Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarter ended September 26, 2009

 

or

 

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                 

 

Commission File Number: 000-22012

 

 

WINMARK CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(763) 520-8500

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act:  Yes o No x

 

Common stock, no par value, 5,231,953 shares outstanding as of October 16, 2009.

 

 

Table of Contents

 

WINMARK CORPORATION AND SUBSIDIARIES

 

INDEX

 

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	CONSOLIDATED CONDENSED BALANCE SHEETS: September 26, 2009 and December 27, 2008	3
	CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS: Three Months Ended September 26, 2009 and September 27, 2008 Nine Months Ended September 26, 2009 and September 27, 2008	4
	CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS: Nine Months Ended September 26, 2009 and September 27, 2008	5
	NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS	6 – 14
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14 – 23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4T.	Controls and Procedures	24
PART II.	OTHER INFORMATION	24
Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	25
Item 4.	Submission of Matters to a Vote of Security Holders	25
Item 5.	Other Information	25
Item 6.	Exhibits	26

 

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PART I.         FINANCIAL INFORMATION

 

ITEM 1:         Financial Statements

 

WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

		September 26, 2009			December 27, 2008
ASSETS
Current Assets:
Cash and cash equivalents		$	11,542,300		$	2,140,000
Marketable securities		1,191,900			438,300
Current investments		2,000,000			500,000
Receivables, less allowance for doubtful accounts of $36,300 and $52,700		1,669,000			2,064,100
Net investment in leases - current		16,577,900			17,379,700
Income tax receivable		—			792,200
Inventories		110,800			141,500
Prepaid expenses		394,600			1,018,800
Deferred income taxes		—			216,900
Total current assets		33,486,500			24,691,500
Net investment in leases - long-term		22,515,800			28,035,300
Long-term investments		2,271,900			3,833,300
Long-term receivables, net		22,000			39,200
Property and equipment, net		1,936,600			512,200
Other assets		677,500			677,500
Deferred income taxes		—			320,800
		$	60,910,300		$	58,109,800
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Current line of credit		$	3,941,600		$	4,313,200
Current renewable unsecured subordinated notes		8,655,200			8,052,400
Accounts payable		1,133,200			1,108,200
Income tax payable		650,700			—
Accrued liabilities		2,424,100			2,905,400
Current discounted lease rentals		1,049,100			1,012,900
Current rents received in advance		273,700			141,600
Current deferred revenue		910,500			993,600
Deferred income taxes		368,300			—
Total current liabilities		19,406,400			18,527,300
Long-term line of credit		6,308,500			9,276,300
Long-term renewable unsecured subordinated notes		13,952,700			12,788,700
Long-term discounted lease rentals		741,500			1,298,500
Long-term rents received in advance		1,446,800			1,696,400
Long-term deferred revenue		699,500			631,400
Other long-term liabilities		1,327,000			—
Deferred income taxes		490,700			—
Shareholders’ Equity:
Common stock, no par, 10,000,000 shares authorized, 5,255,284 and 5,433,610 shares issued and outstanding		—			427,500
Accumulated other comprehensive income (loss)		80,700			(38,500		)
Retained earnings		16,456,500			13,502,200
Total shareholders’ equity		16,537,200			13,891,200
		$	60,910,300		$	58,109,800

 

The accompanying notes are an integral part of these financial statements

 

