Overview

As of March 28, 2009, we had 909 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 $43.9 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 three months of 2009, our royalties increased $301,900 or 5.7% compared to the first three months of 2008. Franchise fees decreased $377,500 or 71.6% compared to the same period last year.

During the first three months of 2009, we purchased $4.9 million in equipment for lease contracts compared to $7.8 million in the first three 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 $43.9 million at March 28, 2009 from $45.4 million at December 27, 2008. Revenue generated from our leasing activities was $2,701,700 compared to $1,952,600 in the same period last year, an increase of 38.4%. (See Note 11 - "Segment Reporting"). Our earnings are also impacted by credit losses. During the first three months of 2009, our provision for credit losses increased to $419,700 from $385,100 in the first three months of 2008, as we continued to experience a higher level of net charge-offs and delinquencies in the small-ticket financing business portion of our leasing segment.

Management continually monitors the level and timing of selling, general and administrative expenses. The major components of selling, general and administrative expenses include salaries, wages and benefits, advertising, travel, occupancy, legal and professional fees. During the first three months of 2009, selling, general and administrative expense decreased $303,300, or 5.8%, compared to the first three 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 three months ended March 28, 2009:

                                                                           THREE MONTHS ENDING 3/28/09
                                                                            AVAILABLE
                                 TOTAL                           TOTAL         FOR           COMPLETED
                                12/27/08    OPENED    CLOSED    3/28/09      RENEWAL         RENEWALS
Play It Again Sports®
Franchises - US and Canada           364         1        (9 )      356               5                4

Once Upon A Child®
Franchises - US and Canada           229         2        (1 )      230               6                5

Plato's Closet®
Franchises - US and Canada           241         4        (2 )      243               4                4

Music Go Round®
Franchises - US                       36         0        (1 )       35               0                0

Total Franchised Stores              870         7       (13 )      864              15               13

Wirth Business Credit®
Territories - US                      54         0        (9 )       45               0                0

Total Franchises/Territories         924         7       (22 )      909              15               13

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 three months of 2009, we renewed 13 franchise agreements of the 15 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.

Results of Operations



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



                                                     Three Months Ended
                                               March 28, 2009   March 29, 2008
Revenue:
Royalties                                                60.9 %           60.1 %
Leasing income                                           29.2             22.0
Merchandise sales                                         6.8             10.5
Franchise fees                                            1.6              5.9
Other                                                     1.5              1.5
Total revenue                                           100.0 %          100.0 %
Cost of merchandise sold                                 (6.4 )          (10.1 )
Leasing expense                                          (7.4 )           (5.5 )
Provision for credit losses                              (4.5 )           (4.3 )
Selling, general and administrative expenses            (52.8 )          (58.4 )
Income from operations                                   28.9             21.7
Loss from equity investments                             (0.0 )           (0.9 )
Interest expense                                         (3.8 )           (3.9 )
Interest and other income                                 0.6              0.8
Income before income taxes                               25.7             17.7
Provision for income taxes                              (10.4 )           (7.2 )
Net income                                               15.3 %           10.5 %

Comparison of Three Months Ended March 28, 2009 to Three Months Ended March 29, 2008

Revenue

Revenues for the first three months of 2009 totaled $9.3 million compared to $8.9 million for the comparable period in 2008.

Royalties increased to $5.6 million for the first three months of 2009 from $5.3 million for the first three months of 2008, a 5.7% increase. The increase was due to higher Plato's Closet® and Once Upon A Child® royalties of $375,300 and $176,600, respectively, partially offset by lower Play It Again Sports® royalties of $250,600. The increase in Plato's Closet® and Once Upon A Child® royalties is primarily due to having 23 additional Plato's Closet® franchise stores in the first three months of 2009 compared to the same period last year and higher franchisee retail sales in both brands.

Franchise fees decreased to $150,000 for the first three months of 2009 compared to $527,500 for the first three months of 2008, primarily as a result of opening 21 fewer franchise territories in the 2009 period compared to the same period in 2008.

Leasing Income

Leasing income increased to $2,701,700 for the first three months of 2009 compared to $1,952,600 for the same period in 2008, a 38.4% increase. The increase is due to a larger lease portfolio in 2009 compared to 2008 as well as the classification of certain leases as sales-type leases in accordance with FASB Statement No. 13, Accounting for Leases. Our trailing-twelve-month average lease portfolio as of March 28, 2009 was $45.4 million compared to $34.8 million as of March 29, 2008.

Merchandise Sales

Merchandise sales include the sale of product to franchisees either through the Play It Again Sports® buying group, or through our Computer Support Center (together, "Direct Franchisee Sales"). Direct Franchisee Sales decreased 33.0% to $625,400 for the first three months of 2009 from $932,800 for 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 15 fewer Play It Again Sports® stores open than one year ago.

