WINMARK CORP (WINA) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
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 | | | |
| | 12/25/2021 | | OPENED | | CLOSED | | 12/31/2022 | RENEWAL | | RENEWALS | | % RENEWED | | ||
| Plato’s Closet | 489 | 14 | (3) | 500 | 55 | 55 | 100 | % | |||||||
| Once Upon A Child | 401 | 8 | (3) | 406 | 32 | | 32 | 100 | % | ||||||
| Play It Again Sports | 273 | 16(1) | (8) | 281 | 57 | | 57 | 100 | % | ||||||
| Style Encore | 71 | 4 | (4) | 71 | — | — | N/A | | |||||||
| Music Go Round | 37 | — | — | 37 | — | — | N/A | | |||||||
| Total Franchised Stores(2) | 1,271 | 42 | (18) | 1,295 | 144 | 144 | 100 | % |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (1) | Includes 11 stores formerly operated outside the Winmark franchise system. (See Note 5 – “Intangible Assets”). |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (2) | All stores are owned and operated by franchisees. Winmark does not own or operate any corporate stores. |
Renewal activity is a key focus area for management. Our franchisees sign 10-year agreements with us. The renewal of existing franchise agreements as they approach their expiration is an indicator that management monitors to determine the health of our business and the preservation of future royalties. In 2022, we renewed 100% of franchise agreements up for renewal. This percentage of renewal has ranged between 99% and 100% during the last three years.
Our ability to grow our operating income is dependent on our ability to: (i) effectively support our franchise partners so that they produce higher revenues, (ii) open new franchises, and (iii) control our selling, general and administrative expenses. A detailed description of the risks to our business along with other risk factors can be found in Item 1A “Risk Factors”.
In 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) | | |
| | 2022 | 2021 | 2021 | ||||
| Revenue: | | | | | | | |
| Royalties | 82.5 | % | 77.7 | % | 10.5 | % | |
| Leasing income | 8.5 | | 14.2 | | (37.8) | | |
| Merchandise sales | 4.8 | | 4.0 | | 26.5 | | |
| Franchise fees | 1.9 | | 1.9 | | 5.2 | | |
| Other | 2.3 | | 2.2 | | 8.1 | | |
| Total revenue | 100.0 | | 100.0 | | 4.1 | | |
| | | | | | | | |
| Cost of merchandise sold | (4.6) | | (3.8) | | 26.3 | | |
| Leasing expense | (1.2) | | (2.4) | | (46.8) | | |
| Provision for credit losses | 0.1 | | 0.3 | | 72.0 | | |
| Selling, general and administrative expenses | (28.4) | | (28.5) | | 3.9 | | |
| Income from operations | 65.9 | | 65.6 | | 4.4 | | |
| Interest expense | (3.6) | | (1.9) | | 100.5 | | |
| Interest and other income (expense) | 0.1 | | — | | (670.7) | | |
| Income before income taxes | 62.4 | | 63.7 | | 1.8 | | |
| Provision for income taxes | (14.0) | | (12.7) | | 14.2 | | |
| Net income | 48.4 | % | 51.0 | % | (1.2) | % |
Revenue
Revenues for the year ended 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 | |||||
| | December 31, 2022 | December 25, 2021 | |||||
| Revenue: | | | | | | | |
| Franchising | | $ | 74,473,100 | | $ | 67,067,900 | |
| Leasing | | 6,937,700 | | 11,148,300 | | ||
| Total revenue | | $ | 81,410,800 | | $ | 78,216,200 | |
| | | | | | | | |
| Reconciliation to income from operations: | | | | | | | |
| Franchising segment contribution | | $ | 49,007,900 | | $ | 44,832,100 | |
| Leasing segment contribution | | 4,604,900 | | 6,504,100 | | ||
| Total income from operations | | $ | 53,612,800 | | $ | 51,336,200 | |
Revenues are all generated 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 | | | | | | | | | | | | | | | | |
| Line of Credit/Term loan(1)(3) | | $ | 38,768,400 | | $ | 1,395,500 | | $ | 2,791,000 | | $ | 2,791,000 | | $ | 31,790,900 | |
| Notes Payable(2)(3) | | 50,247,200 | | | 5,833,500 | | | 9,491,100 | | | 4,207,100 | | | 30,715,500 | | |
| Operating Lease Obligations | | 5,806,200 | | | 763,300 | | | 1,590,300 | | | 1,679,300 | | | 1,773,300 | | |
| Total Contractual Obligations | | $ | 94,821,800 | | $ | 7,992,300 | | $ | 13,872,400 | | $ | 8,677,400 | | $ | 64,279,700 | |
| Column 1 | Column 2 |
|---|---|
| (1) | Includes interest payable monthly at rates ranging from 4.60% to 4.75%. |
| Column 1 | Column 2 |
|---|---|
| (2) | Includes interest payable quarterly at rates ranging from 3.18% to 5.50% assuming principal payments in accordance with amortizing schedules. |