WINMARK CORPORATION Overview
Winmark - theResale Company is focused on sustainability and small business formation. As ofApril 1, 2023 , we had 1,297 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 revenue is royalties received from our
franchisees. During the first three months of 2023, our royalties increased
Management continually monitors the level and timing of selling, general and administrative expenses. The major components of selling, general and administrative expenses include salaries, wages and benefits, advertising, conferences, travel, occupancy, legal and professional fees. During the first three months of 2023, selling, general and administrative expenses increased$1.1 million , or 19.8% compared to the first three months of 2022. 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 first three months endedApril 1, 2023 :
AVAILABLE
TOTAL TOTAL FOR COMPLETED
12/31/2022 OPENED CLOSED 4/1/2023 RENEWAL RENEWALS % RENEWED
Plato's Closet 500 2 (2) 500 19 19 100 %
Once Upon A Child 406 - - 406 5 5 100 %
Play It Again Sports 281 3 (1) 283 6 6 100 %
Style Encore 71 - - 71 - - N/A
Music Go Round 37 - - 37 - - N/A
Total Franchised Stores 1,295 5 (3) 1,297 30 30 100 %
Renewal activity is a key focus area for management. Our franchisees sign
10-year agreements with us. The renewal of existing franchise agreements as they
approach their expiration is an indicator that management monitors to determine
the health of our business and the preservation of future royalties. During the
first three months of 2023, we renewed 30 of the 30 franchise agreements
available for renewal.
Our ability to grow our operating income is dependent on our ability to: (i) effectively support our franchise partners so that they produce higher revenues, (ii) open new franchises, and (iii) control our selling, general and administrative expenses.
InMay 2021 , we made the decision to no longer solicit new leasing customers and pursue an orderly run-off of our middle-market leasing portfolio. Leasing income net of leasing expense for the first three months of 2023 was$1.3 million compared to$2.7 million in the first three months of 2022. Given the decision to run-off the portfolio, we anticipate that leasing income net of leasing expense will continue to decrease through the run-off period. 12 Table of Contents Results of Operations The following table sets forth selected information from our Consolidated Condensed Statements of Operations expressed as a percentage of total revenue: Three Months Ended April 1, 2023 March 26, 2022 Revenue: Royalties 81.6 % 76.7 % Leasing income 8.0 14.3 Merchandise sales 6.2 4.6 Franchise fees 1.8 2.1 Other 2.4 2.3 Total revenue 100.0 100.0 Cost of merchandise sold (5.8) (4.3) Leasing expense (1.5) (1.1) Provision for credit losses - - Selling, general and administrative expenses (32.3) (27.6) Income from operations 60.4 67.0 Interest expense (3.9) (2.6)
Interest and other income (expense) 0.6
- Income before income taxes 57.1 64.4 Provision for income taxes (13.5) (15.3) Net income 43.6 % 49.1 %
Comparison of Three Months Ended
Revenue
Revenues for the quarter ended
Royalties and Franchise Fees
Royalties increased to$16.7 million for the first three months of 2023 from$15.4 million for the first three months of 2022, an 8.8% increase. The increase is primarily from higher franchisee retail sales and from having additional franchise stores in the first three months of 2023 compared to the same period in 2022.
Franchise fees of
Leasing Income
Leasing income decreased to$1.6 million for the first quarter of 2023 compared to$2.9 million for the same period in 2022. The decrease is primarily due to a decrease in selling profit at the commencement of sales type leases and lower levels of interest and other income from the smaller lease portfolio, partially offset by an increase in operating lease income when compared to the same period last year. Merchandise Sales
Merchandise sales include the sale of product to franchisees either through our Computer Support Center or through thePlay It Again Sports buying group (together, "Direct Franchisee Sales"). Direct Franchisee Sales increased to$1.3 million for the first quarter of 2023 compared to$0.9 million in the same period of 2022. The increase is primarily due to an increase in technology and buying group purchases by our franchisees. 13 Table of Contents 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$1.2 million for the first quarter of 2023 compared to$0.9 million in the same period of 2022. The increase was primarily due to an increase in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the first quarter of 2023 and 2022 was 93.0% and 94.6%, respectively. Leasing Expense Leasing expense increased to$0.3 million for the first quarter of 2023 compared to$0.2 million for the first quarter of 2022. The increase was primarily due to an increase in depreciation on operating leases.
Selling, General and Administrative
Selling, general and administrative expenses increased 19.8% to$6.6 million in the first quarter of 2023 from$5.5 million in the same period of 2022. The increase was primarily due to an increase in conference expenses, as during the first quarter of 2023 we returned to holding in-person conferences for our apparel brands for the first time since the Covid-19 outbreak.
