UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 30, 2002 Commission File Number 000-22012 Winmark Corporation (Exact Name of Registrant as Specified in Its Charter) Minnesota 41-1622691 --------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 4200 Dahlberg Drive, Suite 100 Golden Valley, MN 55422-4837 ------------------------------- (Address of Principal Executive Offices, Zip Code) Registrant's Telephone Number, Including Area Code 763-520-8500 ------------ 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, and (2) has been subject to such filing requirements for the past 90 days. Yes: X No: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, no par value, 5,402,197 shares outstanding as of May 1, 2002. ---------------------------------------------------------------------------
WINMARK CORPORATION AND SUBSIDIARY INDEX <TABLE> <CAPTION> PART I. FINANCIAL INFORMATION PAGE - ----------------------------------------------------------------------------------------------------------- <S> <C> <C> Item 1. Financial Statements (Unaudited) Condensed Balance Sheets: 3 March 30, 2002 and December 29, 2001 Condensed Statements of Operations: 4 Three Months Ended March 30, 2002 and March 31, 2001 Condensed Statements of Cash Flows: 5 Three Months Ended March 30, 2002 and March 31, 2001 Notes to Condensed Financial Statements 6 - 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 - 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk 12 PART II. OTHER INFORMATION - ----------------------------------------------------------------------------------------------------------- Items 1 through 5 have been omitted since all items are inapplicable or answers negative. Item 6. Exhibits and Reports on Form 8-K (a.) Exhibits: Exhibit 99.1 - Letter to Commission Pursuant to Temporary Note 3T 13 (b.) Reports on On February 15, 2002, the Company filed an 8-K related Form 8-K: to its fiscal 2001 results. 13 </TABLE> 2
PART I. FINANCIAL INFORMATION Item 1: Financial Statements WINMARK CORPORATION AND SUBSIDIARY CONDENSED BALANCE SHEETS <TABLE> <CAPTION> ------------ ------------ (unaudited) March 30, December 29, 2002 2001 ------------ ------------ <S> <C> <C> ASSETS Current Assets: Cash and cash equivalents $ 678,000 $ 1,053,000 Investments 4,664,100 2,934,500 Receivables, less allowance for doubtful accounts of $570,000 and $576,000 3,563,700 3,308,800 Inventories 975,100 1,084,100 Prepaid expenses and other 728,600 667,800 Deferred income taxes 1,598,000 1,598,000 ------------ ------------ Total current assets 12,207,500 10,646,200 Notes receivable, net 90,100 124,100 Property and equipment, net 599,000 738,100 Other assets, net 742,700 780,600 ------------ ------------ $ 13,639,300 $ 12,289,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 2,271,400 $ 1,794,700 Accrued liabilities 2,665,100 2,885,500 Current maturities of long-term debt 24,100 41,500 Current deferred revenue 710,600 515,600 ------------ ------------ Total current liabilities 5,671,200 5,237,300 Long-Term Debt, less current maturities 69,500 158,000 Deferred Gain on Sale of Building 227,500 273,300 Shareholders' Equity: Common stock, no par, 10,000,000 shares authorized, 5,383,354 shares issued and outstanding 1,376,000 1,376,000 Common stock warrants 822,000 822,000 Other comprehensive loss (25,200) -- Retained earnings 5,498,300 4,422,400 ------------ ------------ Total shareholders' equity 7,671,100 6,620,400 ------------ ------------ $ 13,639,300 $ 12,289,000 ============ ============ </TABLE> The accompanying notes are an integral part of these financial statements 3
WINMARK CORPORATION AND SUBSIDIARY CONDENSED STATEMENTS OF OPERATIONS (Unaudited) <TABLE> <CAPTION> ------------------------------ Three Months Ended March 30, March 31, 2002 2001 ------------ ------------ <S> <C> <C> REVENUE: Merchandise sales $ 4,429,900 $ 5,651,100 Royalties 4,415,700 3,974,500 Franchise fees 165,000 162,500 Other 200,600 364,200 ------------ ------------ Total revenue 9,211,200 10,152,300 COST OF MERCHANDISE SOLD 3,678,200 4,851,300 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,781,600 4,003,800 ------------ ------------ Income from operations 1,751,400 1,297,200 INTEREST INCOME 53,600 99,800 INTEREST EXPENSE (13,600) (224,800) ------------ ------------ Income before income taxes 1,791,400 1,172,200 PROVISION FOR INCOME TAXES (715,500) (459,500) ------------ ------------ NET INCOME $ 1,075,900 $ 712,700 ============ ============ NET INCOME PER COMMON SHARE - BASIC $ .20 $ .13 ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 5,383,354 5,386,433 ============ ============ NET INCOME PER COMMON SHARE - DILUTED $ .17 $ .13 ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 6,152,857 5,510,141 ============ ============ </TABLE> The accompanying notes are an integral part of these financial statements 4
