WINMARK CORPORATION Overview
We are a franchising business focused on sustainability and small business formation. As ofSeptember 24, 2022 , we had 1,291 resale franchises operating under the Plato's Closet, Once Upon A Child,Play It Again Sports , Style Encore and Music Go Round brands. Our franchise 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 the first nine months of 2022, our royalties increased$4.1 million or 9.1% compared to the first nine months of 2021. 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 nine months of 2022, selling, general and administrative expenses increased$0.4 million , or 2.4% compared to the first nine months of 2021. 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 nine months endedSeptember 24, 2022 : AVAILABLE TOTAL TOTAL FOR COMPLETED 12/25/2021 OPENED CLOSED 9/24/2022 RENEWAL RENEWALS Plato's Closet Franchises - US and Canada 489 12 (2) 499 42 42 Once Upon A Child Franchises - US and Canada 401 6 (3) 404 25 25Play It Again Sports Franchises - US and Canada 273 13(1) (6) 280 47 47 Style Encore . Franchises - US and Canada 71 4 (4) 71 - - Music Go Round Franchises - US 37 - - 37 - - Total Franchised Stores 1,271 35 (15) 1,291 114 114
(1) Includes 11 stores formerly operated outside the
(See Note 6 - "Intangible Assets").
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 nine months of 2022, we renewed 114 of the 114 franchise agreements available for renewal.
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.
InMay 2021 , we made the decision to no longer solicit new leasing customers and pursue an orderly run-off of our middle-market leasing portfolio, the operations of which constitute our leasing segment. Leasing income net of leasing expense for the first nine months of 2022 was$5.0 million compared to$6.9 million in the first nine months of 2021. Our leasing portfolio (net investment in leases - current and long-term), was$0.9 million atSeptember 24, 2022 compared to$3.1 million atDecember 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 5 - "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. 15 Table of Contents COVID-19 As discussed in our 2021 Form 10-K, the COVID-19 pandemic has had a significant impact on our business. We are closely monitoring the effects of the ongoing COVID-19 pandemic and its continued impact on our business. We cannot estimate with certainty the length or severity of this pandemic, or the extent to which the disruption may materially impact our Consolidated Condensed Financial Statements.
Results of Operations
The following table sets forth selected information from our Consolidated
Condensed Statements of Operations expressed as a percentage of total revenue:
Three Months Ended Nine Months Ended
September 24, 2022 September 25, 2021 September 24, 2022 September 25, 2021
Revenue:
Royalties 84.4 % 81.3 % 81.7 % 78.1 %
Leasing income 8.3 11.2 9.7 14.4
Merchandise sales 3.5 3.5 4.5 3.4
Franchise fees 1.7 1.9 1.9 1.9
Other 2.1 2.1 2.2 2.2
Total revenue 100.0 100.0 100.0 100.0
Cost of merchandise sold (3.4) (3.4) (4.2) (3.3)
Leasing expense (1.8) (1.8) (1.5) (2.4)
Provision for credit losses 0.1 0.3 0.1 0.3
Selling, general and
administrative expenses (26.8) (26.7) (27.7) (28.2)
Income from operations 68.1 68.4 66.7 66.4
Interest expense (3.9) (1.6) (3.4) (1.6)
Interest and other income
(expense) 0.1 (0.1) - -
Income before income taxes 64.3 66.7 63.3 64.8
Provision for income taxes (15.3) (16.7) (14.8) (15.8)
Net income 49.0 % 50.0 % 48.5 % 49.0 %
Comparison of Three Months Ended
Revenue
Revenues for the quarter ended
Royalties and Franchise Fees
Royalties increased to$17.9 million for the third quarter of 2022 from$16.4 million for the third quarter of 2021, a 9.1% increase. The increase is primarily from higher franchisee retail sales and from having additional franchise stores in the third quarter of 2022 compared to the same period in 2021.
Franchise fees of
Leasing Income
Leasing income decreased to$1.8 million for the third quarter of 2022 compared to$2.3 million for the same period in 2021. The decrease is primarily due to lower levels of interest and other income from the smaller lease portfolio.
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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 of$0.7 million for the third quarter of 2022 were comparable to$0.7 million in the same period of 2021. 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 of$0.7 million for the third quarter of 2022 were comparable to$0.7 million in the same period of 2021. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the third quarter of 2022 and 2021 was 96.2% and 96.6%, respectively. Leasing Expense
Leasing expense of
Selling, General and Administrative
Selling, general and administrative expenses increased 5.4% to$5.7 million in the third quarter of 2022 compared to$5.4 million in the same period of 2021. The increase was primarily due to increases in compensation, benefits and advertising related expenses.
Interest Expense
Interest expense increased to
Income Taxes The provision for income taxes was calculated at an effective rate of 23.9% and 25.0% for the third quarter of 2022 and 2021, respectively. The decrease is primarily due to higher benefits on the exercise of non-qualified stock options and a decrease in state taxes.
