ITEM 1A: RISK FACTORS
Our business, results of operations, financial condition, cash flows and the market value of our common stock can be adversely affected by pandemics, epidemics or other public health emergencies, such as the outbreak of COVID-19.
Our business, results of operations, financial condition, cash flows and the market value of our common stock can be adversely affected by pandemics, epidemics or other public health emergencies, such as the outbreak of COVID-19 which spread from China to many other countries including the United States and Canada. In March 2020, the World Health Organization characterized COVID-19 as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency. The outbreak resulted in federal, state, provincial and local governments throughout the United States and Canada implementing increasingly stringent measures to help control the spread of the virus, including quarantines, “shelter in place” and “stay at home” orders, travel restrictions, business curtailments, school closures, and other measures. In addition, governments and central banks in several parts of the world enacted fiscal and monetary stimulus measures to counteract the impacts of COVID-19.
The outbreak of COVID-19 and any preventive or protective actions taken by governmental authorities had a material adverse effect on our operations and those of our franchisees, including forced or voluntary store closures, business shutdowns or disruptions during the height of the pandemic. The extent to which pandemics, epidemics or other public health emergencies may adversely impact our business depends on future developments, which are highly uncertain and unpredictable, depending upon the severity and duration of any such outbreak and the effectiveness of actions taken globally, nationally and locally to contain or mitigate its effects. Any resulting financial impact cannot be estimated reasonably at this time, but may materially adversely affect our business, results of operations, financial condition and cash flows. Even after any pandemic, epidemic or other public health emergency has subsided, we may experience materially adverse effects to our business due to any resulting economic recession or depression. Additionally, concerns over the economic affect of any pandemic, epidemic or other public health emergency may cause extreme volatility in financial and other capital markets which may adversely impact the market value of our common stock and our ability to access capital markets and debt capital. To the extent any pandemic, epidemic or other public health emergency adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in this Annual Report.
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We are dependent on franchise renewals.
Each of our franchise agreements is 10 years long. At the end of the term of each franchise agreement, each franchisee may, if certain conditions are met, “renew” the franchise relationship by signing a new 10-year franchise agreement. As of December 31, 2022 each of our five brands have the following number of franchise agreements that will expire over the next three years:
Play It Again Sports 35 23 45
Music Go Round 6 2 4
We believe that renewing a significant number of these franchise relationships is important to our continued success. If a significant number of franchise relationships are not renewed, our financial performance would be materially and adversely impacted.
We are dependent on new franchisees.
Our ability to generate increased revenue and achieve higher levels of profitability depends in part on increasing the number of franchises open. Unfavorable macro-economic conditions may affect the ability of potential franchisees to obtain external financing and/or impact their net worth, both of which could lead to a lower level of openings than we have historically experienced. There can be no assurance that we will sustain our current level of franchise openings.
We may make additional investments outside of our core businesses.
From time to time, we have and may continue to make investments both inside and outside of our current businesses. To the extent that we make additional investments that are not successful, such investments could have a material adverse impact on our financial results.
We may sell franchises for a territory, but the franchisee may not open.
We believe that a substantial majority of franchises awarded 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.
Our franchisees are dependent on supply of used merchandise.
Our retail brands are based on offering customers a mix of used and new merchandise. As a result, the ability of our franchisees to obtain 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 may not be regular or highly reliable. In addition, adherence to federal and state product safety and other requirements may limit the amount of used merchandise available to our franchisees. In addition to laws and regulations that apply to businesses generally, our franchised retail stores may be subject to state or local statutes or ordinances that govern secondhand dealers. There can be no assurance that our franchisees will avoid supply problems with respect to used merchandise.
We may be unable to collect accounts receivable from franchisees.
In the event that our ability to collect accounts receivable significantly declines from current rates, we may incur additional charges that would affect earnings. If we are unable to collect payments due from our franchisees, it would materially adversely impact our results of operations and financial condition.