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 26, 2009			September 27, 2008			September 26, 2009			September 27, 2008
REVENUE:
Royalties		$	6,405,200		$	5,740,600		$	17,646,600		$	16,376,000
Leasing income		2,271,600			2,060,400			7,116,400			5,920,000
Merchandise sales		593,800			777,600			1,898,500			2,685,400
Franchise fees		419,600			431,900			804,600			1,345,500
Other		134,600			117,700			446,800			396,000
Total revenue		9,824,800			9,128,200			27,912,900			26,722,900
COST OF MERCHANDISE SOLD		569,700			730,800			1,816,700			2,565,400
LEASING EXPENSE		548,000			471,000			1,743,300			1,420,000
PROVISION FOR CREDIT LOSSES		853,600			571,800			1,877,500			1,226,100
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		4,666,800			4,744,100			14,379,900			15,068,400
Income from operations		3,186,700			2,610,500			8,095,500			6,443,000
LOSS FROM EQUITY INVESTMENTS		(57,300		)	(145,200		)	(61,400		)	(281,700		)
INTEREST EXPENSE		(317,300		)	(309,600		)	(1,009,800		)	(998,200		)
INTEREST AND OTHER INCOME		178,700			114,500			351,400			246,300
Income before income taxes		2,990,800			2,270,200			7,375,700			5,409,400
PROVISION FOR INCOME TAXES		(1,211,300		)	(919,400		)	(2,987,200		)	(2,190,800		)
NET INCOME		$	1,779,500		$	1,350,800		$	4,388,500		$	3,218,600
EARNINGS PER SHARE — BASIC		$	.34		$	.24		$	.82		$	.58
EARNINGS PER SHARE — DILUTED		$	.33		$	.24		$	.82		$	.58
WEIGHTED AVERAGE SHARES OUTSTANDING — BASIC		5,282,349			5,522,188			5,335,869			5,519,265
WEIGHTED AVERAGE SHARES OUTSTANDING — DILUTED		5,329,697			5,548,461			5,357,259			5,548,473

 

The accompanying notes are an integral part of these financial statements

 

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended
		September 26, 2009			September 27, 2008
OPERATING ACTIVITIES:
Net income		$	4,388,500		$	3,218,600
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		405,200			263,500
Provision for credit losses		1,877,500			1,226,100
Compensation expense related to stock options		576,000			632,300
Gain from sale of marketable securities		(76,700		)	—
Gain from disposal of property and equipment		(1,200		)	—
Loss from equity investments		61,400			281,700
Deferred initial direct costs, net of amortization		162,900			(297,700		)
Change in operating assets and liabilities:
Receivables		412,300			237,000
Income tax receivable/payable		1,368,600			228,400
Inventories		30,700			39,000
Prepaid expenses		624,200			83,400
Other assets		—			(51,700		)
Deferred income taxes		1,396,700			—
Accounts payable		25,000			(328,700		)
Accrued and other liabilities		(226,700		)	228,200
Additions to advance and security deposits		101,300			722,700
Deferred revenue		(15,000		)	(82,500		)
Net cash provided by operating activities		11,110,700			6,400,300
INVESTING ACTIVITIES:
Proceeds from sale of marketable securities		311,500			—
Purchase of marketable securities		(794,900		)	—
Proceeds from sale of property and equipment		1,800			—
Purchases of property and equipment		(757,800		)	(191,600		)
Purchase of equipment for lease contracts		(12,164,800		)	(16,845,800		)
Principal collections on lease receivables		15,278,000			11,231,000
Net cash provided by (used for) investing activities		1,873,800			(5,806,400		)
FINANCING ACTIVITIES:
Proceeds from borrowings on line of credit		—			3,000,000
Payments on line of credit		(3,339,400		)	(5,221,900		)
Proceeds from issuance of subordinated notes		4,964,700			1,399,400
Payments on subordinated notes		(3,197,900		)	(1,504,400		)
Repurchases of common stock		(2,493,200		)	(556,700		)
Proceeds from exercises of stock options		50,000			—
Proceeds from discounted lease rentals		428,100			2,912,600
Tax benefits on exercised stock options and warrants		5,500			1,025,500
Net cash provided by (used for) financing activities		(3,582,200		)	1,054,500
INCREASE IN CASH AND CASH EQUIVALENTS		9,402,300			1,648,400
Cash and cash equivalents, beginning of period		2,140,000			1,253,000
Cash and cash equivalents, end of period		$	11,542,300		$	2,901,400
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest		$	1,720,500		$	1,851,200
Cash paid for income taxes		$	216,300		$	990,500
Non-cash landlord leasehold improvements		$	1,072,400		$	—

 

The accompanying notes are an integral part of these financial statements

 

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WINMARK CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

1.     Management’s Interim Financial Statement Representation:

 

The accompanying consolidated condensed financial statements have been prepared by Winmark Corporation and subsidiaries (the Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.  The Company has a 52/53 week year which ends on the last Saturday in December.  The information in the consolidated condensed financial statements includes normal recurring adjustments and reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of such financial statements.  The consolidated condensed financial statements and notes are presented in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions for Form 10-Q, and therefore do not contain certain information included in the Company’s annual consolidated financial statements and notes.  This report should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K.

