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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 of

the Securities Exchange Act of 1934

For the fiscal year ended December 28, 2002

Commission File Number:  000-22012

WINMARK CORPORATION

(Exact name of Registrant as specified in its charter)

4200 Dahlberg Drive, Suite 100, Minneapolis, MN 55422-4837

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number:  (763) 520-8500

Securities registered pursuant to Section 12 (b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value per share

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  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 126-2 of the Act).

Yes  ¨        No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of such stock on March 10, 2003, as reported on the Nasdaq SmallCap Market, was $16,212,801 million.

Shares of no par value Common Stock outstanding as of March 10, 2003:  5,607,197 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the Registrant’s Annual Meeting of Shareholders to be held on April 30, 2003 have been incorporated by reference into Items 10, 11, 12 and 13 of Part III of this report.

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WINMARK CORPORATION AND SUBSIDIARY

INDEX TO ANNUAL REPORT ON FORM 10-K

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ITEM 1: BUSINESS

Background

Winmark Corporation, a Minnesota corporation, (referred to herein as “Company,” “we,” “us,” “our” and other similar terms) is a franchisor of four retail brands that buy, sell, trade and consign merchandise. The Company was incorporated in Minnesota in 1988.

Each of our retail store brands emphasizes consumer value by offering high-quality used merchandise at substantial savings from the price of new merchandise and by purchasing customers’ used goods that have been outgrown or are no longer used. The stores also offer new merchandise to customers.

Our significant assets are located within the United States, and we generate all revenues from United States operations other than 2002 franchising revenues from Canadian operations of approximately $1.7 million.

Our four store brands with their fiscal year 2002 system-wide sales, defined as revenues from all franchised and Company owned stores, are summarized as follows:

Play It Again Sports^® - $257 million

We began franchising the Play It Again Sports^® brand in 1988. Play It Again Sports^® stores sell, buy, trade and consign used and new sporting goods, equipment and accessories for a variety of athletic activities including hockey, wheeled sports (in-line skating, skateboards, etc.), fitness, ski/snowboard, golf and baseball/softball. The stores offer a flexible mix of merchandise that is adjusted to adapt to seasonal and regional differences. Play It Again Sports^® is known for providing the highest value to the customer by offering a mix of used and new sporting goods.

Once Upon A Child^® - $88 million

We began franchising the Once Upon A Child^® brand in 1993. Once Upon A Child^® stores sell and buy used and new children’s clothing, toys, furniture, equipment and accessories. This store brand primarily targets cost-conscious parents of children ages infant to 10 years with emphasis on children ages seven years old and under. These customers have the opportunity to sell their used children’s items to a Once Upon A Child^® store when outgrown and to purchase quality used children’s clothing, toys, furniture and equipment at prices lower than new merchandise. New merchandise is offered to supplement the used merchandise.

Music Go Round^® - $31 million

We began franchising the Music Go Round^® brand in 1994. Music Go Round^® stores sell, buy, trade and consign used and new musical instruments, speakers, amplifiers, music-related electronics and related accessories for parents of children who play musical instruments, as well as professional and amateur musicians.

Plato’s Closet^® - $34 million

We began franchising the Plato’s Closet^® brand in 1999. Plato’s Closet^® stores sell and buy used and new clothing and accessories geared toward the teenage and young adult market. Customers also have the opportunity to sell their used items to a Plato’s Closet^® store when outgrown and to purchase quality used clothing and accessories at prices lower than new merchandise.

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Following is a summary of our franchising and corporate store activity for the fiscal year ended December 28, 2002:

Franchising Overview

We use franchising as a business method of distributing goods and services through our retail brands to consumers. We, as franchisor, own a business brand, represented by a service mark or similar right, and an operating system for the franchised business. We then enter into franchise agreements with franchisees and grant the franchisee the right to use our business brand, service marks and operating system to manage a retail business. Franchisees are required to operate their businesses in accordance with the systems, specifications, standards and formats we develop for the business brand. We train the franchisees on how to operate the franchised business. We also provide continuing support and service to our franchisees.

Business Strategy

Our business strategy is to develop value-oriented retail brands based on a mix of used and new merchandise and to franchise rights to franchisees who open franchised stores under such brands. The key elements of this strategy include (i) franchising the rights to operate retail stores offering value-oriented merchandise, (ii) attracting new, qualified franchisees and (iii) provide initial and continuing support to franchisees. The Company has and intends to reinvest operating cash flow generated from its business into (i) supporting the current franchise system, (ii) making investments in infrastructure to support our corporate needs and (iii) pursuing investment opportunities.

