managementās strategic decision to have more franchisees purchase merchandise directly from vendors and having 21 fewer Play It Again SportsĀ® stores open than one year ago.
Franchise fees decreased to $386,100 for the second quarter of 2008 compared to $417,400 for the second quarter of 2007. The decrease is due to opening 16 franchises in the second quarter of 2008, compared to 21 in the same period of 2007.
Leasing income increased to $1,907,000 for the second quarter of 2008 compared to $995,800 for the same period in 2007. The increase is due to a larger lease portfolio in 2008 compared to 2007.
Cost of Merchandise Sold
Cost of merchandise sold decreased $207,300 or 18.1% for the second quarter of 2008 compared to the same period last year. The decrease was primarily due to a decrease in Direct Franchisee Sales discussed in the revenue section.
Cost of merchandise sold includes in-bound freight and the cost of merchandise sold to franchisees either through the Play It Again SportsĀ® buying group, or through our Computer Support Center (āDirect Franchisee Salesā).
Leasing expense increased to $463,100 in the second quarter of 2008 compared to $197,400 in the second quarter of 2007. The increase is due to interest on increased borrowings in connection with the growth of our lease portfolio.
Provision for Credit Losses
Provision for credit losses increased to $269,200 in the second quarter of 2008 compared to $165,300 in the second quarter of 2007. The increase is due to a higher level of net charge-offs and originations in the leasing segment.
Selling, General and Administrative
The $214,900, or 4.4%, increase in selling, general and administrative expenses in the second three months of 2008 compared to the same period in 2007 is primarily due to increases in bank charges, stock option expenses and amortization of initial direct costs of $125,000, $118,000 and $125,000, respectively, partially offset by a $127,000 decrease in development advertising.
Loss from Equity Investments
During the second quarter of 2008 and 2007, we recorded losses of $60,700 and $197,400, respectively, from our investment in Tomsten. This represents our pro rata share of losses for the period. As of June 28, 2008, the Company owns 18.3% of the outstanding common stock of Tomsten.
Interest expense decreased to $340,200 in the second quarter of 2008 compared to $387,600 in the second quarter of 2007. The decrease is due to lower interest rates and $1.3 million net repayment on the line of credit since year end.
Interest and Other Income
During the second quarter of 2008, the Company had interest and other income of $59,000 compared to $171,400 of interest and other income in the second quarter of 2007. The decrease is primarily due to the sale of the Commercial Credit Group senior subordinated notes in August 2007.
The provision for income taxes was calculated at an effective rate of 40.5% and 39.8% for the second quarter of 2008 and 2007, respectively. The lower effective rate in 2007 compared to 2008 reflects a lower amount of non-deductible expenses.