 

Revenues and operating results for the nine months ended September 26, 2009 are not necessarily indicative of the results to be expected for the full year.

 

Subsequent events have been evaluated through October 23, 2009, the date of issuance of these financial statements.

 

Reclassifications

 

Certain reclassifications of previously reported amounts have been made to conform to the current year presentation.  Such reclassifications did not impact net income or shareholders’ equity as previously reported.

 

2.     Organization and Business:

 

The Company offers licenses to operate franchises using the service marks Play It Again Sports®, Once Upon A Child®, Music Go Round®, Plato’s Closet® and Wirth Business Credit®.  In addition, the Company sells inventory to its Play It Again Sports® franchisees through its buying group.  The Company also operates both small-ticket and middle market equipment leasing businesses under the Wirth Business Credit® and Winmark Capital® marks.

 

3.     Investments:

 

Marketable Securities

 

The following is a summary of marketable securities classified as available-for-sale securities as required by Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic (ASC) 320, Investments-Debt and Equity Securities:

 

		September 26, 2009						December 27, 2008
		Cost			Fair Value			Cost			Fair Value
Equity securities		$	1,060,900		$	1,191,900		$	500,800		$	438,300

 

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The Company’s unrealized gains and losses for marketable securities classified as available-for-sale securities in accumulated other comprehensive income (loss) are as follows:

 

		September 26, 2009			December 27, 2008
Unrealized gains		$	131,000		$	—
Unrealized losses		—			(62,500		)
Net unrealized gains (losses)		$	131,000		$	(62,500	)

 

The Company’s realized gains recognized on sales of available-for-sale marketable securities are as follows:

 

		Three Months Ended						Nine Months Ended
		September 26, 2009			September 27, 2008			September 26, 2009			September 27, 2008
Realized gains		$	75,900		$	—		$	76,700		$	—
Realized losses		—			—			—			—
Net realized gains		$	75,900		$	—		$	76,700		$	—

 

Other Long-Term Investments

 

The Company has an investment in Tomsten, Inc. (“Tomsten”), the parent company of “Archiver’s” retail chain.  Archiver’s is a retail concept created to help people preserve and enjoy their photographs.  The Company has invested a total of $7.5 million in the purchase of common stock of Tomsten.  The Company’s investment currently represents 18.3% of the outstanding common stock of Tomsten.  As of September 26, 2009, $0.2 million of the Company’s investment, with a current carrying cost of $2.3 million, is attributable to goodwill.  The amount of goodwill was determined by calculating the difference between the Company’s net investment in Tomsten less its pro rata share of Tomsten’s net worth.

 

Summarized financial information for Tomsten, Inc. is as follows:

 

		Nine Month Fiscal Period Ended
		Third Quarter 2009			Third Quarter 2008
Net sales		$	42,831,200		$	47,396,000
Gross profit		21,022,300			23,361,400
Net income (loss) from continuing operations		(302,300		)	(1,160,500		)
Net income (loss)		(302,300		)	(1,160,500		)

 

On October 13, 2004, the Company made a commitment to lend $2.0 million to BridgeFunds Limited at an annual rate of 12% pursuant to several senior subordinated promissory notes.  BridgeFunds Limited advances funds to claimants involved in civil litigation to cover litigation expenses.  At December 27, 2008 and September 26, 2009, the Company had funded the $2.0 million commitment.  In addition, the Company has received a warrant to purchase approximately 257,000 shares of BridgeFunds at $1 per share, which currently represents 6.5% of the equity of BridgeFunds on a fully diluted basis.  On August 23, 2007, in connection with raising capital, BridgeFunds Limited completed a restructuring where all assets and liabilities, including the warrant, were assigned to and assumed by BridgeFunds, LLC.  As of September 26, 2009, the warrants have not been exercised.  On October 22, 2009, the Company entered into a modification agreement with BridgeFunds, LLC, whereby the maturity date of all of the outstanding promissory notes was changed to September 30, 2010, the annual rate of interest on the notes was increased to 15% and monthly prepayments of the principal of such notes in an amount equal to Available Cash Flow (as defined within the modification agreement) is required.  As of September 26, 2009, the $2.0 million investment balance is classified as current based on expected payments from Available Cash Flow.