Cost of Merchandise Sold

Cost of merchandise sold includes in-bound freight and the cost of merchandise associated with Direct Franchisee Sales. Cost of merchandise sold decreased 33.3% to $595,900 for the first three months of 2009 from $893,900 for the same period last year. The decrease was primarily due to a decrease in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the first three months of 2009 and 2008 was 95.3% and 95.8%, respectively.

Leasing Expense

Leasing expense increased to $682,500 for the first three months of 2009 compared to $485,900 for the first three months of 2008. The increase is due to the classification of certain leases as sales-type leases in accordance with FASB Statement No. 13.

Provision for Credit Losses

Provision for credit losses increased to $419,700 for the first three months of 2009 compared to $385,100 for the first three months of 2008. The increase is primarily due to a higher level of net charge-offs and delinquencies in the small-ticket financing business portion of our leasing segment.

Selling, General and Administrative

The $303,300, or 5.8%, decrease in selling, general and administrative expenses in the first three months of 2009 compared to the same period in 2008 is primarily due to a decrease in advertising expenses.

Loss from Equity Investments

During the first three months of 2009 and 2008, we recorded losses of $3,500 and $75,800, respectively, from our investment in Tomsten (representing our pro-rata share of losses for the periods).

Income Taxes

The provision for income taxes was calculated at an effective rate of 40.5% for the first three months of 2009 and 2008, respectively.

Segment Comparison of Three Months Ended March 28, 2009 to Three Months Ended March 29, 2008

Franchising segment operating income

The franchising segment's operating income for the first three months of 2009 increased by $284,300, or 12.9%, to $2.5 million from $2.2 million for the first three months of 2008. The increase in segment contribution was primarily due to lower selling, general and administrative expenses, mainly advertising expenses.

Leasing segment operating income (loss)

The leasing segment generated operating income of $186,200 for the first three months of 2009 compared to a loss of ($272,200) during the first three months of 2008. This improvement was primarily due to a $749,100 increase in leasing income, partially offset by a $196,600 increase in leasing expense.

Liquidity and Capital Resources

Our primary sources of liquidity have historically been cash flow from operations and borrowings. The components of the income statement that affect our liquidity include non-cash items for depreciation, compensation expense related to stock options and loss from and impairment of equity investments. The most significant component of the balance sheet that affects liquidity is investments. Investments include $4.3 million of investments in two private companies: Tomsten, Inc. and BridgeFunds, LLC.

We ended the first quarter of 2009 with $5.0 million in cash and cash equivalents and a current ratio (current assets divided by current liabilities) of 1.4 to 1.0 compared to $1.5 million in cash and cash equivalents and a current ratio of 1.1 to 1.0 at the end of the first quarter of 2008.

Operating activities provided $2.8 million of cash during the first three months of 2009 compared to $1.6 million during the same period last year. Cash provided by operating assets and liabilities include an increase in deferred and current income taxes of $859,400, primarily due to tax depreciation on lease equipment purchases. Cash utilized by operating assets and liabilities include a $614,100 decrease in accrued and other liabilities due to a decrease in accrued compensation.

Investing activities used $0.4 million of cash during the first three months of 2009 compared to $3.8 million during the same period of 2008. The 2009 activities consisted primarily of the purchase of equipment for lease contracts of $4.9 million and collections on lease receivables of $5.5 million.

Financing activities provided $0.4 million of cash during the first three months of 2009 compared to $2.5 million during the same period of 2008. The 2009 activities were net proceeds from subordinated notes and discounted lease rentals of $2.8 million, net payments of $1.4 million on the line of credit and $0.9 million used to purchase 87,941 shares of our common stock.

As of March 28, 2009, we had no off balance sheet arrangements.

As of March 28, 2009, our borrowing availability under our Amended and Restated Revolving Credit Agreement (the "Credit Facility"), which provides for an aggregate commitment of $55.0 million subject to certain borrowing base limitations, was $55.0 million (the lesser of the borrowing base or the aggregate line of credit). There were $12.2 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 $42.8 million available for additional borrowings.

The Credit Facility has been and will continue to be used for growing our leasing business, stock repurchases and general corporate purposes. The Credit Facility is secured by a lien against substantially all of our assets, contains customary financial conditions and covenants, and requires maintenance of minimum levels of debt service coverage and tangible net worth and maximum levels of leverage (all as defined within the Credit Facility). As of March 28, 2009, we were in compliance with all of our financial covenants.