Comparison of Nine Months Ended
Revenue
Revenues for the first nine months of 2022 totaled
Royalties and Franchise Fees
Royalties increased to$49.2 million for the first nine months of 2022 from$45.1 million for the first nine months of 2021, a 9.1% increase. The increase in royalties is primarily from higher franchisee retail sales and from having additional franchised stores in the first nine months of 2022 compared to the same period last year.
Franchise fees of
Leasing Income
Leasing income decreased to$5.8 million for the first nine months of 2022 compared to$8.4 million for the same period in 2021. The decrease is primarily due to lower levels of equipment sales to customers and lower levels of interest income from the smaller lease portfolio when compared to the same period last year. 17 Table of Contents 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$2.7 million for the first nine months of 2022 compared to$2.0 million in the same period of 2021. The increase is primarily due to an increase in buying group and technology 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$2.6 million for the first nine months of 2022 compared to$1.9 million in the same period of 2021. The increase is due to an increase in Direct Franchise Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the first nine months of 2022 and 2021 was 95.0% and 95.3%, respectively. Leasing Expense
Leasing expense decreased to$0.9 million for the first nine months of 2022 compared to$1.4 million for the first nine months of 2021. The decrease was due to a decrease in the associated cost of equipment sales to customers discussed above.
Selling, General and Administrative
Selling, general and administrative expenses increased 2.4% to$16.7 million in the first nine months of 2022 compared to$16.3 million in the same period of 2021. The increase was primarily due to increases in travel and advertising related expenses.
Interest Expense
Interest expense was$2.1 million for the first nine months of 2022 compared to$0.9 million for the first nine months of 2021. The increase is primarily due to higher average corporate borrowings when compared to the same period last year.
Income Taxes
The provision for income taxes was calculated at an effective rate of 23.4% and 24.4% for the first nine months of 2022 and 2021, respectively. The decrease is primarily due to higher tax benefits on the exercise of non-qualified stock options and a decrease in state taxes.
Segment Comparison of Three Months Ended
Franchising Segment Operating Income
The franchising segment's operating income for the third quarter of 2022
increased to
Leasing Segment Operating Income
The leasing segment's operating income for the third quarter of 2022 decreased to$1.1 million from$1.5 million for the third quarter of 2021. The decrease in segment contribution was due to a decrease in leasing income net of leasing expenses, partially offset by a decrease in selling, general and administrative expenses. 18 Table of Contents
Segment Comparison of Nine Months Ended
Franchising Segment Operating Income
The franchising segment's operating income for the first nine months of 2022 increased to$36.3 million from$33.6 million for the first nine months of 2021. The increase in segment contribution was 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 the first nine months of 2022 decreased to$3.9 million from$4.8 million for the first nine months of 2021. The decrease in segment contribution was due to a decrease in leasing income net of leasing expenses, partially offset by a decrease in selling, general and administrative expenses.
Liquidity and Capital Resources
Our primary sources of liquidity have historically been cash flows from operations and borrowings. The components of the consolidated condensed 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 the third quarter of 2022 with
Operating activities provided$34.2 million of cash during the first nine months of 2022, compared to$35.0 million provided during the same period last year. The decrease in cash provided by operating activities in the first nine months of 2022 compared to 2021 was primarily due to a decrease in principal collections on lease receivables, partially offset by an increase in accrued and other liabilities. Investing activities used$3.6 million of cash during the first nine months of 2022. The 2022 activities consisted primarily of reacquired franchise rights (See Note 6 - "Intangible Assets"). Financing activities used$25.0 million of cash during the first nine months of 2022. Our most significant financing activities during the first nine months of 2022 consisted of$48.3 million to repurchase 222,307 shares of our common stock,$6.5 million for the payment of dividends, and payments on notes payable of$3.2 million ; partially offset by$30.0 million of net borrowing on our line of credit and$2.9 million of proceeds from exercise of stock options. (See Note 8 - "Shareholders' Equity (Deficit)," and Note 9 - "Debt"). 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 ofSeptember 24, 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 ofSeptember 24, 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 atSeptember 24, 2022 was$44.5 million ). As ofSeptember 24, 2022 , we had not issued any notes under the Shelf Agreement. Of the$44.5 million of principal outstanding under the Note Agreement,$14.5 million amortizes over the remainder of 2022 through 2027, and$30.0 million matures in 2028.
See Part I, Item 1, Note 9 - "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
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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 our Form 10-K for the fiscal year ended
December 25, 2021 and under Item 1A below. 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
A discussion of our critical accounting policies is contained in our annual report on Form 10-K for the year endedDecember 25, 2021 . There have been no changes to our critical accounting policies from those disclosed on our Form 10-K for the year endedDecember 25, 2021 .
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, specific and overall impacts of the COVID-19 pandemic on the Company's financial condition or results of operations, 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. Additionally, many of these risks and uncertainties are currently elevated by and may or will continue to be elevated by the COVID-19 pandemic. 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 endedDecember 25, 2021 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.
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