 

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4.  Investment in Leasing Operations:

 

Investment in leasing operations consists of the following:

 

		September 26, 2009			December 27, 2008
Minimum lease payments receivable		$	43,257,400		$	51,110,200
Estimated residual value of equipment		2,951,600			2,406,500
Unearned lease income net of initial direct costs deferred		(7,120,100		)	(8,675,300		)
Security deposits		(1,926,500		)	(1,707,700		)
Allowance for credit losses		(1,112,100		)	(1,538,900		)
Equipment installed on leases not yet commenced		3,043,400			3,820,200
Total net investment in leases		39,093,700			45,415,000
Less: net investment in leases – current		(16,577,900		)	(17,379,700		)
Net investment in leases – long-term		$	22,515,800		$	28,035,300

 

The Company had $2,304,300 and $974,200 of write-offs, net of recoveries, related to the lease portfolio during the first nine months of 2009 and 2008, respectively.

 

As of September 26, 2009, no customer had leased assets totaling more than 10% of the Company’s total assets.

 

Minimum lease payments receivable under lease contracts and the amortization of unearned lease income, net of initial direct costs deferred, is as follows for the remainder of fiscal 2009 and the full fiscal years thereafter as of September 26, 2009:

 

Fiscal Year		Minimum Lease Payments Receivable			Income  Amortization
2009		$	5,930,700		$	1,506,600
2010		20,689,000			3,924,800
2011		11,531,700			1,364,200
2012		4,326,400			289,200
2013		733,400			34,300
Thereafter		46,200			1,000
		$	43,257,400		$	7,120,100

 

During the first nine months of 2009, the Company entered into lease transactions that were classified as sales-type leases in accordance with ASC 840, Leases.

 

5.  Accounting for Stock-Based Compensation:

 

ASC 718, Compensation – Stock Compensation requires the cost of all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated financial statements based on the grant date fair value of those awards.  In accordance with ASC 718, this cost is recognized over the period for which an employee is required to provide service in exchange for the award.  ASC 718 requires that the benefits associated with tax deductions in excess of recognized compensation expense be reported as a financing cash flow rather than as an operating cash flow.  Compensation expense of $576,000 and $632,300 relating to the vested portion of the fair value of stock options granted was expensed to “Selling, General and Administrative Expenses” in the first nine months of 2009 and 2008, respectively.

 

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The Company estimates the fair value of options granted using the Black-Scholes option valuation model.  The Company estimates the volatility of its common stock at the date of grant based on its historical volatility rate, consistent with ASC 718 and Securities and Exchange Commission Staff Accounting Bulletin No. 107 (SAB 107).  The Company’s decision to historical volatility was based upon the lack of actively traded options on its common stock.  The Company estimates the expected term based upon historical option exercises.  The risk-free interest rate assumption is based on observed interest rates for the volatility period.  The Company uses historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest.  For options granted, the Company amortizes the fair value on a straight-line basis.  All options are amortized over the vesting periods.

 

In accordance with ASC 718, the fair value of each option granted in 2009 and 2008 was estimated on the date of the grant using the Black-Scholes option pricing model with the following assumptions:

 

Year Granted		Option Fair Value		Risk Free Interest Rate		Expected Life (Years)		Expected Volatility		Dividend Yield
2009		$4.25		2.92%		6		27.1%		none
2008		$5.20 / $5.69 / $3.71		3.36% / 3.04% / 1.77%		6 / 6 / 6		24.4% / 24.7% / 26.0%		none

 

6.     New Accounting Pronouncements:

 

Effective December 30, 2007, the Company adopted ASC 820, Fair Value Measurements and Disclosures.  ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.  The adoption of ASC 820 did not have a material impact on the Company’s financial condition or results of operations.

 

ASC 820 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  ASC 820 also describes three levels of inputs that may be used to measure fair value:

 

·                  Level 1 – quoted prices in active markets for identical assets and liabilities.

·                  Level 2 – observable inputs other than quoted prices in active markets for identical assets and liabilities.

·                  Level 3 – unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.

 

The Company’s cash and cash equivalents and marketable securities are valued based on Level 1 inputs using quoted prices.  The fair values of the Company’s other long-term investments (described in Note 3) were determined based on Level 3 inputs using a discounted cash flow model.