WINMARK CORPORATION AND SUBSIDIARY CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> ---------------------------- Three Months Ended March 30, March 31, 2002 2001 ----------- ----------- <S> <C> <C> OPERATING ACTIVITIES: Net income $ 1,075,900 $ 712,700 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 195,600 244,800 Deferred financing cost 11,500 29,300 Deferred gain on building sale (45,800) (45,800) Change in operating assets and liabilities: Receivables (220,900) 762,800 Inventories 109,000 154,800 Prepaid expenses and other (44,000) (78,400) Accounts payable 476,700 (2,300) Accrued liabilities (220,400) 348,700 Deferred franchise fee revenue 195,000 32,500 ----------- ----------- Net cash provided by operating activities 1,532,600 2,159,100 ----------- ----------- INVESTING ACTIVITIES: Purchase of investments (1,771,600) -- Purchases of property and equipment (30,100) (32,700) ----------- ----------- Net cash used for investing activities (1,801,700) (32,700) ----------- ----------- FINANCING ACTIVITIES: Payments on long-term debt (105,900) (304,400) ----------- ----------- Net cash used for financing activities (105,900) (304,400) ----------- ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (375,000) 1,822,000 Cash and cash equivalents, beginning of period 1,053,000 2,005,100 ----------- ----------- Cash and cash equivalents, end of period $ 678,000 $ 3,827,100 =========== =========== SUPPLEMENTAL DISCLOSURES: Cash paid for interest $ 14,500 $ 195,800 =========== =========== Cash paid for income taxes $ -- $ 217,300 =========== =========== </TABLE> The accompanying notes are an integral part of these financial statements 5
WINMARK CORPORATION AND SUBSIDIARY NOTES TO CONDENSED FINANCIAL STATEMENTS 1. Management's Interim Financial Statement Representation: The accompanying condensed financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The information in the 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. Although the Company believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these condensed financial statements be read in conjunction with the audited financial statements and the notes thereto included in the Company's latest Annual Report on Form 10-K. Revenues and operating results for the three months ended March 30, 2002 are not necessarily indicative of the results to be expected for the full year. Comprehensive Loss The Company reports comprehensive loss in accordance with Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting in the financial statements all changes in equity during a period. For the Company, comprehensive loss consists of unrealized holding gains and losses from investments classified as "available-for-sale." Reclassification Certain amounts in the March 31, 2001 financial statements have been reclassified to conform with the March 30, 2002 presentation. These reclassifications have no effect on net income or shareholders' equity as previously reported. 2. Organization and Business: Winmark Corporation (the "Company") offers licenses to operate retail stores using the service marks Play it Again Sports(R), Once Upon A Child(R), Music Go Round(R) and Plato's Closet(R). In addition, the Company sells inventory to its Play It Again Sports(R) franchisees through its buying group and operates retail stores. The Company has a 52/53 week year which ends on the last Saturday in December. 3. Net Income Per Common Share: The Company calculates net income per share in accordance with SFAS No. 128 by dividing net income by the weighted average number of shares of common stock outstanding to arrive at the Net Income Per Common Share - Basic. The Company calculates Net Income Per Share - Dilutive by dividing net income by the weighted average number of shares of common stock and dilutive stock equivalents from the exercise of stock options and warrants 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 769,503 and 123,708 stock options and warrants for the quarters ended March 30, 2002 and March 31, 2001, respectively. 6
4. New Accounting Pronouncements: On June 29, 2001, the FASB approved for issuance, SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Intangible Assets." Major provisions of these Statements are as follows: all business combinations initiated after June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1 2001; intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite lives are not amortized but tested for impairment annually, except in certain circumstances, and whenever there is an impairment indicator; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting; effective January 1, 2002, goodwill is no longer subject to amortization. The Company adopted SFAS No. 142 in the first quarter of its fiscal year ended December 28, 2002. The Company's annual goodwill amortization was approximately $38,100, which ceased effective January 1, 2002 upon adoption of the new rules. The adoption of the impairment