We operate in an extremely competitive industry.
Retailing, including the sale of apparel, sporting goods and musical instruments, is highly competitive. Many retailers and online marketplaces 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. We may face additional competition as our franchise systems expand and if additional competitors enter the used merchandise market.
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We are subject to restrictions in our line of credit/term loan and note facilities. Additionally, we are subject to counter party risk in our line of credit facility.
The terms of our line of credit/term loan and note facilities impose certain operating and financial restrictions on us and require us to meet certain financial tests including tests related to minimum levels of debt service coverage and maximum levels of leverage. As of December 31, 2022, we were in compliance with all of our financial covenants under these facilities; however, failure to comply with these covenants in the future may result in default under one or both of these sources of capital and could result in acceleration of the related indebtedness. Any such acceleration of indebtedness would have an adverse impact on our business activities and financial condition.
Sustained credit market deterioration could jeopardize the counterparty obligations of the bank participating in our line of credit facility, which could have an adverse impact on our business if we are not able to replace such credit facility or find other sources of liquidity on acceptable terms.
We have indebtedness.
We have existing indebtedness in the form of notes payable and term loans (see Note 7 — “Debt”). We expect to generate the cash necessary to pay our expenses and to pay the principal and interest on all of 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. 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.
We are subject to government regulation.
As a franchisor, we are subject to various federal and state franchise laws and regulations. Fourteen states, the Federal Trade Commission and six 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. Future franchise legislation could impose costs or other burdens on us that could have a material adverse impact on our operations. In addition, evolving labor and employment laws, rules and regulations could result in potential claims against us as a franchisor for labor and employment related liabilities that have historically been borne by franchisees.
We may be unable to protect against data security risks.
We have implemented security systems with the intent of maintaining the physical security of our facilities and protecting our employees, franchisees, lessees, customers’, clients’ and suppliers’ confidential information and information related to identifiable individuals against unauthorized access through our information systems or by other electronic transmission or through the misdirection, theft or loss of physical media. These include, for example, the appropriate encryption of information. Despite such efforts, we are subject to potential breach of security systems which may result in unauthorized access to our facilities or the information we are trying to protect. Because the techniques used to obtain unauthorized access are constantly changing and becoming increasingly more sophisticated and often are not recognized until launched against a target, we may be unable to anticipate these techniques or implement sufficient preventative measures. If unauthorized parties gain physical access to one of our facilities or electronic access to our information systems or such information is misdirected, lost or stolen during transmission or transport, any theft or misuse of such information could result in, among other things, unfavorable publicity, governmental inquiry and oversight, difficulty in marketing our services, allegations by our customers and clients that we have not performed our contractual obligations, litigation by affected parties and possible financial obligations for damages related to the theft or misuse of such information, any of which could have a material adverse effect on our business.
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ITEM 1B: UNRESOLVED STAFF COMMENTS
None.
ITEM 2: PROPERTIES
We lease 41,016 square feet at our headquarters facility in Minneapolis, Minnesota. We are obligated to pay rent monthly under the lease, and will pay an average of $829,500 annually over the remaining term that expires in 2029. We are also obligated to pay estimated taxes and operating expenses as described in the lease, which change annually. The total rentals, taxes and operating expenses paid may increase if we exercise any of our rights to acquire additional space described in the lease. Our facilities are sufficient to meet our current and immediate future needs.
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: MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5:MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information, Holders, Dividends
Winmark Corporation’s common stock trades on the NASDAQ Global Market under the symbol “WINA”. For dividend information see Note 6 – “Shareholders’ Equity (Deficit).”
At March 6, 2023, there were approximately 52 shareholders of record of our common stock.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Total Number of Maximum Number
Shares Purchased as of Shares that may
Total Number of Average Price Part of a Publicly yet be Purchased
Period Shares Purchased Paid Per Share Announced Plan(1) Under the Plan
ITEM 6: [RESERVED]
None.
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ITEM 7:MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 ended December 25, 2021.