 

In February 2008, the FASB issued guidance that delayed the effective date of ASC 820 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  The Company adopted ASC 820 for non-financial assets and non-financial liabilities on December 28, 2008, and such adoption did not have a material impact on the Company’s financial condition or results of operations.

 

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Effective December 30, 2007, the Company adopted the Fair Value Option of ASC 825, Financial Instruments.  ASC 825 permits entities to choose to measure many financial instruments and certain other items at fair value.  The Company did not elect the fair value of accounting option for any of its eligible assets or liabilities; therefore, this adoption had no impact on the Company’s financial condition or results of operations.

 

In April 2009, the FASB issued guidance that requires interim reporting period disclosure about the fair value of certain financial instruments, effective for interim reporting periods ending after June 15, 2009.  The Company has adopted these disclosure requirements; see Note 3 for disclosures associated with this adoption.  Due to their nature, the carrying value of cash, receivables, payables and debt obligations approximates fair value.

 

In May 2009, the FASB issued ACS 855, Subsequent Events.  ACS 855 incorporates guidance into accounting literature that was previously addressed only in auditing standards.  The statement refers to subsequent events that provide additional evidence about conditions that existed at the balance-sheet date as “recognized subsequent events”.  Subsequent events which provide evidence about conditions that arose after the balance-sheet date but prior to the issuance of the financial statements are referred to as ‘non-recognized subsequent events”.  It also requires companies to disclose the date through which subsequent events have been evaluated and whether this date is the date the financial statements were issued or the date the financial statements were available to be issued.  The disclosure requirements of ASC 855 are effective for interim and annual periods ending after June 15, 2009.  The Company has adopted this new standard.

 

In June 2009, the FASB issued guidance that establishes the FASB Accounting Standards CodificationTM (the Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (GAAP).  Use of the new Codification is effective for interim and annual periods ending after September 15, 2009.  The Company has used the new Codification in reference to GAAP in this quarterly report on Form 10-Q  and such use has not impacted the consolidated results of the Company.

 

7.     Earnings Per Share:

 

The Company calculates earnings per share in accordance with ASC 260, Earnings Per Share, by dividing net income by the weighted average number of shares of common stock outstanding to arrive at the Earnings Per Share - Basic.  The Company calculates Earnings Per Share - Diluted by dividing net income by the weighted average number of shares of common stock and dilutive stock equivalents from the exercise of stock options using the treasury stock method.  The weighted average diluted outstanding shares is computed by adding the weighted average basic shares outstanding with the dilutive effect of stock options equivalent to 47,348 shares and 26,273 shares for the three months and 21,390 shares and 29,208 shares for the nine months ended September 26, 2009 and September 27, 2008, respectively.

 

Options totaling 75,895 and 186,935 shares for the three months and 295,784 and 161,893 shares for the nine months ended September 26, 2009 and September 27, 2008, respectively, were outstanding but were not included in the calculation of Earnings Per Share – Diluted because their exercise prices were greater than the average market price of the common shares and, therefore, including the options in the denominator would be anti-dilutive.

 

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8.     Shareholders’ Equity:

 

Repurchase of Common Stock

 

Under the board of directors’ authorization, the Company has the ability to repurchase up to 4,500,000 shares of its common stock, of which all but 391,215 shares have been repurchased.  Repurchases may be made from time to time at prevailing prices, subject to certain restrictions on volume, pricing and timing.  Since inception of stock repurchase activities in November 1995 through September 26, 2009, the Company has repurchased 4,108,785 shares of its stock at an average price of $14.09 per share.  In the first nine months of 2009, the Company repurchased 183,326 shares for an aggregate purchase price of $2,493,200 or $13.60 per share.  These repurchase transactions reduced the dollar amount of common stock on the balance sheet to zero, with the remainder recorded to retained earnings.

 

Stock Option Plans

 

The Company has authorized up to 750,000 shares of common stock be reserved for granting either nonqualified or incentive stock options to officers and key employees under the Company’s 2001 Stock Option Plan (the “2001 Plan”).

 

The Company also sponsors a Stock Option Plan for Nonemployee Directors (the “Nonemployee Directors Plan”) and has reserved a total of 300,000 shares for issuance to directors of the Company who are not employees.

