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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WINMARK CORPORATION AND SUBSIDIARIES
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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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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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
Non-accrual leases are those that the Company believes have a higher risk of loss. The following table sets forth information regarding the Company’s accruing and non-accrual leases. Delinquent balances are determined based on the contractual terms of the lease.
Delinquent Delinquent Delinquent and
and Accruing and Accruing Accruing Non-Accrual Total
Total investment in leases $ 348,700 $ — $ — $ — $ 348,700
Delinquent Delinquent Delinquent and
and Accruing and Accruing Accruing Non-Accrual Total
Total investment in leases $ 3,163,000 $ — $ — $ — $ 3,163,000
The Company leases high-technology and other business-essential equipment to its leasing customers. Upon expiration of the initial term or extended lease term, depending on the structure of the lease, the customer may return the equipment, renew the lease for an additional term, or purchase the equipment. Due to the uncertainty of such outcome at the end of the lease term, the lease as recorded at commencement represents only the current terms of the agreement. As a lessor, the Company’s leases do not contain non-lease components. The 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. The Company’s risk management strategy for its residual value includes the contractual obligations of its customers to maintain, service, and insure the leased equipment, the use of third party remarketers as well as the analytical review of historical asset dispositions.
Leasing income as presented on the Consolidated Statements of Operations consists of the following:
Year Ended Year Ended Year Ended
4. Receivables:
The Company’s current receivables consisted of the following:
As part of its normal operating procedures, the Company requires Standby Letters of Credit as collateral for a portion of its trade receivables.
5. Intangible Assets:
In June 2022, Winmark terminated an agreement that contained the rights for eleven Play It Again Sports stores to operate separately from Winmark’s franchise system. In terminating the agreement, which included $3.54 million of consideration paid by Winmark, Winmark reacquired the franchise rights to these eleven stores. Upon termination of the agreement, individual franchise agreements were signed for these eleven stores, each with an initial term of ten years.
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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 consist of these reacquired franchise rights. The Company amortizes the fair value of the reacquired franchise rights over the contract term of the franchise. The Company recognized $191,700 of amortization expense for the year ended December 31, 2022.
Intangible assets consist of the following:
Reacquired franchise rights $ 3,540,000
Accumulated amortization (191,700)
The following table illustrates future amortization to be expensed for the next five fiscal years and fiscal years thereafter related to reacquired franchise rights as of December 31, 2022.
Amortization expected to be expensed in Amount
6. Shareholders’ Equity (Deficit):
Dividends
In 2022, the Company declared and paid quarterly cash dividends totaling $2.55 per share ($8.9 million) and a $3.00 per share special cash dividend (the “2022 Special Dividend”). The 2022 Special Dividend totaled $10.4 million and was paid by cash on hand.
In 2021, the Company declared and paid quarterly cash dividends totaling $1.60 per share ($5.9 million) and a $7.50 per share special cash dividend (the “2021 Special Dividend”). The 2021 Special Dividend totaled $27.3 million and was paid by cash on hand.
In 2020, the Company declared and paid quarterly cash dividends totaling $0.80 per share ($3.0 million) and a $3.00 per share special cash dividend (the “2020 Special Dividend”). The 2020 Special Dividend totaled $11.3 million and was paid by cash on hand.
Repurchase of Common Stock
In 2022, the Company purchased 226,165 shares of our common stock for an aggregate purchase price of $49.1 million.
In 2021, the Company purchased 225,839 shares of our common stock for an aggregate purchase price of $44.2 million.
In December 2019, the Company’s Board of Directors authorized the repurchase of up to 300,000 shares of our common stock for a price of $163.00 per share through a tender offer (the “2020 Tender Offer”). The 2020 Tender Offer began on the date of the announcement, December 17, 2019 and expired on January 16, 2020. Upon expiration, the Company purchased 300,000 shares for a total purchase price of approximately $49.0 million, including fees and expenses related to the Tender Offer. The 2020 Tender Offer was financed in part by net borrowings under the Line of Credit. (See Note 7 – “Debt”).
Under the Board of Directors’ authorization, as of December 31, 2022 the Company has the ability to repurchase an additional 78,600 shares of its common stock. Repurchases may be made from time to time at prevailing prices, subject to certain restrictions on volume, pricing and timing.
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WINMARK CORPORATION AND SUBSIDIARIES
Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
Stock Option Plans and Stock-Based Compensation
The Company had authorized up to 750,000 shares of common stock for granting either nonqualified or incentive stock options to officers and key employees under the Company’s 2001 Stock Option Plan (the “2001 Plan”). The 2001 Plan expired on February 20, 2011. The Company had authorized up to 700,000 shares of common stock for granting either nonqualified or incentive stock options to officers and key employees under the Company’s 2010 Stock Option Plan (the “2010 Plan”). The 2010 Plan expired on February 24, 2020. The Company had also sponsored a Stock Option Plan for Nonemployee Directors (the “Nonemployee Directors Plan”), which had reserved a total of 350,000 shares for issuance to directors of the Company who are not employees.
At the April 29, 2020 Annual Shareholders Meeting, the Company’s shareholders approved a new stock option plan, the 2020 Stock Option Plan (the “2020 Plan”). The 2020 Plan (as described more completely in the Company’s definitive Proxy Statement filed with the United States Securities and Exchange Commission on March 10, 2020) provides for the issuance of up to 100,000 shares of common stock plus (i) the number of common stock authorized and unissued under the 2010 Plan (as of April 29, 2020, 125,465 shares), and (ii) the number of shares of common stock authorized and unissued under the Nonemployee Director Plan (as of April 29, 2020, 24,500 shares) in the form of either nonqualified or incentive stock option grants. Participants in the 2020 Plan may include employees, officers, directors, consultants and advisors of the Company.
Grants under the 2020 Plan are (as they were under the 2001 Plan, 2010 Plan and Nonemployee Directors Plan) made by the Compensation Committee of the Board of Directors at a price of not less than 100% of the fair market value on the date of grant. If an incentive stock option is granted to an individual who owns more than 10% of the voting rights of the Company’s common stock, the option exercise price may not be less than 110% of the fair market value on the date of grant. The term of the options may not exceed 10 years, except in the case of nonqualified stock options, whereby the terms are established by the Compensation Committee. Options may be exercisable in whole or in installments, as determined by the Compensation Committee.
Stock option activity under the 2001 Plan, 2010 Plan, 2020 Plan and Nonemployee Directors Plan (collectively, the “Option Plans”) as of December 31, 2022 was as follows:
Weighted Average
Remaining
Number of Weighted Average Contractual Life
Shares Exercise Price (years) Intrinsic Value
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Notes to the Consolidated Financial Statements
December 31, 2022, December 25, 2021 and December 26, 2020
The fair value of options granted under the Option Plans during 2022, 2021 and 2020 were estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions and results:
Year Ended
Risk free interest rate 3.15 % 1.13 % 0.45 %
Expected life (years) 6 6 6