1. Offering Value-Oriented Merchandise

Our retail brands provide value to consumers by purchasing and reselling used merchandise that consumers have outgrown or no longer use at substantial savings from the price of new merchandise. We also offer value-priced new merchandise. By offering a combination of high-quality used and value-priced new merchandise, we benefit from consumer demand for value-oriented retailing. In addition, we believe that among national retail operations our retail store brands provide a unique source of value to consumers by purchasing used merchandise. We also believe that the strategy of buying used merchandise increases consumer awareness of our retail brands.

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2. Attracting Franchisees

Our franchise marketing program seeks to attract prospective franchisees with experience in management and operations and an interest in being the owner and operator of their own business. We seek franchisees who: (i) have a sufficient net worth, (ii) have prior business experience, and (iii) intend to be integrally involved with the management of the store. At December 28, 2002, we had 22 franchise agreements for stores that are expected to open in 2003.

We began franchising in Canada in 1991 and, as of December 28, 2002, had 81 franchised stores open in Canada. The Canadian stores are operated by franchisees under agreements substantially similar to those used in the United States.

3. Franchise Support

As a franchisor, our success depends upon our ability to develop and support competitive and successful franchise brands. We emphasize the following areas of franchise support and assistance.

Training

Each franchisee must attend our training program regardless of prior experience. Soon after signing a franchise agreement, the franchisee is required to attend new owner orientation training. This course covers basic management issues, such as preparing a business plan, lease evaluation, evaluating insurance needs and obtaining financing. Our training staff assists each franchisee in developing a business plan for their store with financial and cash flow projections. The second training session is centered on store operations. It covers, among other things, point-of-sale computer training, inventory selection and acquisition, sales, marketing and other topics. We provide the franchisee with operations manuals that we periodically update.

Field Support

We provide operations personnel to assist the franchisee in the opening of a new business. We also have an ongoing field support program designed to assist franchisees in operating their stores. Our franchise support personnel visit each store periodically and, in most cases, a business assessment is made to determine whether the franchisee is operating in accordance with our standards. The visit is also designed to assist franchisees with operational issues.

Purchasing

During training each franchisee is taught how to evaluate, purchase and price used goods. In addition to purchasing used products from customers who bring merchandise to the store, the franchisee is also encouraged to develop sources for purchasing used merchandise in the community. Franchisees typically do not repair or recondition used products, but rather, purchase quality used merchandise that may be put directly on display for resale on an ‘as is’ basis. We have developed specialized computer point-of-sale systems for Once Upon A Child^® and Plato’s Closet^® stores that provide the franchisee with standardized pricing information to assist in the purchasing of used items. Play It Again Sports^® and Music Go Round^® also use buying guides and the point-of-sale system to assist franchisees in pricing used items.

We provide centralized buying services including credit and billing for the Play It Again Sports^® franchisees. Upon credit approval, Play It Again Sports^® franchisees may order through the buying group, in which case, product is drop-shipped directly to the store by the vendor. We are invoiced by the vendor and, in turn, we invoice the franchisee adding a 4% service fee to cover our costs of operating the buying group. Our Play It Again Sports^® franchise system uses several major vendors including Bauer^® Nike Hockey, The Hockey Company and Keys Fitness. The loss of any of the above vendors would change the vendor mix, but not significantly change our product offered.

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To provide the franchisees of our Plato’s Closet^®, Once Upon A Child^®, and Music Go Round^® systems a source of affordable new product, we have developed relationships with our significant vendors and negotiated prices for our franchisees to take advantage of the buying power a franchise system brings.

Our typical Once Upon A Child^® franchised store purchases approximately 75% of its new product from Graco^®, Million Dollar Baby and Cosco^®. While we believe that there are several other vendors that could adequately replace the loss of any of these three major vendors, it would alter the selection of product offered.

There are no significant vendors to our typical Music Go Round^® or Plato’s Closet^® franchised store.

Retail Advertising and Marketing

We encourage our franchisees to implement a marketing program that includes one or more of the following: television, radio, direct mail, point-of-purchase materials, in store signage and local store marketing programs. Through these mediums, we advertise that we buy, sell and trade used and new items. Franchisees of the respective brands are required to spend the following minimum percentage of their gross sales on approved advertising and marketing: Play It Again Sports^® - 5%, Once Upon A Child^® - 5%, Music Go Round^® - 3% and Plato’s Closet^® - 4%. In addition, all franchisees are required to pay us an annual marketing fee of $500. Franchisees may be required to participate in regional cooperative advertising groups.

Computerized Point-Of-Sale Systems

We require franchisees to use a retail information management computer system in each store, which has evolved with the development of new technology. Stores which were opened prior to April 1992 were not required to install the system. This computerized point-of-sale system is designed specifically for use in our franchise retail stores. The current system includes our proprietary Data Recycling System^® software (unless a franchisee receives approval for another acceptable software program), a dedicated server, one or more work station registers, a receipt printer, a report printer and a bar code scanner, together with software modules for inventory management, cash management and customer information management. We generally require franchisees to purchase their computer hardware from us. The Data Recycling System^® software is designed to accommodate buying and consigning of used merchandise. This system provides franchisees with an important management tool that reduces errors, increases efficiencies and enhances inventory control. We provide both computer software and hardware support for the system through our Computer Support Center located at our Company headquarters.

