# WINMARK CORP (WINA) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from WINMARK CORP's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/908315/000090831524000010/wina-20231230x10k.htm
Accession: 0000908315-24-000010
Filing date: 2024-02-28
Report date: 2023-12-30
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/WINA/
All MD&A years: /company/WINA/mda/
Previous year: /company/WINA/mda/fy2022/ (FY 2022)
Next year: /company/WINA/mda/fy2024/ (FY 2024)

ITEM 7:     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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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 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-date comparisons between 2022 and 2021 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 31, 2022.

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Overview

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Winmark – the Resale Company is focused on sustainability and small business formation. As of December 30, 2023, we had 1,319 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.

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The financial criteria that management closely tracks to evaluate current business operations and future prospects include royalties and selling, general and administrative expenses.

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Our most significant source of franchising revenue is royalties received from our franchisees. During 2023, our royalties increased $3.1 million or 4.6% compared to 2022.

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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 2023, selling, general and administrative expense increased $2.0 million, or 8.4%, compared to the same period last year.

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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 30, 2023:

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[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

​

[[GREPCENT_TABLE]]
[["","(1)","All stores are owned and operated by franchisees. Winmark does not own or operate any corporate stores."]]
[[/GREPCENT_TABLE]]

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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 2023, we renewed 99% of franchise agreements up for renewal. This percentage of renewal has ranged between 99% and 100% during the last three years.

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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”.

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13

Table of Contents

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. Leasing income net of leasing expense for the fiscal year of 2023 was $4.4 million compared to $6.0 million in 2022. Our leasing portfolio (net investment in leases – current and long-term), was $0.1 million at December 30, 2023 compared to $0.3 million at December 31, 2022. 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.

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Results of Operations

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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:

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[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

​

Revenue

​

Revenues for the year ended December 30, 2023 totaled $83.2 million compared to $81.4 million in 2022.

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Royalties and Franchise Fees

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Royalties increased to $70.2 million for 2023 from $67.1 million for the same period in 2022, a 4.6% increase. The increase is primarily due to higher franchisee retail sales and from having additional franchise stores in 2023 compared to 2022. Fiscal 2023 was a 52-week year compared to a 53-week year in fiscal 2022, which also impacted the comparability of royalty revenue.

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Franchise fees of $1.5 million for 2023 were comparable to $1.6 million for 2022. 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

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Leasing income decreased to $4.8 million in 2023 compared to $6.9 million for the same period in 2022. The decrease is primarily due to a decrease in selling profit on the commencement of sales type leases and lower levels of equipment sales to customers, partially offset by an increase in operating lease income when compared to last year.

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14

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Merchandise Sales

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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 $4.8 million in 2023 from $3.9 million in 2022. The increase is due to an increase in technology and buying group purchases by our franchisees.

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Cost of Merchandise Sold

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Cost of merchandise sold includes in-bound freight and the cost of merchandise associated with Direct Franchisee Sales. Cost of merchandise sold increased to $4.5 million in 2023 from $3.7 million in 2022. 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 2023 and 2022 was 93.7% and 94.7%, respectively.

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Leasing Expense

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Leasing expense decreased to $0.4 million in 2023 compared to $1.0 million in 2022. The decrease was primarily due to a decrease in depreciation on operating leases and a decrease in the associated cost of equipment sales to customers noted above.

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Selling, General and Administrative Expenses

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Selling, general and administrative expenses increased 8.4% to $25.1 million in 2023 from $23.2 million in 2022. The increase was primarily due to an increase in conference expenses, as we returned to holding an in-person conference for our apparel brands for the first time since the Covid-19 outbreak, advertising related expenses, outside services and amortization expense.

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Interest Expense

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Interest expense was $3.1 million in 2023 compared to $2.9 million in 2022. The increase is primarily due to higher average corporate borrowings when compared to last year.

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Income Taxes

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The provision for income taxes was calculated at an effective rate of 21.8% and 22.4% for 2023 and 2022, respectively. The decrease is primarily due to higher tax benefits on the exercise of non-qualified stock options.

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Segment Comparison of Fiscal Years 2023 and 2022

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As of December 30, 2023, we have one reportable operating segment, franchising, and one non-reportable operating segment. The franchising segment franchises value-oriented retail store concepts that buy, sell and trade merchandise. The non-reportable operating 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 operating segments. The following tables summarize financial information by segment and provide a reconciliation of segment contribution to income from operations:

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended"],["\u200b","","December 30, 2023","","December 31, 2022"],["Revenue:","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["Franchising","\u200b","$","78,477,300","\u200b","$","74,473,100","\u200b"],["Other","\u200b","","4,766,200","\u200b","","6,937,700","\u200b"],["Total revenue","\u200b","$","83,243,500","\u200b","$","81,410,800","\u200b"],["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["Reconciliation to income from operations:","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["Franchising segment contribution","\u200b","$","49,375,900","\u200b","$","49,007,900","\u200b"],["Other operating segment contribution","\u200b","","3,904,700","\u200b","","4,604,900","\u200b"],["Total income from operations","\u200b","$","53,280,600","\u200b","$","53,612,800","\u200b"]]
[[/GREPCENT_TABLE]]

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Revenues are all generated from United States operations other than franchising revenue from Canadian operations of $6.8 million and $6.4 million in each of fiscal 2023 and 2022, respectively.

​

15

Table of Contents

Franchising Segment Operating Income

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The franchising segment’s 2023 operating income increased by $0.4 million, or 0.8%, to $49.4 million from $49.0 million for 2022. The increase in segment contribution was primarily due to increased royalty revenues, partially offset by an increase in selling, general and administrative expenses.

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Other Segment Operating Income

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The other segment operating income for 2023 decreased by $0.7 million, or 15.2%, to $3.9 million from $4.6 million for 2022. 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.

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Liquidity and Capital Resources

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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.

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We ended 2023 with $13.4 million in cash, cash equivalents and restricted cash compared to $13.7 million in cash, cash equivalents and restricted cash at the end of 2022.

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Operating activities provided $44.0 million of cash during 2023 compared to $43.8 million provided during 2022.

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Investing activities used $0.4 million of cash during 2023 compared to $3.7 million used during 2022.

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Financing activities used $43.9 million of cash during 2023 compared to $37.9 million used during 2022. 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 2023, we paid $43.7 million in cash dividends (including a $9.40 per share special cash dividend; the “2023 Special Dividend”), and paid $4.3 million on notes payable; partially offset by $4.0 million of proceeds from the exercise of stock options. (See Note 6 — “Shareholders’ Equity (Deficit)” and Note 7 — “Debt”).

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We have debt obligations and future operating lease commitments for our corporate headquarters. As of December 30, 2023, we had no other material outstanding commitments. (See Note 12 — “Commitments and Contingencies”). The following table summarizes our significant future contractual obligations at December 30, 2023:

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[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Includes interest payable monthly at rates ranging from 4.60% to 4.75%."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(2)","Includes interest payable quarterly at rates ranging from 3.18% to 5.50% assuming principal payments in accordance with amortizing schedules."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]