On April 19, 2006, we announced the filing of a "shelf registration" on Form S-1 registration statement with the Securities and Exchange Commission for the sale of up to $50 million of renewable subordinated unsecured notes with maturities from three months to ten years. In June 2006, the Form S-1 registration became effective. In March 2007, we filed Post-Effective Amendment No. 2 to the public offering that was declared effective March 30, 2007. In November 2007, we filed Post-Effective Amendment No. 3 to the public offering that was declared effective November 29, 2007. In March 2008, we filed Post-Effective Amendment No. 4 to the public offering that was declared effective March 27, 2008. In March 2009, we filed Post-Effective Amendment No. 5 to the public offering that was declared effective March 27, 2009. We have in the past and continue to intend to use the net proceeds from the offering to pay down our credit facility, expand our leasing portfolio, to make acquisitions, to repurchase common stock and for other general corporate purposes. As of March 28, 2009, $29.5 million of the renewable subordinated notes have been sold.

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

We believe that the combination of our cash on hand, the cash generated from our franchising business, cash generated from discounting sources, our bank line of credit as well as our renewable subordinated unsecured notes, will be adequate to fund our planned operations, including leasing activity, for 2009.

Critical Accounting Policies

The Company prepares the consolidated financial statements of Winmark Corporation and Subsidiaries in conformity with accounting principles generally accepted in the United States of America. As such, the Company is required to make certain estimates, judgments and assumptions that it believes are reasonable based on information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. There can be no assurance that actual results will not differ from these estimates. The critical accounting policies that the Company believes are most important to aid in fully understanding and evaluating the reported financial results include the following:

Revenue Recognition - Royalty Revenue and Franchise Fees

The Company collects royalties from each retail franchise based on a percentage of retail store gross sales. The Company recognizes royalties as revenue when earned. At the end of each accounting period, estimates of royalty amounts due are made based on applying historical weekly sales information to the number of weeks of unreported franchisee sales. If there are significant changes in the actual performances of franchisees versus the Company's estimates, its royalty revenue would be impacted. During the first three months of 2009, the Company collected $33,500 more than it estimated at December 27, 2008. As of March 28, 2009, the Company's royalty receivable was $1,149,400.

The Company collects initial franchise fees when franchise agreements are signed and recognizes the initial franchise fees as revenue when the franchise is opened, which is when the Company has performed substantially all initial services required by the franchise agreement. Franchise fees collected from franchisees but not yet recognized as income are recorded as deferred revenue in the liability section of the consolidated balance sheet. As of March 28, 2009, deferred franchise fees were $935,800.

Stock-Based Compensation

The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of the awards on the date of grant using an option-pricing model is affected by stock price as well as assumptions regarding a number of complex and subjective variables. These variables include implied volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

The Company evaluates the assumptions used to value awards on an annual basis. If factors change and the Company employs different assumptions for estimating stock-based compensation expense in future periods or if the Company decides to use a different valuation model, the future periods may differ significantly from what it has recorded in the current period and could materially affect operating income, net income and earnings per share.

Impairment of Long-term Investments

The Company evaluates its long-term investments for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. The impairment, if any, is measured by the difference between the assets' carrying amount and their fair value, based on the best information available, including market prices, discounted cash flow analysis or other financial metrics that management utilizes to help determine fair value. Judgments made by management related to the fair value of its long-term investments are affected by factors such as the ongoing financial performance of the investees, additional capital raised by the investees as well as general changes in the economy.

Leasing Income Recognition

Leasing income is recognized under the effective interest method. The effective interest method of income recognition applies a constant rate of interest equal to the internal rate of return on the lease. Generally, when a lease is 90 days or more delinquent, the lease is classified as being on non-accrual and the Company stops recognizing leasing income on that date.

Allowances for Credit Losses

The Company maintains an allowance for credit losses at an amount that it believes to be sufficient to absorb losses inherent in its existing lease portfolio as of the reporting dates. A provision is charged against earnings to maintain the allowance for credit losses at the appropriate level. If the actual results are different from the Company's estimates, results could be different. The Company's policy is to charge-off against the allowance the estimated unrecoverable portion of accounts once they reach 121 days delinquent.

Forward Looking Statements

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, the Company's belief that it will have adequate capital and reserves to meet its current and contingent obligations and operating needs, as well as its disclosures regarding market rate risk 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. Investors are cautioned to consider these forward looking statements in light of important factors which may result in material variations between results contemplated by such forward looking statements and actual results and conditions. See the section appearing in our annual report on Form 10-K for the fiscal year ended December 27, 2008 entitled "Risk Factors" and Part II, Item 1A in this Report for a more complete discussion of certain factors that may cause the Company's actual results to differ from those in its forward looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date they were made. The Company undertakes no obligation to revise or update publicly any forward-looking statements for any reason.