 

Stock option activity under the 2001 Plan and Nonemployee Directors Plan as of September 26, 2009 was as follows:

 

		Number of Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (years)		Intrinsic Value
Outstanding at December 27, 2008		548,800		$	18.22		7.36		$	—
Granted		50,750		13.01
Exercised		(5,000	)	10.00
Forfeited		(29,900	)	20.11
Outstanding at September 26, 2009		564,650		$	17.72		6.92		$	1,964,900
Exercisable at September 26, 2009		263,533		$	18.49		5.38		$	812,400

 

All unexercised options at September 26, 2009 have an exercise price equal to the fair market value on the date of the grant.

 

As of September 26, 2009, the Company had $1,290,200 of total unrecognized compensation expense related to stock options that is expected to be recognized over the remaining weighted average period of approximately 2.5 years.

 

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9.  Long-term Debt:

 

Line of Credit

 

On August 12, 2009, the Company amended its Amended and Restated Revolving Credit Agreement (the “Credit Facility”) to reduce the aggregate commitment under the Credit Facility from $55.0 million to $40.0 million (subject to certain borrowing base limitations). As of September 26, 2009, the Company’s borrowing availability under the Credit Facility was $40.0 million (the lesser of the borrowing base or the aggregate line of credit).  There were $10.3 million in borrowings outstanding under the Credit Facility bearing interest ranging from 4.58% to 5.76% and having initial terms ranging from three years to five years, leaving $29.7 million available for additional borrowings at September 26, 2009.

 

The Credit Facility has been and will continue to be used for growing the Company’s leasing business, stock repurchases and general corporate purposes.  The Credit Facility is secured by a lien against substantially all of the Company’s 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 Credit Facility).  As of September 26, 2009, the Company was in compliance with all of its financial covenants.

 

Renewable Unsecured Subordinated Notes

 

In 2006, the Company filed a public offering of up to $50 million of Renewable Unsecured Subordinated Notes that was declared effective in June of that year.  In March 2007, the Company filed Post-Effective Amendment No. 2 to the public offering that was declared effective March 30, 2007.  In November 2007, the Company filed Post-Effective Amendment No. 3 to the public offering that was declared effective November 29, 2007.  In March 2008, the Company filed Post-Effective Amendment No. 4 to the public offering that was declared effective March 27, 2008.  In March 2009, the Company filed Post-Effective Amendment No. 5 to the public offering that was declared effective March 27, 2009.  As of September 26, 2009, the Company has $22.6 million outstanding in renewable unsecured subordinated notes.  The table below presents the Company’s outstanding renewable unsecured subordinated notes as of September 26, 2009:

 

		Original Term		Principal Amount			Weighted Average Interest Rate
Renewable unsecured subordinated notes		3 months		$	1,357,600		6.55	%
		6 months		546,400			7.26	%
		1 year		2,401,100			8.27	%
		2 years		4,068,200			9.28	%
		3 years		5,302,100			9.95	%
		4 years		1,973,500			9.86	%
		5 years		5,998,500			10.11	%
		10 years		960,500			10.51	%
Total				$	22,607,900		9.44	%

 

The Company made interest payments of $1,624,300 and $1,495,300 on the renewable unsecured subordinated notes during the first nine months of 2009 and 2008, respectively.  The weighted average initial and remaining terms of the outstanding renewable unsecured subordinated notes are 40 months and 20 months, respectively.

 

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10.  Discounted Lease Rentals

 

The Company utilized certain lease receivables and underlying equipment as collateral to borrow from financial institutions at a weighted average rate of 5.69% at September 26, 2009 on a non-recourse basis.  In the event of a default by a customer in non-recourse financing, the financial institution has a first lien on the underlying leased equipment, with no further recourse against the Company.  As of September 26, 2009, $1.0 million of the $1.8 million liability balance is current.