provisions of SFAS No. 142, did not have a material impact on the consolidated financial position or results of operations of the Company. The following tables set forth pro forma net income and earnings per share: ----------------------------- Three Months Ended March 30, March 31, 2002 2001 ------------- ----------- Net Income as reported $ 1,075,900 $ 712,700 Add back: Goodwill amortization -- 5,800 ------------- ----------- Adjusted net income $ 1,075,900 $ 718,500 ============= =========== Basic earnings per share: Reported net income $ .20 $ .13 Goodwill amortization -- -- ------------- ----------- Adjusted net income $ .20 $ .13 ============= =========== Diluted earnings per share: Reported net income $ .17 $ .13 Goodwill amortization -- -- ------------- ----------- Adjusted net income $ .17 $ .13 ============= =========== In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes previous guidance for financial accounting and reporting for the impairment or disposal of long-lived assets and for segments of a business to be disposed of. The adoption of this pronouncement on January 1, 2002 had no effect on the Company's results of operations or financial position. 7
5. Other Contingencies: In addition to the operating lease obligations disclosed in footnote 10 of the Company's Form 10-K for the year ended December 29, 2001, the Company has remained a guarantor on Company-owned retail stores that have been either sold or closed. As of March 30, 2002, the Company is contingently liable on these leases for up to an additional $251,400. These leases have various expiration dates through 2006. The Company believes it has adequate reserves for any future liability, along with the monthly reduction of exposure as leases are paid, expire, or are renewed by the current operator of the location. Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations. General - ------- Winmark Corporation, (the "Company") is a franchise company that franchises retail brands that buy, sell, trade and consign merchandise. Each brand operates in a different industry and provides the consumer with high value retailing by offering 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 stores also offer new merchandise. Following is a summary of our franchising and corporate retail store activity for the retail brands for the three months ended March 30, 2002: <TABLE> <CAPTION> -------- ------ ------ ------- TOTAL TOTAL 12/29/01 OPENED CLOSED 3/30/02 -------- ------ ------ ------- <S> <C> <C> <C> <C> Play It Again Sports(R) - ----------------------- Franchised Stores - US and Canada 478 2 (4) 476 Other 24 0 0 24 Once Upon A Child(R) - -------------------- Franchised Stores - US and Canada 229 4 (3) 230 Corporate 1 0 0 1 Music Go Round(R) - ----------------- Franchised Stores 57 0 0 57 Corporate 6 0 0 6 Plato's Closet(R) - ----------------- Franchised Stores 45 6 0 51 Corporate 1 0 0 1 --- -- -- --- Total 841 12 (7) 846 === == == === </TABLE> 8
Results of Operations - --------------------- The following table sets forth for the periods indicated, certain income statement items as a percentage of total revenue and the percentage change in the dollar amounts from the prior period: <TABLE> <CAPTION> ----------------------- ------------------ Three Months Ended First Quarter March 30, March 31, 2002 over (under) 2002 2001 First Quarter 2001 --------- --------- ------------------ <S> <C> <C> <C> Revenue: Merchandise sales 48.1% 55.7% (21.6)% Royalties 47.9 39.1 11.1 Franchise fees 1.8 1.6 1.5 Other 2.2 3.6 (44.9) ----- ----- ------ Total revenue 100.0% 100.0% (9.3)% Cost of merchandise sold 39.9 47.8 (24.2) Selling, general and administrative expenses 41.1 39.4 (5.5) ----- ----- ------ Income from operations 19.0 12.8 35.0 Interest income (expense), net 0.4 (1.3) (132.0) ----- ------ ------ Income before income taxes 19.4 11.5 52.8 Provision for income taxes (7.7) (4.5) (55.7) ----- ----- ------ Net income 11.7% 7.0% 51.0% ===== ===== ====== </TABLE> Comparison of Three Months Ended March 30, 2002 to Three Months Ended - --------------------------------------------------------------------- March 31, 2001 - -------------- Revenues - -------- Revenues for the quarter ended March 30, 2002 totaled $9.2 million compared to $10.2 million for the comparable period in 2001. Merchandise sales consist of the sale of product to franchisees through the buying group and retail sales at the Company-owned stores. For the first quarter of 2002 and 2001 they were as follows: 2002 2001 ----------- ----------- Buying Group $ 3,106,800 $ 4,195,700 Retail 1,323,100 1,455,400 ----------- ----------- Merchandise Sales $ 4,429,900 $ 5,651,100 =========== =========== 9
