Winmark - 10-Q quarterly report FY

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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 29, 2003

Commission File Number 000-22012

Winmark Corporation

(Exact Name of Registrant as Specified in Its Charter)

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.

Indicate by check mark whether the Registrant is an accelerated filer

(as defined in Rule 12b-2 of the Exchange Act).

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, 5,615,586 shares outstanding as of May 1, 2003.

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WINMARK CORPORATION AND SUBSIDIARY

INDEX

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PART I.     FINANCIAL INFORMATION

Item 1:     Financial Statements

WINMARK CORPORATION AND SUBSIDIARY

CONDENSED BALANCE SHEETS

(unaudited)

The accompanying notes are an integral part of these financial statements

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WINMARK CORPORATION AND SUBSIDIARY

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying notes are an integral part of these financial statements

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WINMARK CORPORATION AND SUBSIDIARY

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of these financial statements

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WINMARK CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED FINANCIAL STATEMENTS

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 29, 2003 are not necessarily indicative of the results to be expected for the full year.

Other Long-Term Investments

On July 30, 2002, the Company executed a subscription agreement with Tomsten, Inc., the parent company of “Archiver’s” retail chain. Archiver’s is a new retail concept created to help people preserve and enjoy their photographs. Archiver’s stores feature a wide variety of photo-safe products, including photo albums, scrapbooks and scrapbook supplies, frames, rubber stamps and photo storage and organization products. The agreement requires the Company to invest a total of $6 million in three equal installments, in the purchase of common stock of Tomsten, Inc. The first $2 million was paid on July 30, 2002, and the second $2 million was paid on February 1, 2003. The final $2 million increment is due August 1, 2003. Our investment currently represents 14.5% of the outstanding common stock of Tomsten, Inc. and is currently accounted for by the cost method. The accounting method will be reviewed after each incremental payment.

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.”

Comprehensive income and the components of other comprehensive income were as follows:

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Accounting for Stock-Based Compensation

The Company adopted in 2002 the fair value method recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (Statement No. 123) using the prospective method as provided by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Historically, the Company had applied the intrinsic value method permitted under Statement 123, as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations, in accounting for our stock-based compensation plans. Accordingly, no compensation cost has been recognized for our stock option plans prior to 2002. Compensation expense of $38,700 relating to stock options granted in 2002, upon adoption of the fair value method, has been expensed to “Selling, General and Administration Expenses” in the first quarter of 2003. The fair value of all future employee stock option grants and other stock-based compensation will be expensed to “Selling, General and Administrative Expenses” over the vesting period based on the fair value at the date the stock-based compensation is granted.

For the options granted prior to fiscal 2002, the Company accounts for the stock option plans under Accounting Principles Board (APB) Opinion No. 25, and accordingly, no compensation expense relating to the granting of options has been recognized in the Statement of Operations. Had compensation cost for these plans been determined consistent with SFAS No. 123 “Accounting for Stock-Based Compensations” (SFAS 123), the Company’s pro forma net income (loss) and net income (loss) per common share would have changed to the following pro forma amounts:

The fair value of each option granted subsequent to January 1, 1995 in accordance with SFAS 123 was estimated to be $5.86 and 5.91 in 2002 on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions: risk free interest rates of 3.59% and 3.63%, expected life of seven years, expected volatility of 55.2% and 55.0% and no dividend yield expected in any year.

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Reclassification

Certain amounts in the March 30, 2002 financial statements have been reclassified to conform with the March 29, 2003 presentation. These reclassifications have no effect on net income or shareholders’ equity as previously reported.

Winmark Corporation (the “Company”) offers licenses to operate retail stores using the service marks Play it Again Sports^®, Once Upon A Child^®, Music Go Round^® and Plato’s Closet^®. In addition, the Company sells inventory to its Play It Again Sports^® 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.

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 476,990 and 769,503 stock options and warrants for the quarters ended March 29, 2003 and March 30, 2002, respectively.

As of March 29, 2003, the Company had a total of 1,195,000 stock options and warrants outstanding with an average price of $6.19. Of these 561,250 were exercisable as of March 29, 2003.

In June 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The standard requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. The provisions of the standard are effective for exit or disposal activities initiated after December 31, 2002. We will account for any exit or disposal activities in accordance with the new pronouncement.

In December 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment to FASB Statement 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of SFAS No. 148 on December 29, 2002.

In addition to the operating lease obligations disclosed in footnote 10 of the Company’s Form 10-K for the year ended December 28, 2002, the Company has remained a guarantor on Company-owned retail stores that have been either sold or closed. As of March 29, 2003, the Company is contingently liable on these leases for up to an additional $67,600. These leases have various expiration dates through 2006.

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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 three months ended March 29, 2003:

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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:

Comparison of Three Months Ended March 29, 2003 to Three Months Ended March 30, 2002

Revenues

Revenues for the quarter ended March 29, 2003 totaled $8.4 million compared to $9.2 million for the comparable period in 2002.

Merchandise sales include the sale of product to franchisees either through the Play It Again Sports^® buying group, or through our Computer Support Center (“Direct Franchisee Sales”) and retail sales at the Company-owned stores. For the first quarter of 2003 and 2002, they were as follows:

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Play It Again Sports^® buying group revenues decreased $570,800, or 18.4%, for the three months ended March 29, 2003 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 27 fewer Play It Again Sports^® stores open than one year ago. Retail store sales decreased $58,600, or 4.4%, for the three months ended March 29, 2003 compared to the same period last year. The revenue decline was primarily due to selling one Company-owned ReTool^® store in the fourth quarter of 2002.