 

11.  Segment Reporting:

 

The Company currently has two reportable business segments, franchising and leasing.  The franchising segment franchises value-oriented retail store concepts that buy, sell, trade and consign merchandise and Wirth Business Credit, Inc., a small ticket leasing franchise.  The leasing segment includes (i) Winmark Capital Corporation, a middle-market equipment leasing business and (ii) Wirth Business Credit, Inc., a small ticket financing business.  Segment reporting is intended to give financial statement users a better view of how the Company manages and evaluates its businesses. The Company’s internal management reporting is the basis for the information disclosed for its business segments and includes allocation of shared-service costs.  Segment assets are those that are directly used in or identified with segment operations, including cash, accounts receivable, prepaids, inventory, property and equipment and investment in leasing operations. Unallocated assets include corporate cash and cash equivalents, marketable securities, current and long-term investments, deferred tax amounts and other corporate assets.  Inter-segment balances and transactions have been eliminated.  The following tables summarize financial information by segment and provide a reconciliation of segment contribution to operating income:

 

		Three Months Ended						Nine Months Ended
		September 26, 2009			September 27, 2008			September 26, 2009			September 27, 2008
Revenue:
Franchising		$	7,553,200		$	7,067,800		$	20,796,500		$	20,802,900
Leasing		2,271,600			2,060,400			7,116,400			5,920,000
Total revenue		$	9,824,800		$	9,128,200		$	27,912,900		$	26,722,900
Reconciliation to operating income:
Franchising segment contribution		$	3,886,600		$	3,022,800		$	8,967,600		$	7,375,100
Leasing segment contribution		(699,900		)	(412,300		)	(872,100		)	(932,100		)
Total operating income		$	3,186,700		$	2,610,500		$	8,095,500		$	6,443,000
Depreciation and amortization:
Leasing		$	2,800		$	16,600		$	39,500		$	51,700
Allocated		123,800			75,600			365,700			211,800
Total depreciation and amortization		$	126,600		$	92,200		$	405,200		$	263,500

 

		As of
		September 26, 2009			December 27, 2008
Identifiable assets:
Franchising		$	2,750,300		$	3,835,100
Leasing		41,619,600			47,500,800
Unallocated		16,540,400			6,773,900
Total		$	60,910,300		$	58,109,800

 

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12.  Related Party Transactions:

 

On February 27, 2009, Sheila Morgan, spouse of John L. Morgan, chief executive officer and chairman of Winmark, subscribed for and purchased $300,000 of three month maturity unsecured subordinated notes on a monthly interest payment schedule at the rates described on the Interest Rate Supplement filed on Form 424(b)(2) with the Securities and Exchange Commission on March 31, 2008 (“March 2008 Interest Rate Supplement”) offered by Winmark pursuant to a prospectus and related documents declared effective on March 27, 2008 (“March 2008 Prospectus”).  In connection with her investment, Mrs. Morgan agreed that her notes would be voted consistent with the majority of the remaining note holders in an event of default.

 

On March 2, 2009, John L. Morgan subscribed for and purchased $1.6 million of unsecured subordinated notes of various maturities ($200,000 of six month maturity, $200,000 of one year maturity, $200,000 of two year maturity, $130,000 of three year maturity, $180,000 of four year maturity, $190,000 of five year maturity and $500,000 of ten year maturity) all on a monthly interest payment schedule at the rates described in the March 2008 Interest Rate Supplement offered by Winmark pursuant to the March 2008 Prospectus.  In connection with his investment, Mr. Morgan agreed that his notes would be voted consistent with the majority of the remaining note holders in an event of default.

 

ITEM 2:   Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Overview

 

As of September 26, 2009, we had 911 franchises operating under the Play it Again Sports®, Once Upon A Child®, Plato’s Closet®, Music Go Round® and Wirth Business Credit® brands and had a leasing portfolio of $39.1 million.  Management closely tracks the following criteria to evaluate current business operations and future prospects: franchising revenue, leasing activity, and selling, general and administrative expenses.

 

Our most profitable sources of franchising revenue are royalties earned from our franchise partners and franchise fees for new store openings and transfers.  During the first nine months of 2009, our royalties increased $1,270,600 or 7.8% compared to the first nine months of 2008.  Franchise fees decreased $540,900 or 40.2% compared to the same period last year.