Overview
Winmark – the Resale Company is focused on sustainability and small business formation. As of December 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 $6.4 million or 10.5% compared to 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 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 ended December 31, 2022:
AVAILABLE
TOTAL TOTAL FOR COMPLETED
Style Encore 71 4 (4) 71 — — N/A
Music Go Round 37 — — 37 — — N/A
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 May 2021, we made the decision to no longer solicit new leasing customers and will pursue an orderly run-off of our middle-market leasing portfolio, the operations of which constitute our leasing segment. Leasing income net of leasing
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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)
Revenue:
Merchandise sales 4.8 4.0 26.5
Franchise fees 1.9 1.9 5.2
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 72.0
Selling, general and administrative expenses (28.4) (28.5) 3.9
Income from operations 65.9 65.6 4.4
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
Revenue
Revenues for the year ended December 31, 2022 totaled $81.4 million compared to $78.2 million in 2021.
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 $6.9 million in 2022 compared to $11.1 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 last year.
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Merchandise Sales
Merchandise sales include the sale of product to franchisees either through our Computer Support Center or through the Play 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
Revenue:
Reconciliation to income from operations:
Revenues are all generated from United 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.
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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 $3.7 million of cash during 2022 compared to $0.3 million used during 2021. Our most significant investing activities consisted of reacquired franchise rights (See Note 5 – “Intangible Assets”).
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 of December 31, 2022, we had no other material outstanding commitments. (See Note 12 — “Commitments and Contingencies”). The following table summarizes our significant future contractual obligations at December 31, 2022:
Payments due by period
Less than 1 More than 5
Total year 1-3 years 3-5 years years
Contractual Obligations
(1) Includes interest payable monthly at rates ranging from 4.60% to 4.75%.
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Our debt facilities include a Line of Credit with CIBC 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 of December 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 of December 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 at December 31, 2022 was $43.4 million). As of December 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 of Winmark Corporation and Subsidiaries in conformity with accounting principles generally accepted in the United States of America. As such, the Company is required to make certain estimates, judgments and assumptions that it believes are reasonable based on information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. There can be no assurance that actual results will not differ from these estimates. The critical accounting policies that the Company believes are most important to aid in fully understanding and evaluating the reported financial results include the following:
Revenue Recognition — Royalty Revenue and Franchise Fees
The Company collects royalties from each retail franchise based on a percentage of retail store gross sales. The Company recognizes royalties as revenue when earned. At the end of each accounting period, estimates of royalty amounts due are made based on 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 at December 25, 2021. As of December 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 of December 31, 2022, deferred franchise fee revenue was $6,667,900.
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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”.
ITEM 7A:QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company incurs financial markets risk in the form of interest rate risk. Risk can be quantified by measuring the financial impact of a near-term adverse increase in short-term interest rates. At December 31, 2022, the Company’s line of credit with CIBC Bank USA included a commitment for revolving loans of $20.0 million. The interest rates applicable to revolving loans are based on either the bank’s base rate or SOFR for short-term borrowings (twelve months or less). The Company had no revolving loans outstanding at December 31, 2022 under this line of credit. The Company’s earnings would be affected by changes in short-term interest rates only in the event that it were to borrow amounts under this facility. With the Company’s borrowings at December 31, 2022, a one percent increase in short-term rates would have no impact on annual pretax earnings. The Company had no interest rate derivatives in place at December 31, 2022.
None of the Company’s cash and cash equivalents at December 31, 2022 was invested in money market mutual funds, which are subject to the effects of market fluctuations in interest rates.
Foreign currency transaction gains and losses were not material to the Company’s results of operations for the year ended December 31, 2022, as less than 8% of the Company’s total revenues and less than 1% of expenses were denominated in a foreign currency. Based upon these revenues and expenses, a 10% increase or decrease in the foreign currency exchange rates would impact annual pretax earnings by approximately $628,000. To date, the Company has not entered into any foreign currency forward exchange contracts or other derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency exchange rates.