Play It Again Sports(R) buying group revenues decreased $1,088,900, or 26.0%, for the three months ended March 30, 2002 compared to the same period last year. This is a result of management's strategic decision to have more franchisees purchase merchandise directly from vendors and having 42 fewer Play It Again Sports(R) stores open than one year ago. Retail store sales decreased $132,300, or 9.1%, for the three months ended March 30, 2002 compared to the same period last year. The revenue decline was due to closing three Company-owned stores in the first and second quarters of 2001. Royalties increased to $4.4 million for the first quarter of 2002 from $4.0 million for the same period in 2001, a 11.1% increase. Although Play It Again Sports(R) experienced a decrease in the number of franchised stores open in 2002 compared to the prior year, this was more than offset by an increase in franchise store sales in the first quarter of 2002. Franchise fees increased to $165,000 for the first quarter of 2002 compared to $162,500 for the first quarter of 2001. Other revenue decreased $163,600, or 44.9%, for the first quarter of 2002 compared to the first quarter of 2001. The decrease is primarily due to approximately $100,000 in fees received on the consulting agreement with Hollis Technologies, LLC in the first quarter of 2001. Cost of Merchandise Sold - ------------------------ Cost of merchandise sold includes the cost of merchandise sold through the Play It Again Sports(R) buying group and at Company-owned retail stores. Cost of merchandise sold through the buying group as a percentage of the buying group revenue and cost of merchandise sold at Company-owned stores as a percentage of Company-owned store retail revenue, respectively, for the first quarter of 2002 and 2001 were as follows: 2002 2001 ----- ----- Buying Group 96.1% 96.2% Retail 52.3% 55.9% The 3.6% decrease in retail cost of goods sold is primarily due to better inventory and margin management at the Company-owned retail stores. Selling, General and Administrative - ----------------------------------- The $222,200, or 5.5%, decrease in operating expenses in the first three months of 2002 compared to the same period in 2001 is primarily due to closing three Company-owned stores in the first and second quarters of 2001 and elimination of related costs. Interest - -------- During the first quarter of 2002, the Company had a net interest income of $40,000 compared to $125,000 of net expense in the first quarter of 2001. This decrease is primarily the result of reduced outstanding debt in the first quarter of 2002 compared to the same period last year. The decrease in interest income is primarily due to reduced finance charge income on the Play It Again Sports(R) buying group receivables. The receivable balance has decreased as a result of increased collection efforts combined with fewer stores using the buying group central billing function. 10
Liquidity and Capital Resources - ------------------------------- The Company's primary sources of liquidity have historically been cash flow from operations and bank borrowings. The Company ended the first quarter of 2002 with $5.3 million in cash and investments and a current ratio of 2.2 to 1.0 compared to $3.8 million in cash and a current ratio of 2.0 to 1.0 at the end of the first quarter of 2001. Ongoing operating activities provided cash of $1.5 million for the first three months of 2002 compared to $2.2 million for the same period last year. The higher level of cash provided in 2001 compared to 2002 was primarily due to increased efforts of collecting accounts receivable in 2001 offset by an increase in net income of $363,200 in the first quarter of 2002. For the first quarter of 2002, components of the cash provided by operating assets and liabilities for the first three months of 2002 include a $476,700 increase in accounts payable as a result of a seasonal increase in buying group activity. Deferred franchise fee revenue provided cash of $195,000 due to increased deposits on future store openings. Inventory provided cash of $109,000 due to reduced inventory levels at the Company-owned stores. Components of cash utilized by operating assets and liabilities include a $220,900 increase in accounts receivable as a result of a seasonal increase in buying group activity and a $220,400 decrease in accrued liabilities due to lower bonus and payroll accruals partially offset by an increase in the income tax accrual. Investing activities used $1.8 million of cash during the first quarter of 2002 primarily related to the purchase of investments. Financing activities used $105,900 of cash during the first quarter of 2002 for payment on long-term debt. The payments on long-term debt included $82,800 to Tool Traders, Inc. as part of a full and final settlement and $23,100 on other notes. On July 31, 2000, the Company entered into a credit agreement with Rush River Group, LLC, an affiliate of the Company, to provide a credit facility of up to $7.5 million dollars ("Rush River Facility"). The credit agreement allows such amount