Winmark Business Solutions

In November 2002, we established Winmark Business Solutions to provide support to franchisees beyond that typically provided by a franchisor as well as other small businesses. Winmark Business Solutions focuses on providing training, information, products and services, directly or through third parties, that focuses on making franchisees and small businesses more successful.

Other Support Services

We assist each new franchisee with site location by providing demographic data and general site selection information. A third party vendor provides design layouts and opening materials including pricing materials, stationary, signage, fixtures, slatwall and carpeting. Additional communication with franchisees is made through weekly news updates, emails, broadcast faxes, extranet and semi-annual conferences which generally include trade shows.

The Franchise Agreement

We enter into franchise agreements with our franchisees. The following is a summary of certain key provisions of our current standard franchise agreement. Except as noted, the franchise agreements used for each of our business brands are generally the same.

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Each franchisee must execute our franchise agreement and pay an initial franchise fee. At December 28, 2002, the franchise fee for all brands was $20,000 for an initial store. Once a franchisee opens its initial store, it can open additional stores, in any brand, by paying a $15,000 franchise fee, provided an acceptable territory is available and the franchisee meets minimum standards. Typically, the franchisee’s initial store is open for business within 270 days from the date the franchise agreement is signed. The franchise agreement has an initial term of 10 years, with subsequent 10-year renewal periods, and grants the franchisee an exclusive geographic area which will vary in size depending upon population, demographics and other factors. A renewal fee equal to $5,000 is payable to us as part of any franchise renewal. As an incentive, we generally refund the renewal fee if a franchisee modernizes its store to meet our standards. Under current franchise agreements, franchisees of the respective brands are required to pay us weekly continuing fees (royalties) equal to the following percentage of gross sales: Play It Again Sports^® - 5%, Once Upon A Child^® - 5%, Music Go Round^® - 3% and Plato’s Closet^® - 4%. Upon completion of the initial 10-year term, Play It Again Sports^® and Once Upon A Child^® royalties are adjusted to 4%. Play It Again Sports^® franchisees opening their second or additional store pay us a 4% royalty for that store.

Each franchisee is required to pay us an annual marketing fee of $500. Each Play It Again Sports^® and Once Upon A Child^® franchisee is required to spend 5% of its gross sales for advertising and promoting its franchised store. We have the option to increase the minimum advertising expenditure requirement for these franchises to 6% of the franchisee’s gross sales, of which up to 2% would be paid to us as an advertising fee for deposit in an advertising fund. This fund would be managed by us and would be used for advertising and promotion of the franchise system. We expect to initiate this advertising fund when we determine that the respective franchise system warrants such an advertising and promotion program. Music Go Round^® franchisees are required to spend at least 3% of gross sales for approved advertising. We have the option to increase the minimum advertising expenditure requirement for these franchises to a total of 4% of the franchisee’s gross sales, of which up to one-third would be paid to us as an advertising fee for deposit into an advertising fund. Plato’s Closet^® franchisees are required to spend at least 4% of gross sales for approved advertising. We have an option to increase the minimum advertising expenditure requirement for these franchises up to at total of 5% of franchisee’s gross sales, of which up to 2% would be paid to us as an advertising fee for deposit into an advertising fund.

During the term of a franchise agreement, franchisees agree not to operate directly or indirectly any competitive business. In addition, franchisees agree that after the end of the term or termination of the franchise agreement, franchisees will not operate any competitive business for a period of one year and within a reasonable geographic area. We will pursue enforcement of our noncompetition clause vigorously; however, these noncompetition clauses are not enforceable in certain states or in all circumstances.

Although our franchise agreements contain provisions designed to assure the quality of a franchisee’s operations, we have less control over a franchisee’s operations than we would if we owned and operated the store. Under the franchise agreement, we have a right of first refusal on the sale of any franchised store, but we are not obligated to repurchase any franchise.

Renewal of the Franchise Relationship

At the end of the 10-year term of each franchise agreement, each franchisee has the option to “renew” the franchise relationship by signing a new 10-year franchise agreement. If a franchisee chooses not to sign a new franchise agreement, a franchisee must comply with all post termination obligations including the franchisee’s noncompetition clause discussed above. This noncompetition clause may not be enforceable in certain states or in all circumstances. We may choose not to renew the franchise relationship only when permitted by the franchise agreement and applicable state law.

