I know the management of the SF Lomography store, and we sell Lomography cameras in our shop, so I've had a pretty up close view of what's going on with the brand.
First off, the Lomography gallery stores are not franchises. They are funded, built and closely managed by Lomography. There are also small stores like ours that carry Lomography products as merchandise, but to my knowledge there are no real franchises.
I don't know how Lomo is doing as a company, but I think as far as the stores are concerned, they are taking action on a bad business decision, which was to expand in the retail market and compete not only with their other retailers (like us), but also with their own online store. They make much more profit selling a camera online than through one of their stores, so why have stores? I believe Lomography thought the stores would expand their overall market (like the Apple stores did for Apple), but it turned out not to be the case.
As a Lomography user and retailer, I have mixed feelings about the brand and their products. I fully credit Lomography with stoking excitement in film photography and introducing it to a new generation of photographers. Lomography, if nothing else, is genius at marketing and I'm REALLY glad that what they are marketing is film photography. I also agree with alienmeatsack above that their products are interesting and innovative. And they brought back 110! How cool is that?
In our shop, however, we and our customers have struggled with the quality of Lomography products (and their sister brand The Impossible Project), especially given the price. While I love the Diana Mini, we rarely recommend it anymore because they usually break within a few weeks. This is also true of the Sardina, and everyone I know with an LCA has had it break. From what we can see, the quality problem has definitely dimmed interest in Lomography cameras.
I think their business of marketing cameras as style products (like shoes) has been surprisingly successful, but they are starting to find the limits, and are perhaps losing some sales as their customers get frustrated with some products and move on to other entertainments. Closing the gallery stores is a wise business decision that will hopefully ensure that the brand continues to thrive for a long time.