WINMARK CORPORATION The following is management's discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements and should be read in conjunction with those consolidated financial statements. This section of this 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-date comparisons between 2021 and 2020 that are not included in this Form 10-K, can be found in 'Management's Discussion and Analysis of Financial Condition and Results of Operations' in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year endedDecember 25, 2021 .
Overview
Winmark - theResale Company is focused on sustainability and small business formation. As ofDecember 31, 2022 , we had 1,295 franchises operating under the Plato's Closet, Once Upon A Child,Play It Again Sports , Style Encore and Music Go Round brands. Our business is not capital intensive and is designed to generate consistent, recurring revenue and strong operating margins.
The financial criteria that management closely tracks to evaluate current business operations and future prospects include royalties and selling, general and administrative expenses.
Our most significant source of franchising revenue is royalties received from
our franchisees. During 2022, our royalties increased
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 2022, selling, general and administrative expense increased$0.9 million , or 3.9%, compared to the same period last year. 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 net store growth and renewal activity for the fiscal year endedDecember 31, 2022 : AVAILABLE TOTAL TOTAL FOR COMPLETED 12/25/2021 OPENED CLOSED 12/31/2022 RENEWAL RENEWALS % RENEWED Plato's Closet 489 14 (3) 500 55 55 100 % Once Upon A Child 401 8 (3) 406 32 32 100 % Play It Again Sports 273 16(1) (8) 281 57 57 100 % Style Encore 71 4 (4) 71 - - N/A Music Go Round 37 - - 37 - - N/A Total Franchised Stores(2) 1,271 42 (18) 1,295 144 144 100 %
(1) Includes 11 stores formerly operated outside the
(See Note 5 - "Intangible Assets").
(2) All stores are owned and operated by franchisees.
operate any corporate stores.
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. In 2022, we renewed 100% of franchise agreements up for renewal. This percentage of renewal has ranged between 99% and 100% during the last three years. Our ability to grow our operating income is dependent on our ability to: (i) effectively support our franchise partners so that they produce higher revenues, (ii) open new franchises, and (iii) control our selling, general and administrative expenses. A detailed description of the risks to our business along with other risk factors can be found in Item 1A "Risk Factors".
In
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expense for the fiscal year of 2022 was $6.0 million compared to $9.3 million in
2021. Our leasing portfolio (net investment in leases - current and long-term),
was $0.3 million at December 31, 2022 compared to $3.1 million at December 25,
2021 . Given the decision to run-off the portfolio, we anticipate that leasing
income net of leasing expense and the size of the leasing portfolio will
continue to decrease through the run-off period. See Note 3 - "Investment in
Leasing Operations" for information regarding the lease portfolio, including
future minimum lease payments receivable under lease contracts and the
amortization of unearned lease income.
Results of Operations
The following table sets forth selected information from our Consolidated Statements of Operations expressed as a percentage of total revenue and the percentage change in the dollar amounts from the prior period:
Fiscal Year Ended Fiscal 2022
December 31, December 25, over (under)
2022 2021 2021
Revenue:
Royalties 82.5 % 77.7 % 10.5 %
Leasing income 8.5 14.2 (37.8)
Merchandise sales 4.8 4.0 26.5
Franchise fees 1.9 1.9 5.2
Other 2.3 2.2 8.1
Total revenue 100.0 100.0 4.1
Cost of merchandise sold (4.6) (3.8) 26.3
Leasing expense (1.2) (2.4) (46.8)
Provision for credit losses 0.1 0.3 72.0Selling, general and administrative expenses (28.4)
(28.5) 3.9 Income from operations 65.9 65.6 4.4 Interest expense (3.6) (1.9) 100.5
Interest and other income (expense) 0.1
- (670.7)
Income before income taxes 62.4 63.7 1.8
Provision for income taxes (14.0) (12.7) 14.2
Net income 48.4 % 51.0 % (1.2) %
Revenue
Revenues for the year ended
Royalties and Franchise Fees Royalties increased to$67.1 million for 2022 from$60.8 million for the same period in 2021, a 10.5% increase. The increase is primarily due to higher franchisee retail sales and from having additional franchise stores in 2022 compared to 2021. Fiscal 2022 was a 53-week year compared to a 52-week year in fiscal 2021, which also contributed to the increase in royalty revenue. Franchise fees of$1.6 million for 2022 were comparable to$1.5 million for 2021. 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 over the estimated life of the franchise, beginning when the franchise opens. An overview of retail brand franchise fees is presented in the Operations subsection of the Business section (Item 1).
Leasing Income
Leasing income decreased to
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Merchandise Sales
Merchandise sales include the sale of product to franchisees either through our Computer Support Center or through thePlay It Again Sports buying group (together, "Direct Franchisee Sales"). Direct Franchisee Sales increased to$3.9 million in 2022 from$3.1 million in 2021. The increase is due to an increase in technology and buying group purchases by our franchisees.