In 2002, 114 Play It Again Sports^® franchise agreements expired. Of those franchise relationships, 102 were “renewed” with the signing of a new 10-year franchise agreement. In 2003, 2004 and 2005, 68, 42 and 30 Play It Again Sports^® franchise agreements will expire, respectively. We believe that renewing a significant number of these franchise relationships is important to the success of this franchise system.

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Two Once Upon A Child^® franchise agreements expired in 2002, one franchise relationship was renewed for an additional 10-year period. In 2003, 2004 and 2005, 37, 42 and 19 Once Upon A Child^® franchise agreements will expire, respectively. We believe that renewing a significant number of these franchise relationships is important to the success of the Company.

None of our other franchise systems have franchise agreements that will expire in 2003.

Acquisition and Dispositions

We acquired the rights to Play It Again Sports^® in 1988 and, since that date, have made a series of acquisitions and dispositions to grow, diversify and divest, in certain cases, our franchise brands. Our more recent acquisitions and dispositions are listed below.

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Competition

Retailing, including the sale of sporting goods, children’s and teenage apparel, and musical instruments, is highly competitive. Many retailers have substantially greater financial and other resources than we do. Our franchisees compete with established, locally owned retail stores, discount chains and traditional retail stores for sales of new merchandise. Full line retailers generally carry little or no used merchandise. Resale, thrift and consignment shops and garage and rummage sales offer some competition to our franchisees for the sale of used merchandise. We are aware of, and compete with, one franchisor of stores which sells new and used sporting equipment, two franchisors of stores which sell used and new children’s clothing, toys and accessories and one franchisor of teen apparel stores.

Our Play It Again Sports^® franchisees compete with large retailers such as The Sports Authority^®, Gart Sports and Oshman’s as well as regional and local sporting goods stores. We also compete with department stores such as Target^® and Wal-Mart^®.

Our Once Upon A Child^® franchisees compete primarily with large retailers such as Babies “R” Us^®, Wal-Mart^®, Target^® Stores and various specialty children’s retail stores such as Gap^® Kids.

Our Plato’s Closet^® franchise stores compete with specialty apparel stores primarily such as Gap^®, Abercrombie & Fitch^®, Old Navy^®, Banana Republic^® and The Limited^®. We compete with one other franchisor in the teenage clothing retail market.

Our Music Go Round^® franchise stores compete with large musical instrument retailers such as Guitar Center^® and Sam Ash Music^®. We do not believe we compete with any other franchisor directly in relation to the used and new musical instrument market.

Our franchisees may face additional competition in the future. This could include additional competitors that may enter the used merchandise market. We believe that our franchisees will continue to be able to compete with other retailers based on the strength of our value-oriented brands and the name recognition associated with our service marks.

We also face competition in connection with the sale of franchises. Our prospective franchisees frequently evaluate other franchise opportunities before purchasing a franchise from us. We compete with other franchise companies for franchisees based on the following factors, among others: amount of initial investment, franchise fee, royalty rate, profitability and industry. We believe that our franchise brands are competitive with other franchises based on the fees we charge, our franchise support services and the performance of our existing franchise brands.

Government Regulation

Fourteen states, the Federal Trade Commission and two Canadian Provinces impose pre-sale franchise registration and/or disclosure requirements on franchisors. In addition, a number of states have statutes which regulate substantive aspects of the franchisor-franchisee relationship such as termination, nonrenewal, transfer, discrimination among franchisees and competition with franchisees.

Additional legislation, both at the federal and state levels, could expand pre-sale disclosure requirements, further regulate substantive aspects of the franchise relationship and require us to file our franchise offering circulars with additional states. We cannot predict the effect of future franchise legislation, but do not believe there is any imminent legislation currently under consideration which would have a material adverse impact on our operations.

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Trademarks and Service Marks

Play It Again Sports^®, Once Upon A Child^®, Music Go Round^® and Plato’s Closet^®, among others, are our registered service marks. Winmark^™ has been filed with the United States Patent and Trademark Office. These marks are of considerable value to our business. They support our franchise brands and our marketing and sales efforts. We intend to protect our service marks by appropriate legal action where and when necessary. Each service mark registration must be renewed every 10 years. We have, and intend to, continue to take all steps necessary to renew the registration of all our material service marks.

Seasonality

Our Play It Again Sports^® and Music Go Round^® franchise brands have experienced higher than average sales volumes during the holiday shopping season. Our Once Upon a Child^® and Plato’s Closet^® franchise brands have experienced higher than average sales volumes during the spring months and, along with our Music Go Round^® brand, also during the back to school season. Overall, the different seasonal trends of our brands partially offset each other and do not result in significant seasonality trends on a Company-wide basis.

Employees

As of December 28, 2002, we employed 117 full-time employees, of which 2 were franchise salespersons, 73 were franchise support personnel, 21 were administrative and 21 were retail sales staff. We also employed 34 part-time employees at our Company-owned retail stores as of fiscal year end 2002.