to be drawn upon by the Company in one or more term loans. The initial term loan was $5.0 million dollars to be repaid by the Company over a seven-year period. Each term loan was accruing interest at 14% per year. New term loans will accrue interest at 8% per year. Once repaid, amounts may not be reborrowed. As of March 30, 2002, there was no outstanding balance on the initial term loan. The Rush River Facility is secured by a lien against substantially all of the Company's assets. Rush River, LLC has agreed to subordinate its lien to any lien of a financial institution relating to financing not to exceed $2.5 million dollars. As of March 30, 2002, the Company had remaining borrowing availability of $2.5 million under the Rush River Facility, which is available until July 2007. Among other requirements, the Rush River Facility currently requires that the Company maintain shareholder equity of at least $1,922,000. In addition, if there is a change of control as defined in the credit agreement governing the Rush River Facility, such change is an event of default, and Rush River Group, LLC may declare all amounts outstanding under such term notes immediately due and payable. The Rush River Facility also contains an agreement allowing the Company to prepay any and all amounts outstanding under the Rush River Facility without premium or penalty. In connection with the Rush River Facility, the Company has issued to Rush River Group, LLC a warrant to purchase 200,000 shares of the Company's common stock at an exercise price of $2.00 per share. The warrant is currently exercisable and expires on July 31, 2010. The Company believes that the Rush River Facility, along with cash generated from future operations and cash and investments on hand, will be adequate to meet the Company's current obligations and operating needs. 11
New Accounting Pronouncements - ----------------------------- On June 29, 2001, the FASB approved for issuance, SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Intangible Assets." Major provisions of these Statements are as follows: all business combinations initiated after June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1 2001; intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite lives are not amortized but tested for impairment annually, except in certain circumstances, and whenever there is an impairment indicator; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting; effective January 1, 2002, goodwill is no longer subject to amortization. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes previous guidance for financial accounting and reporting for the impairment or disposal of long-lived assets and for segments of a business to be disposed of. The adoption of this pronouncement on January 1, 2002 had no effect on the Company's results of operations or financial position. Factors That May Affect Future Results - -------------------------------------- The statements contained in this Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" that are not strictly historical fact, including without limitation, our statement that we will have adequate capital reserves to meet our current and contingent obligations and operating needs are forward looking statements made under the safe harbor provision of the Private Securities Litigation Reform Act. Such statements are based on management's current expectations as of the date of this Report, but involve risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by such forward looking statements. Item 3: Quantitative and Qualitative Disclosures About Market Risk The Company incurs financial markets risk in the form of interest rate risk. Management deals with such risk by negotiating fixed rate loan agreements. Accordingly, the Company is not exposed to cash flow risks related to interest rate changes. A one percent change in interest rates would not have a significant impact on the Company's fixed rate debt. Approximately $1.8 million of our investments at March 30, 2002 was invested in fixed income securities which are subject to the effects of market fluctuations in interest rates. A one percent change in interest rates would not have a significant impact on the fair value of our fixed income investments. 12
PART II. OTHER INFORMATION Items 1 - 5: Not applicable. Item 6: Exhibits and Reports on Form 8-K (a.) Exhibits Exhibit 99.1 - Letter to Commission Pursuant to Temporary Note 3T (b.) Reports on Form 8-K On February 15, 2002, the Company filed an 8-K related to its fiscal 2001 results. 13
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WINMARK CORPORATION Date: May 9, 2002 By: /s/ John L. Morgan ------------------------------------- John L. Morgan Chairman of the Board and Chief Executive Officer Date: May 9, 2002 By: /s/ Paul F. Kelly ------------------------------------- Paul F. Kelly Vice President of Financial Services 14