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 increased to$3.7 million in 2022 from$2.9 million in 2021. The increase was due to an increase in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for 2022 and 2021 was 94.7% and 94.9%, respectively. Leasing Expense
Leasing expense decreased to$1.0 million in 2022 compared to$1.9 million in 2021. The decrease was primarily due to a decrease in the associated cost of equipment sales to customers noted above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 3.9% to$23.2 million in 2022 from$22.3 million in 2021. The increase was primarily due to an increase in advertising and promotional expenses and travel related expenses. Fiscal 2022 was a 53-week year compared to a 52-week year in fiscal 2021, which also contributed to an increase in salaries, wages and benefit expense.
Interest Expense
Interest expense was$2.9 million in 2022 compared to$1.5 million in 2021. The increase is primarily due to higher average corporate borrowings when compared to last year. Income Taxes
The provision for income taxes was calculated at an effective rate of 22.4% and
19.9% for 2022 and 2021, respectively. The increase is primarily due to lower
tax benefits on the exercise of non-qualified stock options.
Segment Comparison of Fiscal Years 2022 and 2021
As of December 31, 2022 , we have two reportable business segments, franchising
and leasing. The franchising segment franchises value-oriented retail store
concepts that buy, sell and trade merchandise. The leasing segment includes our
equipment leasing business. Segment reporting is intended to give financial
statement users a better view of how we manage and evaluate our businesses. Our
internal management reporting is the basis for the information disclosed for our
business segments and includes allocation of shared-service costs. The following
tables summarize financial information by segment and provide a reconciliation
of segment contribution to income from operations:
Year Ended
December 31, 2022 December 25, 2021
Revenue:
Franchising $ 74,473,100 $ 67,067,900
Leasing 6,937,700 11,148,300
Total revenue $ 81,410,800 $ 78,216,200
Reconciliation to income from operations:
Franchising segment contribution $ 49,007,900 $ 44,832,100 Leasing segment contribution 4,604,900 6,504,100 Total income from operations$ 53,612,800 $ 51,336,200 Revenues are all generated fromUnited States operations other than franchising revenue from Canadian operations of$6.4 million and$4.9 million in each of fiscal 2022 and 2021, respectively. 14
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Franchising Segment Operating Income
The franchising segment's 2022 operating income increased by$4.2 million , or 9.3%, to$49.0 million from$44.8 million for 2021. The increase in segment contribution was primarily due to increased royalty revenues, partially offset by an increase in selling, general and administrative expenses.
Leasing Segment Operating Income
The leasing segment's operating income for 2022 decreased by$1.9 million , or 29.2%, to$4.6 million from$6.5 million for 2021. The decrease in segment contribution was due to a decrease in leasing income net of leasing expense, partially offset by a decrease in selling, general and administrative expenses.
Liquidity and Capital Resources
Our primary sources of liquidity have historically been cash flow from operations and borrowings. The components of the Consolidated Statements of Operations that reduce our net income but do not affect our liquidity include non-cash items for depreciation and amortization and compensation expense related to stock options.
We ended 2022 with$13.7 million in cash, cash equivalents and restricted cash compared to$11.4 million in cash, cash equivalents and restricted cash at the end of 2021. Operating activities provided$43.8 million of cash during 2022 compared to$48.3 million provided during 2021. The decrease in cash provided by operating activities in 2022 compared to 2021 was primarily due to a decrease in principal collections on lease receivables.
Investing activities used
Financing activities used$37.9 million of cash during 2022 compared to$43.3 million used during 2021. Our most significant financing activities over the past two years have consisted of net borrowings/payments on our debt facilities, the payment of dividends, repurchase of common stock, and net proceeds received from the exercise of stock options. During 2022, we used$49.1 million to purchase 226,165 shares of our common stock, paid$19.3 million in cash dividends (including a$3.00 per share special cash dividend; the "2022 Special Dividend"), and paid$4.3 million on notes payable; partially offset by net borrowings on our line of credit/term loan of$30.0 million and$4.8 million of proceeds from the exercise of stock options. (See Note 6 - "Shareholders' Equity (Deficit)" and Note 7 - "Debt"). We have debt obligations and future operating lease commitments for our corporate headquarters. As ofDecember 31, 2022 , we had no other material outstanding commitments. (See Note 12 - "Commitments and Contingencies"). The following table summarizes our significant future contractual obligations atDecember 31, 2022 : Payments due by period Less than 1 More than 5 Total year 1-3 years 3-5 years years Contractual Obligations Line of Credit/Term loan(1)(3)$ 38,768,400 $ 1,395,500 $ 2,791,000 $ 2,791,000 $ 31,790,900 Notes Payable(2)(3) 50,247,200 5,833,500 9,491,100 4,207,100 30,715,500 Operating Lease Obligations 5,806,200 763,300 1,590,300 1,679,300 1,773,300 Total Contractual Obligations$ 94,821,800 $ 7,992,300 $ 13,872,400 $ 8,677,400 $ 64,279,700 (1) Includes interest payable monthly at rates ranging from 4.60% to 4.75%.