ITEM 2: PROPERTIES

We lease our headquarters facility in Golden Valley, Minnesota. We pay annual base rent of $218,980 plus 55% of common area maintenance charges for the building. The lease expires in July 2004. Our facilities are sufficient to meet our current needs and our immediate future needs.

At December 28, 2002, we leased space for our 8 retail store locations, typically for a fixed monthly rental and operating costs. Four leases are due to expire in 2003, three in 2004 and one in 2008.

ITEM 3: LEGAL PROCEEDINGS

We are not a party to any material litigation and are not aware of any threatened litigation that would have a material adverse effect on our business.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2002.

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PART II

ITEM 5: MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

Market Information; Holders; Dividends

Our common stock is traded on the Nasdaq SmallCap Market under the symbol “WINA”. The table below sets forth the high and low bid prices of our common stock as reported by Nasdaq for the periods indicated:

The above quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. At March 10, 2003, there were 5,607,197 shares of common stock outstanding held by approximately 874 beneficial shareholders and 183 shareholders of record. We have not paid any cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future.

Securities Authorized for Issuance Under Equity Compensation Plans

The following information reflects certain information about our equity compensation plans as of December 28, 2002:

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ITEM 6: SELECTED FINANCIAL DATA.

The following table sets forth selected financial information for the periods indicated. The information should be read in conjunction with the financial statements and related notes discussed in Item 8 and 15, and Management’s Discussion and Analysis of Financial Condition and Results of Operations discussed in Item 7.

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Results of Operations

The following table sets forth selected information from the Company’s Consolidated Statements of Operations expressed as a percentage of total revenue and the percentage change in the dollar amounts from the prior period:

Revenues

Merchandise sales, which 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, are as follows:

The Play It Again Sports^® buying group revenue declined in 2002 compared to 2001 as a result of management’s strategic decision to have more Play It Again Sports^® franchisees purchase merchandise directly from vendors and having approximately 28 fewer Play It Again Sports^® stores open than one year ago. The buying group revenue decline in 2001 compared to 2000 was a result of having 48 fewer Play It Again Sports^® open as well as the Company’s re-evaluation of its extension of credit with certain franchisees. The Play It Again Sports^® buying group does not contribute to the Company’s net income.

The decrease in retail store sales in 2002 compared to 2001 is due to closing three Company-owned stores in 2001, partially offset by aggregate increased sales at the remaining Company-owned stores. The decrease in retail sales at Company-owned stores for 2001 compared to 2000 is a result of selling or closing five Company-owned stores in 2000.

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Revenues from franchising activity were as follows:

Our franchisees pay us royalties on their retail net sales from their store operations. Royalties are 3% to 5% of net sales, depending on the brand. Royalties increased to $16.4 million for the fiscal year ended 2002 from $15.6 million for the fiscal year ended 2001, a 5.3% increase. This increase is due to increased franchise store retail sales primarily in Play It Again Sports^® and a result of having 76 franchised Plato’s Closet^® stores open at December 28, 2002 compared to 45 Plato’s Closet^® stores at December 29, 2001. In 2001, royalties decreased $879,100 compared to 2000. This decrease is due to the sale of the Computer Renaissance^® brand in August 2000, partially offset by aggregate increase of royalty income from the remaining brands. If royalties related to Computer Renaissance^® are excluded from royalties earned in 2000, royalties increased 4.5% in 2001 compared to 2000.

Franchise fees include initial franchise fees from the sale of new franchises and transfer fees related to the transfer of existing franchises. Franchise fee revenue is recognized when the store opens or when the franchise agreement is assigned to a buyer of a franchise. During 1999, the Company revised its fee schedule by eliminating franchise fees for all stores other than the first store opened by a franchisee. As of August 1, 2000, existing franchisees are required to pay an initial franchise fee of $15,000 for each additional franchise. Franchise fees increased to $769,000 for 2002 compared to $722,700 for 2001. Forty-six franchised stores were opened in 2002 compared to 43 franchised stores opened during 2001. Ten stores that opened in 2002 were not required to pay a franchise fee compared to 20 stores in 2001. Franchise fees in 2001 declined $191,300, or 20.9%, from 2000 as a result of opening 43 franchise stores in 2001 compared to 74 in 2000. Twenty stores were opened during 2001 that were not required to pay a franchise fee compared to 29 stores in 2000.

The impact of years 2002 and 2001 being 52 weeks and 2000 being 53 weeks was not significant to comparability between the periods.