Royalties decreased to $4.3 million for the first quarter of 2003 from $4.4 million for the same period in 2002, a 2.8% decrease. The decrease is due to lower franchisee retail sales and having 16 fewer stores open at the end of the first quarter of 2003 compared to the same period of 2002.

Franchise fees decreased to $135,000 for the first quarter of 2003 compared to $165,000 for the first quarter of 2002.

Other revenue decreased $47,400, or 23.6%, for the first quarter of 2003 compared to the first quarter of 2002. The decrease is primarily due to lower software license fee revenue.

Cost of Merchandise Sold

Cost of merchandise sold includes the cost of merchandise sold to franchisees either through the Play It Again Sports^® buying group, or through our Computer Support Center (“Direct Franchisee Sales”) and at Company-owned retail stores. Direct Franchisee Sales cost of merchandise sold as a percentage of the Direct Franchise Sales 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 2003 and 2002 were as follows:

The increase in retail cost of goods sold is primarily due to discounting older inventory items at the Company-owned retail stores.

Selling, General and Administrative

The $323,600, or 8.6%, decrease in operating expenses in the first three months of 2003 compared to the same period in 2002 is primarily due to lower depreciation, lower advertising production costs due to timing and lower legal fees.

Interest

During the first quarter of 2003, the Company had a net interest income of $69,800 compared to $40,000 of net interest income in the first quarter of 2002. The increase in interest income is primarily due to larger interest earning investment balances in 2003.

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Liquidity and Capital Resources

The Company’s primary sources of liquidity have historically been cash flow from operations and credit agreement borrowings. The Company ended the first quarter of 2003 with $4.9 million in cash and short-term investments and a current ratio of 2.2 to 1.0 compared to $5.3 million in cash and short-term investments and a current ratio of 2.2 to 1.0 at the end of the first quarter of 2002.

Ongoing operating activities provided cash of $1.5 million for the first three months of 2003 and 2002. Components of the cash provided by operating assets and liabilities for the first three months of 2003 include a $416,400 increase in accounts payable as a result of a seasonal increase in buying group activity. Deferred franchise fee revenue provided cash of $140,800 due to increased deposits on future store openings. Prepaid expenses provided cash of $318,300 due to a decrease in prepaid income taxes, partially offset by an increase in prepaid insurance. Components of cash utilized by operating assets and liabilities include a $393,300 increase in accounts receivable as a result of a seasonal increase in buying group activity and a $313,400 decrease in accrued liabilities primarily due to lower bonus/profit sharing accruals, partially offset by an increase in the income tax accrual.

Investing activities used $2.3 million of cash during the first quarter of 2003 compared to $1.8 million for the same period last year, primarily due to the purchase of investments in both periods, including the Company’s investment in Tomsten, Inc., the parent company of Archiver’s.

Financing activities used $1.6 million of cash during the first quarter of 2003 compared to $105,900 in the first quarter of 2002. The first quarter of 2003 includes $1.9 million used to repurchase 200,000 shares of Company common stock, offset by $250,000 received from the exercise of stock options. As of March 29, 2003, the Company has the authorization to repurchase up to an additional 230,272 shares.

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 (“Rush River Facility”). The credit agreement allowed 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. The balance of the Rush River Facility was paid on September 17, 2001. As of December 28, 2002, the Company terminated the Rush River Facility and accelerated the amortization of the remaining associated debt issuance cost, charging the remaining $210,000 to interest expense. The Rush River Facility was secured by a lien against substantially all of the Company’s assets, which lien has been released.

In connection with the Rush River Facility, the Company issued 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 was exercised on May 21, 2002.

The Company believes that cash generated from future operations and cash and investments on hand, will be adequate to meet the Company’s current obligations, including the investments in “Archiver’s”, and operating needs.

New Accounting Pronouncements

In June 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The standard requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. The provisions of the standard are effective for exit or disposal activities initiated after December 31, 2002. We will account for any exit or disposal activities in accordance with the new pronouncement.

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In December 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment to FASB Statement 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of SFAS No. 148 on December 29, 2002.

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 had no debt outstanding at March 29, 2003. 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 29, 2003 was invested in fixed income securities and $1.9 million of cash and cash equivalents in money market mutual funds, which are subject to the effects of market fluctuations in interest rates. A one percent change in interest rates may have a significant impact on the fair value of our fixed income investments.

Item 4:

Evaluation of Disclosure Controls and Procedures – Based on their evaluation, as of a date within 90 days prior to the date of the filing of this Form 10-Q, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) of the Securities exchange Act of 1934, as amended (the “Exchange Act”)), the principal executive officer and the principal financial officer of the Company have each concluded that such disclosure controls and procedures are effective and sufficient to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms.

Changes in Internal Controls – Subsequent to the date of their evaluation, there have not been any significant changes in the Company’s internal controls or in other factors that could significantly affect these controls, including any corrective action with regard to significant deficiencies and material weaknesses.

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PART II.     OTHER INFORMATION

Items 1 – 5:

Not applicable.

Item 6:     Exhibits and Reports on Form 8-K

(a.)   Exhibits

(b.)   Reports on Form 8-K

On February 14, 2003, the Company filed an 8-K related to its fiscal 2002 results.

On March 4, 2003, the Company filed an 8-K related to the purchase of 200,000 shares of Winmark Corporation Common Stock under its existing share repurchase plan.

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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

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EXHIBIT INDEX

WINMARK CORPORATION

FORM 10-Q FOR QUARTER ENDED MARCH 29, 2003

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