ITEM 8:FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Winmark Corporation and Subsidiaries
Index to Consolidated Financial Statements
Consolidated Balance Sheets Page 18
Consolidated Statements of Operations Page 19
Consolidated Statements of Shareholders’ Equity (Deficit) Page 20
Consolidated Statements of Cash Flows Page 21
Notes to the Consolidated Financial Statements Page 22
Report of Independent Registered Public Accounting Firm (PCAOB ID: 248) Page 39
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WINMARK CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
ASSETS
Current Assets:
Net investment in leases — long-term 5,400 229,300
Property and equipment:
Less - accumulated depreciation and amortization (4,731,700) (4,381,800)
Intangible assets 3,348,300 —
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Long-term Liabilities:
Line of credit/Term loan 30,000,000 —
Commitments and Contingencies — —
Shareholders’ Equity (Deficit):
The accompanying notes are an integral part of these consolidated financial statements.
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WINMARK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Fiscal Year Ended
Revenue:
Earnings per share - basic $ 11.30 $ 10.87 $ 8.02
Earnings per share - diluted $ 10.97 $ 10.48 $ 7.72
The accompanying notes are an integral part of these consolidated financial statements.
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WINMARK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity (Deficit)
Fiscal years ended December 31, 2022, December 25, 2021 and December 26, 2020
Retained
Earnings
Common Stock (Accumulated
Shares Amount Deficit) Total
The accompanying notes are an integral part of these consolidated financial statements.
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WINMARK CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Fiscal Year Ended
OPERATING ACTIVITIES:
(Gain)/loss from disposal of property and equipment (9,400) — 200
Deferred initial direct costs — (2,100) (18,300)
Amortization of deferred initial direct costs — 18,900 105,900
Change in operating assets and liabilities:
INVESTING ACTIVITIES:
Proceeds from sales of property and equipment 9,400 — —
Reacquired franchise rights (3,540,000) — —
Purchase of equipment for lease contracts — (208,400) (4,114,000)
FINANCING ACTIVITIES:
Proceeds from borrowings on notes payable — 30,000,000 —
Proceeds from discounted lease rentals — — 1,157,000
SUPPLEMENTAL DISCLOSURES:
Fiscal Year Ended
The accompanying notes are an integral part of these consolidated financial statements.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
1. Organization and Business:
Winmark Corporation and subsidiaries (the Company) offers licenses to operate franchises using the service marks Plato’s Closet®, Once Upon A Child®, Play It Again Sports®, Style Encore® and Music Go Round®. In addition, the Company sells point-of-sale system hardware to its franchisees and certain merchandise to its Play It Again Sports franchisees. The Company also operates a middle-market equipment leasing businesses under the Winmark Capital® mark and operated a small-ticket financing business under the Wirth Business Credit® mark until November 2020. The Company has a 52/53-week fiscal year that ends on the last Saturday in December. Fiscal year 2022 was a 53-week fiscal year, while 2021 and 2020 were 52-week fiscal years.
2. Significant Accounting Policies:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Winmark Capital Corporation, Wirth Business Credit, Inc. and Grow Biz Games, Inc. All material inter-company transactions have been eliminated in consolidation.
Cash Equivalents
Cash equivalents consist of highly liquid investments with an original maturity of three months or less when purchased. Cash equivalents are stated at cost, which approximates fair value. As of December 31, 2022 and December 25, 2021, the Company had $9,900 and $70,400, respectively, of cash located in Canadian banks. The Company holds its cash and cash equivalents with financial institutions and at times, such balances may be in excess of insurance limits.
Receivables
The Company provides an allowance for doubtful accounts on trade receivables. The allowance for doubtful accounts was $800 and $600 at December 31, 2022 and December 25, 2021 respectively. If receivables in excess of the provided allowance are determined uncollectible, they are charged to expense in the year the determination is made. Trade receivables are written off when they become uncollectible (which generally occurs when the franchise terminates and there is no reasonable expectation of collection), and payments subsequently received on such receivable are credited to the allowance for doubtful accounts. Historically, receivables balances written off have not exceeded allowances provided.