Cost of Merchandise Sold

Cost of merchandise sold includes the cost of merchandise sold through the Play It Again Sports^® 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 retail store revenue over the past three years is shown in the following table:

The 2.7 percentage point decrease in 2002 cost of merchandise sold at the Company-owned stores is primarily due to better inventory management and the Company’s efforts to improve its used inventory purchasing methods. The 7.6% percentage point decrease in the 2001 cost of merchandise sold at the Company-owned stores is primarily due to closing under-performing Company-owned stores.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $619,800, or 4.0% in 2002 compared to 2001 primarily due to closing three Company-owned stores in 2001 and the elimination of related costs. The $3.3 million decrease in 2001 selling, general and administrative expenses is primarily due to selling the Computer Renaissance^® brand in the third quarter of 2000 and the elimination of related costs and lower salary expense of remaining operations.

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Sale of Computer Renaissance^®

In August 2000, the Company completed the disposition of substantially all the assets related to the Computer Renaissance^® franchising and retailing operations for $3.0 million to Hollis Technologies, LLC and CompRen, Inc. (“Hollis”). One million dollars of the purchase price was to be held in an escrow account for up to 18 months from August 30, 2000. Amounts received from the escrow were recorded as additional income when received. In addition, the Company entered into a five-year $2.0 million consulting agreement to provide ongoing franchise and business consulting services to Hollis. Pursuant to the Consulting Agreement, Hollis agreed to make 60 equal monthly payments of $33,333 to the Company over the term of the agreement.

On August 1, 2001, the Company entered into a Settlement Agreement and Mutual Release with Hollis to settle claims Hollis asserted against $1.0 million of escrowed funds. Pursuant to the Settlement Agreement and Mutual Release, the parties terminated the escrow agreement, released each other from certain claims, and Hollis and the Company received approximately $400,000 and $600,000 of the escrowed funds, respectively. In addition, all accrued interest on the escrowed funds was distributed to the Company. The Company dismissed its lawsuit against Hollis seeking the escrowed funds. On September 25, 2001, the Company received $200,000 for full settlement of all amounts that would otherwise have been payable under the consulting agreement. The Company recorded $1,112,300 as the total settlement amount under these agreements during 2001. As disclosed in Note 4 to the Company’s December 30, 2000 annual report on Form 10-K, the Company has been accounting for the above-described matters on the cash basis of accounting due to their uncertainty of collection. No further amounts are due or expected to be incurred under these agreements.

Sale of Corporate Headquarters

On July 10, 2000, the Company sold its corporate headquarters facility to Koch Trucking, Inc. for $3.5 million in cash. Net proceeds from the sale were used to pay down then existing bank debt. The Company entered into a four-year lease for approximately 55% of the facility pursuant to which the Company will pay annual base rent of $218,980. The sale resulted in a $731,000 gain which is being recognized over the 48-month lease term. For the year ended December 28, 2002, $183,100 of deferred gain was recognized.

Nonrecurring Charge

The Company recorded a pre-tax, nonrecurring charge of $3.3 million in the second quarter of 2000. This charge consisted primarily of two components. First, approximately $2.0 million relates to management’s assessment of current information relating to notes receivable and lease obligations booked in connection with the 1998 sale of Company-owned stores. The other component relates to re-evaluating its brands and Company-owned stores that are not performing at expected levels. As a result of this re-evaluation, certain intangible assets were written-down to reflect estimated realizability of long-lived assets.

Net Interest

During 2002, the Company had net interest income of $44,400 compared to $723,700 and $944,100 of net interest expense in 2001 and 2000, respectively. This change is primarily due to the increase of interest income, offset by acceleration of the remaining debt issuance expense of $210,000 related to the Company’s termination of the Rush River Credit Facility in the fourth quarter of 2002. The decrease in net interest expense in 2001 is primarily the result of reduced outstanding debt in 2001 compared to 2000, offset by accelerated amortization of debt issuance cost of $429,700 related to early debt repayment.

Income Taxes

The provision for income taxes was calculated at an effective rate of 39.9% and 39.2% for 2002 and 2001, respectively.

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Significant Accounting Policies

We prepare the consolidated financial statements of Winmark Corporation and Subsidiary in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe 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 and revenues and expenses during the periods presented. There can be no assurance that actual results will not differ from these estimates. The following significant accounting policies that we believe are most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition

The Company collects royalties from each 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 historical sales information. If there are significant changes in the estimates of franchise sales our revenue would be impacted.

The Company collects franchise fees when franchise agreements are signed and recognizes the franchise fees as revenue when the store 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 our balance sheet. Merchandise sales through the buying group are recognized when the product has been shipped. Revenue from sales at our Company-owned stores are recognized at the time of the merchandise sale.

Allowance for doubtful accounts

We must make estimates of the uncollectability of our accounts and notes receivables. We base the adequacy of the allowance on historical bad debts, current economic trends and specific analysis of each franchisee’s payment trends and credit worthiness. If any of the above noted items would be significantly different than estimates, the results could be different.