 

During the first nine months of 2009, we purchased $12.2 million in equipment for lease contracts compared to $16.7 million in the first nine months of 2008.  The level of equipment purchases for lease contracts continues to be impacted by the unfavorable general economic environment as well as our decision during 2008 to tighten credit standards in our small-ticket financing business in response to these conditions.  Overall, our leasing portfolio (net investment in leases – current and long-term) decreased to $39.1 million at September 26, 2009 from $45.4 million at December 27, 2008.  Revenue generated from our leasing activities was $7.1 million compared to $5.9 million in the same period last year, an increase of 20.2%.  (See Note 11 – “Segment Reporting”).  Our earnings are also impacted by credit losses.  During the first nine months of 2009, our provision for credit losses increased to $1.9 million from $1.2 million in the first nine months of 2008, as we continued to experience a higher level of net write-offs and delinquencies, primarily in the small-ticket financing business portion of our leasing segment.

 

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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 2009, selling, general and administrative expense decreased $688,500 or 4.6%, compared to the first nine months of 2008.

 

Management also monitors several nonfinancial factors in evaluating the current business operations and future prospects including franchise openings and closings and franchise renewals.  The following is a summary of our franchising activity for the first nine months ended September 26, 2009:

 

										NINE MONTHS ENDING 9/26/09
		TOTAL 12/27/08		OPENED		CLOSED		TOTAL 9/26/09		AVAILABLE FOR RENEWAL		COMPLETED RENEWALS
Play It Again Sports® Franchises - US and Canada		364		4		(23	)	345		13		12
Once Upon A Child® Franchises - US and Canada		229		11		(7	)	233		18		16
Plato’s Closet® Franchises - US and Canada		241		23		(3	)	261		4		4
Music Go Round® Franchises - US		36		0		(1	)	35		4		4
Total Franchised Stores		870		38		(34	)	874		39		36
Wirth Business Credit® Territories - US		54		0		(17	)	37		0		0
Total Franchises/Territories		924		38		(51	)	911		39		36

 

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.  During the first nine months of 2009, we renewed 36 franchise agreements of the 39 franchise agreements up for renewal.

 

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.

 

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Results of Operations

 

The following table sets forth selected information from our Consolidated Condensed Statements of Operations expressed as a percentage of total revenue:

 

		Three Months Ended				Nine Months Ended
		September 26, 2009		September 27, 2008		September 26, 2009		September 27, 2008
Revenue:
Royalties		65.2	%	62.9	%	63.2	%	61.3	%
Leasing income		23.1		22.6		25.5		22.2
Merchandise sales		6.0		8.5		6.8		10.0
Franchise fees		4.3		4.7		2.9		5.0
Other		1.4		1.3		1.6		1.5
Total revenues		100.0		100.0		100.0		100.0
Cost of merchandise sold		(5.8	)	(8.0	)	(6.5	)	(9.6	)
Leasing expense		(5.6	)	(5.1	)	(6.3	)	(5.3	)
Provision for credit losses		(8.7	)	(6.3	)	(6.7	)	(4.6	)
Selling, general and administrative expenses		(47.5	)	(52.0	)	(51.5	)	(56.4	)
Income from operations		32.4		28.6		29.0		24.1
Loss from equity investments		(0.6	)	(1.6	)	(0.2	)	(1.1	)
Interest expense		(3.2	)	(3.4	)	(3.6	)	(3.7	)
Interest and other income		1.8		1.3		1.2		0.9
Income before income taxes		30.4		24.9		26.4		20.2
Provision for income taxes		(12.3	)	(10.1	)	(10.7	)	(8.2	)
Net income		18.1	%	14.8	%	15.7	%	12.0	%

 

Comparison of Three Months Ended September 26, 2009 to Three Months Ended September 27, 2008

 

Revenue

 

Revenues for the quarter ended September 26, 2009 totaled $9.8 million compared to $9.1 million for the comparable period in 2008.

 

Royalties and Franchise Fees

 

Royalties increased to $6.4 million for the third quarter of 2009 from $5.7 million for the same period of 2008, an 11.6% increase.  The increase was due to higher Plato’s Closet® and Once Upon A Child® royalties of $569,900 and $209,000, respectively, partially offset by lower Play It Again Sports® royalties of $102,200.  The increase in Plato’s Closet® and Once Upon A Child® royalties is primarily due to having 28 additional Plato’s Closet® franchise stores in the third quarter of 2009 compared to the same period last year and higher franchisee retail sales in both brands.

 

Franchise fees were $419,600 for the third quarter of 2009 compared to $431,900 for the same period of 2008.

 

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