Restricted Cash
The Company is required by certain states to maintain initial franchise fees in a restricted bank account until the franchise opens. The use of these funds by the Company is restricted until the franchise opens. Cash held in escrow totaled $65,000 and $30,000 at December 31, 2022 and December 25, 2021, respectively.
Investment in Leasing Operations
The Company uses the direct finance method of accounting to record income from direct financing leases. At the inception of a lease, the Company records the minimum future lease payments receivable, the estimated residual value of the leased equipment and the unearned lease income. Initial direct costs related to lease originations are deferred as part of the investment and amortized over the lease term. Unearned lease income is the amount by which the total lease receivable plus the estimated residual value exceeds the cost of the equipment.
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.
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Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
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.
Leasing Expense
Leasing expense includes the cost of financing equipment purchases, the cost of equipment sales as well as depreciation expense for operating lease assets.
Initial Direct Costs
The Company defers initial direct costs incurred to originate its leases in accordance with applicable accounting guidance. The initial direct costs deferred are part of the investment in leasing operations and are amortized using the effective interest method. Initial direct costs include commissions and other incremental costs related to originating a lease.
Lease Residual Values
Residual values reflect the estimated amounts to be received at lease termination from sales or other dispositions of leased equipment to unrelated parties. The leased equipment residual values are based on the Company’s best estimate.
Allowance for Credit Losses
The Company maintains an allowance for credit losses at an amount that it believes to be sufficient to absorb losses inherent in its existing lease portfolio as of the reporting dates. Leases are collectively evaluated for potential loss. The Company’s methodology for determining the allowance for credit losses includes consideration of the level of delinquencies and non-accrual leases, historical net charge-off amounts and review of any significant concentrations.
A provision is charged against earnings to maintain the allowance for credit losses at the appropriate level. If the actual results are different from the Company’s estimates, results could be different. The Company’s policy is to charge-off against the allowance the estimated unrecoverable portion of accounts once they reach 121 days delinquent.
Inventories
The Company values its inventories at the lower of cost, as determined by the weighted average cost method, and net realizable values. Inventory consists of computer hardware and related accessories.
Impairment of Long-lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the carrying amount of the asset exceeds expected undiscounted future cash flows, the Company measures the amount of impairment by comparing the carrying amount of the asset to its fair value.
Property and Equipment
Property and equipment is stated at cost. Depreciation and amortization for financial reporting purposes is provided on the straight-line method. Estimated useful lives used in calculating depreciation and amortization are: three to five years for computer and peripheral equipment, five to seven years for furniture and equipment and the shorter of the lease term or useful life for leasehold improvements. Major repairs, refurbishments and improvements which significantly extend the useful lives of the related assets are capitalized. Maintenance and repairs, supplies and accessories are charged to expense as incurred.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
Intangible Assets
Intangible assets are amortized over the estimated useful life on a straight line basis. The Company reviews its intangible assets for impairment at its fiscal year end or whenever events or changes in circumstances indicate that there has been impairment in the value of its intangible assets. No impairment was noted during fiscal year ended 2022. Intangible assets of $3.3 million in the consolidated balance sheets at December 31, 2022 is all attributable to the Franchising segment.
Goodwill
The Company reviews its goodwill for impairment at its fiscal year end or whenever events or changes in circumstances indicate that there has been impairment in the value of its goodwill. No impairment was noted during fiscal years ended 2022, 2021 and 2020. Goodwill of $607,500 in the consolidated balance sheets at December 31, 2022 and December 25, 2021 is all attributable to the Franchising segment.
Use of Estimates
The preparation of financial statements in conformity with generally accepted U.S. accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The ultimate results could differ from those estimates.