Inventory Reserve

The Company values its inventory at the lower of cost, as determined by the average weighted cost method, or market. We make estimates to establish our inventory reserve. We base the adequacy of our reserve on detailed analysis of existing inventory, the age of the inventory and current trends. If any of the above noted items would be significantly different than estimates, the results could be different.

Liquidity and Capital Resources

The Company’s primary sources of liquidity have historically been cash flow from operations and bank borrowings. The Company ended 2002 with $6.6 million in cash and short-term investments and a current ratio (current assets divided by current liabilities) of 2.78 to 1.0 compared to $3.2 million in cash and short-term investments and a current ratio of 1.89 to 1.0 at the end of 2001.

Ongoing operating activities provided cash of $5.4 million for 2002 compared to $7.4 million for 2001. The higher level of cash provided in 2001 compared to 2002 was primarily due to improved efforts of collecting accounts receivable in 2001 partially offset by an increase in net income of $631,400 in 2002. For 2002, components of the cash provided by changes in operating assets and liabilities include a $690,500 decrease in accounts receivable as a result of improved collection performance and a reduction in buying group activity. Deferred franchise fee revenue provided cash of $60,100 due to increased deposits on future store openings. Inventory provided cash of $363,300 due to reduced inventory levels at the Company-owned stores.

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Components of cash utilized by operating assets and liabilities include a $910,300 decrease in accrued liabilities primarily due to lower accruals for employee bonuses, legal fees and lease and restructuring reserves. Accounts payable utilized $151,700 due primarily to lower balance related to buying group. Ongoing operating activities provided cash of $10.2 million for 2000.

Investing activities used $4.8 million and $940,500 of cash during 2002 and 2001, respectively, and primarily relates to the purchase of investments. Investing activities provided $3.0 million of cash during 2000 primarily from the sale of the Company’s corporate headquarters facility.

Financing activities provided $1.0 million of cash during 2002 principally from cash received on the exercise of options and warrants offset by payments on long-term debt. The payments on long-term debt includes $82,800 to Tool Traders, Inc. as part of a full and final settlement and $116,700 on other notes. Financing activities used $5.4 million of cash during 2001 compared to $11.1 million for 2000. For 2001, the payments on long-term debt also includes $4.9 million to pay in full on the Rush River Group, LLC credit facility and $505,900 on other notes. In 2001, the Company received $22,900 in cash from options exercised to purchase stock and repurchased 8,900 shares of its stock for an aggregate purchase price of $66,800. Under our share repurchase plan, we have repurchased 2,769,728 shares of the Company’s Common Stock since November 1995. Under such plan, we have the authority to repurchase an additional 230,272 shares from time to time at prevailing prices.

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 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 was exercised on May 21, 2002.

The Company had future commitments for leased facilities and for the Tomsten, Inc. subscription at December 28, 2002. The future contractual cash obligations related to the commitments are as follows:

As of December 28, 2002, the Company had no other material outstanding commitments for capital expenditures.

On July 30, 2002, the Company executed a subscription agreement with Tomsten, Inc., the parent company of the “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 Company agreed to invest a total of $6 million in the purchase of common stock of Tomsten, Inc. The initial $2 million was paid on July 30, 2002, with additional $2 million increments due on February 1, 2003 and August 1, 2003. Under the subscription agreement, we made a $2 million investment on or about February 1, 2003.

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 investment in “Archiver’s”, and operating needs.

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Outlook

Forward Looking Statements

The statements contained in the letter from the CEO and the President, Item 1 “Business” and in this Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not strictly historical fact, including without limitation, our statements relating to growth opportunities, the number of stores we believe will open and our belief that we will have adequate capital and 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 which 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 variations from results contemplated by such forward looking statements including, but not limited to the risk factors discussed below.

Risk Factors

Dependence on Renewals. Each of our franchise agreements is 10 years long. At the end of the term of each franchise agreement, each franchisee has the option to “renew” the franchise relationship by signing a new 10-year franchise agreement.

In 2002, of the 114 franchisees that had their Play It Again Sports^® franchise agreement expire, 102 signed new 10-year franchise agreements. In 2003, 2004 and 2005, 68, 42 and 30 Play It Again Sports^® franchise agreements will expire, respectively. We believe that renewing a significant number of these franchise relationships is extremely important to the success of the Company. If a significant number of such franchise relationships are not renewed, our financial performance may be materially and adversely affected.

Two Once Upon A Child^® franchise agreement expired in 2002 and 1 franchise relationship was renewed by the franchisee signing a new 10-year franchise agreement. In 2003, 2004 and 2005, 37, 42 and 19 Once Upon A Child^® franchise agreements will expire, respectively. We believe that renewing a significant number of these franchise relationships is extremely important to the continued success of the Company.