(2) Includes interest payable quarterly at rates ranging from 3.18% to 5.50%
assuming principal payments in accordance with amortizing schedules.
(3) Refer to Part II, Item 8 in this report under Note 7 - "Debt" for additional
information regarding long-term debt.
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Our debt facilities include a Line of Credit withCIBC Bank USA and a Note Agreement and Shelf Agreement with Prudential. These facilities have been and will continue to be used for general corporate purposes, are secured by a lien against substantially all of our assets, contain customary financial conditions and covenants, and require maintenance of minimum levels of debt service coverage and maximum levels of leverage (all as defined within the agreements governing the facilities). As ofDecember 31, 2022 , we were in compliance with all of the financial covenants under the Line of Credit, the Note Agreement and the Shelf Agreement. The Line of Credit provides for up to$20.0 million in revolving loans and$30.0 million in delayed draw term loans. As ofDecember 31, 2022 , we had no revolving loans outstanding, and had delayed draw term loan borrowings totaling$30.0 million that mature in 2029. The Shelf Agreement allows us to offer privately negotiated senior notes to Prudential in an aggregate principal amount up to (i)$100.0 million , less (ii) the aggregate principal amount of notes outstanding at such point (including notes outstanding under the Note Agreement, which atDecember 31, 2022 was$43.4 million ). As ofDecember 31, 2022 , we had not issued any notes under the Shelf Agreement. Of the$43.4 million of principal outstanding under the Note Agreement,$13.4 million amortizes over 2023 through 2027, and$30.0 million matures in 2028.
See Part II, Item 8, Note 7 - "Debt" for more information regarding the Line of Credit, Note Agreement and Shelf Agreement.
We expect to generate the cash necessary to pay our expenses and to pay the principal and interest on our outstanding debt from cash flows provided by operating activities and by opportunistically using other means to repay or refinance our obligations as we determine appropriate. Our ability to pay our expenses and meet our debt service obligations depends on our future performance, which may be affected by financial, business, economic, and other factors including the risk factors described under Item 1A of this report. If we do not have enough money to pay our debt service obligations, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or raise equity. In such an event, we may not be able to refinance our debt, sell assets, borrow more money or raise equity on terms acceptable to us or at all. Also, our ability to carry out any of these activities on favorable terms, if at all, may be further impacted by any financial or credit crisis which may limit access to the credit markets and increase our cost of capital. As of the date of this report we believe that the combination of our cash on hand, the cash generated from our franchising and leasing businesses, our Line of Credit and our Shelf Agreement will be adequate to fund our planned operations through 2023.
Critical Accounting Policies
The Company prepares the consolidated financial statements ofWinmark Corporation and Subsidiaries in conformity with accounting principles generally accepted inthe 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 the most recent franchisee sales information available. If there are significant changes in the actual performance of franchisees versus the Company's estimates, its royalty revenue would be impacted. During 2022, the Company collected$4,100 more than it estimated atDecember 25, 2021 . As ofDecember 31, 2022 , the Company's royalty receivable was$1,216,600 . The Company collects initial franchise fees when franchise agreements are signed and recognizes the initial franchise fees as revenue over the estimated life of the franchise, beginning when the franchise is opened. 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 ofDecember 31, 2022 , deferred franchise fee revenue was$6,667,900 . 16 Table of Contents Leasing Income Recognition Leasing income for direct financing leases 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. For sales-type leases in which the equipment has a fair value greater or less than its carrying amount, selling profit/loss is recognized at commencement. For subsequent periods or for leases in which the equipment's fair value is equal to its carrying amount, the recording of income is consistent with the accounting for a direct financing lease.
For leases that are accounted for as operating leases, income is recognized on a straight-line basis when payments under the lease contract are due.
Generally, when a lease is more than 90 days delinquent (when more than three monthly payments are owed), the lease is classified as being on non-accrual and the Company stops recognizing leasing income on that date. Payments received on leases in non-accrual status generally reduce the lease receivable. Leases on non-accrual status remain classified as such until there is sustained payment performance that, in the Company's judgment, would indicate that all contractual amounts will be collected in full.
Recent Accounting Pronouncements
See Note 2, "Significant Accounting Policies - Recently Issued Accounting Pronouncements".
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