Advertising
Advertising costs are charged to selling, general and administrative expenses as incurred. Advertising costs were $491,900, $348,200 and $273,900 for fiscal years 2022, 2021 and 2020, respectively.
Accounting for Stock-Based Compensation
The Company recognizes the cost of all share-based payments to employees, including grants of employee stock options, in the consolidated financial statements based on the grant date fair value of those awards. This cost is recognized over the period for which an employee is required to provide service in exchange for the award.
The Company estimates the fair value of options granted using the Black-Scholes option valuation model. The Company estimates the volatility of its common stock at the date of grant based on its historical volatility rate. The Company’s decision to use historical volatility was based upon the lack of actively traded options on its common stock. The Company estimates the expected term based upon historical option exercises. The risk-free interest rate assumption is based on observed interest rates for the expected term. The Company uses historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For options granted, the Company amortizes the fair value on a straight-line basis. All options are amortized over the vesting periods, which are generally four years beginning from the date of grant.
Revenue Recognition – Franchising
The following is a description of the principal sources of revenue for the company’s franchising segment. The Company’s performance obligations under franchise agreements consist of (a) a franchise license, including a license to use one of our brands, (b) a point-of-sale software license, (c) initial services, such as pre-opening training and marketing support, and (d) ongoing services, such as marketing services and operational support. These performance obligations are highly interrelated so we do not consider them to be individually distinct and therefore account for them under ASC 606 as a single performance obligation, which is satisfied by providing a right to use our intellectual property over the estimated life of the franchise. The disaggregation of the Company’s franchise revenue is presented within the Revenue lines of the Consolidated Statements of Operations with the amounts included in Revenue: Other delineated below. For more detailed information about reportable segments, see Note 13 – “Segment Reporting”.
Royalties
The Company collects royalties from each retail franchise based upon a percentage of retail store gross sales. The Company recognizes royalties as revenue when earned.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
Merchandise Sales
Merchandise sales include the sale of point-of-sale technology equipment to franchisees and the sale of a limited amount of sporting goods to certain Play It Again Sports franchisees. Merchandise sales, which includes shipping and handling charges, are recognized at a point in time when the product has been shipped to the franchisee. Shipping and handling costs associated with outbound freight are accounted for as a fulfillment cost and included in cost of merchandise sold.
Franchise Fees
The Company collects initial franchise fees when franchise agreements are signed. The Company recognizes franchise fee revenue over the estimated life of the franchise, beginning with the opening of the franchise, which is when the Company has performed substantially all initial services required by the franchise agreement and the franchisee benefits from the rights afforded by the franchise agreement. The Company had deferred franchise fee revenue of $6.7 million and $6.6 million at December 31, 2022 and December 25, 2021, respectively.
Marketing Fees
Marketing fee revenue is included in the Revenue: Other line of the Consolidated Statements of Operations. The Company bills and collects annual marketing fees from its franchisees at various times throughout the year. The Company recognizes marketing fee revenue on a straight line basis over the franchise duration. The Company recognized $1.5 million, $1.3 million and $1.3 million in marketing fee revenue for each of the fiscal years ended December 31, 2022, December 25, 2021 and December 26, 2020, respectively.
Software License Fees
Software license fee revenue is included in the Revenue: Other line of the Consolidated Statements of Operations. The Company bills and collects software license fees from its franchisees when the point-of-sale system is provided to the franchisee. The Company recognizes software license fee revenue on a straight line basis over the franchise duration. The Company recognized $0.3 million in software license fee revenue for each of the fiscal years ended December 31, 2022, December 25, 2021 and December 26, 2020. The Company had deferred software license fees of $1.6 million and $1.6 million at December 31, 2022 and December 25, 2021, respectively.
Contract Liabilities
The Company’s contract liabilities for its franchise revenues consist of deferred revenue associated with franchise fees and software license fees described above.