Decline in Number of Franchisees. In 1998, Play It Again Sports^® closed 64 stores and opened 14 stores, a net loss of 50 stores. In 1999, Play It Again Sports^® closed 58 stores and opened 12 stores, a net loss of 46 stores. In 2000, Play It Again Sports^® closed 64 stores and opened 15 stores, a net loss of 49 stores. In 2001, Play It Again Sports^® closed 59 stores and opened 10 stores, a net loss of 49 stores. In 2002, Play It Again Sports^® closed 35 stores and opened 7 stores, a net loss of 28 stores. It is very important to the future success of the Company that the net loss of Play It Again Sports^® stores be slowed and ultimately reversed. We believe that a certain number of stores will close each year. Our objective is to minimize store closings by continuing our investment in franchisee support services such as franchisee training and the Winmark computer support center, by investing capital to improve Winmark’s proprietary point-of-sale software system and continuing to train our field operations personnel to better serve franchisee needs. We believe that many of the store closings referenced above were related to weaker stores.

Dependence on New Franchisees. Our ability to generate increased revenue and achieve higher levels of profitability depends on increasing the number of franchised stores open. We believe that many larger and smaller markets will continue to provide significant opportunities for sales of franchises and that we can sustain approximately our current annual level of store openings. However, there can be no assurance that we will sustain this level of store openings.

Inability to Collect Accounts Receivable. In the event that our ability to collect accounts receivable significantly declines from current rates. We may incur additional charges that affect earnings.

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Unopened Stores. We believe that a substantial majority of stores sold but not opened will open within the time period permitted by the applicable franchise agreement or we will be able to resell the territories for most of the terminated or expired franchises. However, there can be no assurance that substantially all of the currently sold but unopened franchises will open and commence paying royalties to us.

Dependence on Supply of Used Merchandise. Our brands are based on offering customers a mix of used and new merchandise. As a result, obtaining continuing supplies of high quality used merchandise is important to the success of our brands. Supply of used merchandise comes from the general public and is not regular or highly reliable. There can be no assurance that we will avoid supply problems with respect to used merchandise.

Lease Terminations. We have closed or sold a number of our Company-owned stores over the past several years, most of which were part of the It’s About Games chain of stores. We have been negotiating lease terminations relative to the closed stores. There can be no assurance that we will be able to successfully negotiate satisfactory terminations of such remaining leases. We remain contingently liable with respect to the leases relating to certain Company stores sold. There can be no assurance that such independent third parties will comply with the terms and conditions of such leases, in which case we will be responsible to make payments owed under such leases. We believe that we have adequate reserves to cover any prospective liability with respect to such leases.

Competition. Retailing, including the sale of sporting goods, children and teenage apparel, and musical instruments, is highly competitive. Many retailers have significantly greater financial and other resources than us and our franchisees. Individual franchisees face competition in their markets from retailers of new merchandise and, in certain instances, resale, thrift and other stores that sell used merchandise. To date, our franchisees and our Company-owned stores have not faced a high degree of competition in the sale of used merchandise. However, we may face additional competition as our franchise systems expand and if additional competitors enter the used merchandise market.

Selling, General and Administrative Expense. Our ability to control the amount, and rate of growth in, selling, general and administrative expenses and the impact of unusual items resulting from our ongoing evaluation of our business strategies, asset valuations and organizational structures is important to our financial success. We cannot assure any investor that we will be able to control such items of expense.

Government Regulation. As a franchisor, we are subject to various federal and state franchise laws and regulations. Although we believe we are currently in material compliance with existing federal and state laws, there is a trend toward increasing government regulation of franchising. The promulgation of new franchising laws and regulations could adversely affect us.

Investment in Tomsten, Inc. During, 2002, the Company agreed to purchase $6.0 million of the common stock of Tomsten, Inc. (d/b/a. Archiver’s), a privately-held corporation. Archiver’s is a 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. There is not a market for the common stock of Tomsten and our ability to realize a cash return on our investment will depend, in part, on (i) the development of a public market for Tomsten or (ii) the sale of Tomsten. Winmark’s ownership stake does not represent a majority voting interest and we do not have the contractual ability to control the actions of Tomsten’s. The loss of our entire investment would result in a loss of $6.0 million and have a material impact on our financial performance.

We do not undertake and specifically decline any obligations to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

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ITEM 7A: 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. The Company had no debt outstanding at December 28, 2002. A one percent change in interest rates would not have a significant impact on the Company’s fixed rate debt.

Approximately $3.0 million of our investments at December 28, 2002 were invested in fixed income securities and $4.2 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 the fixed income securities.

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Winmark Corporation and Subsidiary

Index to Consolidated Financial Statements

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WINMARK CORPORATION AND SUBSIDIARY

Consolidated Balance Sheets

See accompanying notes to consolidated financial statements.

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WINMARK CORPORATION AND SUBSIDIARY

Consolidated Statements of Operations