Interest Expense
Interest expense increased to
Income Taxes
The provision for income taxes was calculated at an effective rate of 23.7% and 23.8% for the first quarter of 2023 and 2022, respectively.
Segment Comparison of Three Months Ended
For 2022, our leasing business did not reach any of the quantitative thresholds for a reportable segment, and we do not expect the results from our leasing business to be of significance in future periods. The revenues and operating income from our leasing business are included in Other in our reportable segment disclosures.
Franchising Segment Operating Income
The franchising segment's operating income for the first quarter of 2023 of
Other Operating Segment Income
Other operating segment income for the first quarter of 2023 decreased by$1.0 million to$1.2 million from$2.2 million for the first quarter of 2022. The decrease in segment contribution was due to a decrease in leasing income net of leasing expenses.
Liquidity and Capital Resources
Our primary sources of liquidity have historically been cash flow from operations and borrowings. The components of the consolidated condensed statements of operations that reduce our net income but do not affect our liquidity include non-cash items for depreciation and amortization and compensation expense related to stock options.
We ended the first quarter of 2023 with
Operating activities provided
Investing activities used
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Financing activities used$2.9 million of cash during the first three months of 2023. Our most significant financing activities during the first three months of 2023 consisted of$2.4 million for the payment of dividends and payments on notes payable of$1.1 million ; partially offset by$0.6 million of proceeds from exercise of stock options. (See Note 8 - "Shareholders' Equity (Deficit) and Note 9 - "Debt"). Our debt facilities include a Line of Credit withCIBC Bank USA and a Note Agreement and Shelf Agreement with Prudential. These facilities have been and will continue to be used for general corporate purposes, are secured by a lien against substantially all of our assets, contain customary financial conditions and covenants, and require maintenance of minimum levels of debt service coverage and maximum levels of leverage (all as defined within the agreements governing the facilities). As ofApril 1, 2023 , 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 ofApril 1, 2023 , 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 atApril 1, 2023 was$42.4 million ). As ofApril 1, 2023 , we had not issued any notes under the Shelf Agreement. Of the$42.4 million of principal outstanding under the Note Agreement,$12.4 million amortizes over the remainder of 2023 through 2027, and$30.0 million matures in 2028.
See Part I, Item 1, Note 9 - "Debt" for more information regarding the Line of Credit, Note Agreement and Shelf Agreement.
We expect to generate the cash necessary to pay our expenses and to pay the principal and interest on our outstanding debt from cash flows provided by operating activities and by opportunistically using other means to repay or refinance our obligations as we determine appropriate. Our ability to pay our expenses and meet our debt service obligations depends on our future performance, which may be affected by financial, business, economic, and other factors including the risk factors described under Item 1A of our Form 10-K for the fiscal year endedDecember 31, 2022 and under Item 1A below. If we do not have enough money to pay our debt service obligations, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or raise equity. In such an event, we may not be able to refinance our debt, sell assets, borrow more money or raise equity on terms acceptable to us or at all. Also, our ability to carry out any of these activities on favorable terms, if at all, may be further impacted by any financial or credit crisis which may limit access to the credit markets and increase our cost of capital. As of the date of this report we believe that the combination of our cash on hand, the cash generated from our business, our Line of Credit and our Shelf Agreement will be adequate to fund our planned operations through 2023.
Critical Accounting Policies
A discussion of our critical accounting policies is contained in our annual report on Form 10-K for the year endedDecember 31, 2022 . There have been no changes to our critical accounting policies from those disclosed on our Form 10-K for the year endedDecember 31, 2022 .
Forward Looking Statements
The statements contained in this Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" that are not strictly historical fact, including without limitation, the Company's belief that it will have adequate capital and reserves to meet its current and contingent obligations and operating needs, as well as its disclosures regarding market rate risk are forward looking statements made under the safe harbor provision of the Private Securities Litigation Reform Act. Such statements are based on management's current expectations as of the date of this Report, but involve risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by such forward looking statements. Investors are cautioned to consider these forward looking statements in light of important factors which may result in material variations between results contemplated by such forward looking statements and actual results and conditions. See the section appearing in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2022 entitled "Risk Factors" and Part II, Item 1A in this Report for a more complete discussion of certain factors that may cause the Company's actual results to differ from those in its forward looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date they were made. The Company undertakes no obligation to revise or update publicly any forward-looking statements for any reason. 15
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