Commission Fees
The Company capitalizes incremental commission fees paid as a result of obtaining franchise agreement contracts. Capitalized commission fees of $0.5 million and $0.5 million are outstanding at December 31, 2022 and December 25, 2021, respectively and are included in Prepaid expenses and Other assets in the Consolidated Balance Sheets.
Capitalized commission fees are amortized over the life of the franchise and are included in selling, general and administrative expenses. During the fiscal years ended December 31, 2022, December 25, 2021 and December 26, 2020, the Company recognized $100,800, $95,200 and $102,600 of commission fee expense, respectively.
Income Taxes
The Company accounts for incomes taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest and penalties related to unrecognized tax benefits in income tax expense.
Sales Tax
The Company’s accounting policy is to present taxes collected from customers and remitted to government authorities on a net basis.
Earnings Per Share
The Company calculates earnings per share by dividing net income by the weighted average number of shares of common stock outstanding to arrive at the Earnings Per Share — Basic. The Company calculates Earnings Per Share — Diluted by dividing net income by the weighted average number of shares of common stock and dilutive stock equivalents from the potential exercise of stock options using the treasury stock method.
The following table sets forth the presentation of shares outstanding used in the calculation of basic and diluted earnings per share (“EPS”):
Year Ended
Options excluded from EPS calculation — anti-dilutive 21,153 20,294 14,822
Fair Value Measurements
The Company defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses three levels of inputs to measure fair value:
Due to their nature, the carrying value of cash equivalents, receivables, payables and debt obligations approximates fair value.
Recently Issued Accounting Pronouncements
The Company reviewed all recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact on our consolidated financial statements.
Reclassifications
Certain reclassifications of previously reported amounts have been made to conform to the current year presentation. Such reclassifications did not impact net income or shareholders’ equity (deficit) as previously reported.
3. Investment in Leasing Operations:
In May 2021, the Company made the decision to no longer solicit new leasing customers in its middle-market leasing business and will pursue an orderly run-off of this leasing portfolio.
In August 2020, the Company made the decision to no longer originate financing transactions in its small-ticket financing business. The Company sold the small-ticket portfolio in November 2020 for its approximate carrying value of $0.7 million.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
Investment in leasing operations consists of the following:
Direct financing and sales-type leases:
Estimated unguaranteed residual value of equipment 461,700 1,316,100
Total investment in direct financing and sales-type leases 348,700 3,163,000
Allowance for credit losses (7,100) (63,600)
Net investment in direct financing and sales-type leases 341,600 3,099,400
Operating leases:
Less accumulated depreciation and amortization (707,400) (605,700)
Net investment in operating leases 8,700 20,500
Total net investment in leasing operations $ 350,300 $ 3,119,900
As of December 31, 2022, the $350,300 total net investment in leases consisted of $344,900 classified as current and $5,400 classified as long-term. As of December 25, 2021, the $3.1 million total net investment in leases consisted of $2.9 million classified as current and $0.2 million classified as long-term.
As of December 31, 2022 and December 25, 2021, no customers had leased assets totaling more than 10% of the Company’s total assets.
Future minimum lease payments receivable under lease contracts and the amortization of unearned lease income, net of initial direct costs deferred, is as follows as of December 31, 2022:
Direct Financing and Sales-Type Leases
Minimum Lease Income
Fiscal Year Payments Receivable Amortization
The activity in the allowance for credit losses for leasing operations during 2022, 2021 and 2020, respectively, is as follows:
Deductions for amounts written-off — — (219,300)
The Company’s investment in direct financing and sales-type leases (“Investment In Leases”) and allowance for credit losses by loss evaluation methodology are as follows:
Investment Allowance for Investment Allowance for
In Leases Credit Losses In Leases Credit Losses
Individually evaluated for loss potential — — — —
The Company’s key credit quality indicator for its investment in direct financing and sales-type leases is the status of the lease, defined as accruing or non-accrual. Leases that are accruing income are considered to have a lower risk of loss.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020