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WINMARK CORP - Quarter Report: 2021 June (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 26, 2021

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                  

Commission File Number: 000-22012

WINMARK CORPORATION

(Exact name of registrant as specified in its charter)

Minnesota

41-1622691

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

605 Highway 169 North, Suite 400, Minneapolis, MN 55441

(Address of principal executive offices) (Zip Code)

(763) 520-8500

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

Trading Symbol

Name of each exchange on which registered:

Common Stock, no par value per share

WINA

Nasdaq Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes               No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes               No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer 

Non-accelerated filer   

Accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes               No

Common stock, no par value, 3,632,168 shares outstanding as of July 16, 2021.

Table of Contents

WINMARK CORPORATION AND SUBSIDIARIES

INDEX

PAGE

PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements (Unaudited)

CONSOLIDATED CONDENSED BALANCE SHEETS
June 26, 2021 and December 26, 2020

3

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
Three Months Ended June 26, 2021 and June 27, 2020
Six Months Ended June 26, 2021 and June 27, 2020

4

CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT):
Three Months Ended June 26, 2021 and June 27, 2020
Six Months Ended June 26, 2021 and June 27, 2020

5

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
Six Months Ended June 26, 2021 and June 27, 2020

6

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

13

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

20

Item 4.

Controls and Procedures

21

PART II.

OTHER INFORMATION

21

Item 1.

Legal Proceedings

21

Item 1A.

Risk Factors

21

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

21

Item 3.

Defaults Upon Senior Securities

22

Item 4.

Mine Safety Disclosures

22

Item 5.

Other Information

22

Item 6.

Exhibits

22

SIGNATURES

23

2

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PART I.          FINANCIAL INFORMATION

ITEM 1: Financial Statements

WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

June 26, 2021

December 26, 2020

ASSETS

Current Assets:

Cash and cash equivalents

 

$

7,223,300

 

$

6,659,000

Restricted cash

25,000

25,000

Receivables, less allowance for doubtful accounts of $1,000 and $800

 

1,176,300

 

1,581,900

Net investment in leases - current

 

6,005,300

 

8,687,500

Income tax receivable

 

695,200

 

221,200

Inventories

 

329,400

 

106,600

Prepaid expenses

 

687,200

 

995,200

Total current assets

 

16,141,700

 

18,276,400

Net investment in leases - long-term

 

1,779,400

 

4,573,600

Property and equipment, net

2,158,200

2,332,800

Operating lease right of use assets

3,116,400

3,226,300

Goodwill

 

607,500

 

607,500

Other assets

418,100

435,900

Deferred income taxes

2,798,100

1,890,700

 

$

27,019,400

 

$

31,343,200

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)

Current Liabilities:

Notes payable, net of unamortized debt issuance costs of $13,900 and $13,900

 

$

4,236,100

 

$

4,236,100

Accounts payable

 

1,458,000

 

1,769,600

Accrued liabilities

 

3,102,600

 

2,624,000

Discounted lease rentals

816,200

1,096,600

Deferred revenue

 

1,650,200

 

1,657,400

Total current liabilities

 

11,263,100

 

11,383,700

Long-Term Liabilities:

Notes payable, net of unamortized debt issuance costs of $47,900 and $54,800

 

15,514,600

 

17,632,700

Discounted lease rentals

 

217,200

 

574,000

Deferred revenue

6,937,800

7,050,900

Operating lease liabilities

5,063,500

5,307,400

Other liabilities

 

763,700

 

773,200

Total long-term liabilities

 

28,496,800

 

31,338,200

Shareholders’ Equity (Deficit):

Common stock, no par value, 10,000,000 shares authorized, 3,668,019 and 3,756,028 shares issued and outstanding

 

 

9,281,800

Retained earnings (accumulated deficit)

 

(12,740,500)

 

(20,660,500)

Total shareholders’ equity (deficit)

 

(12,740,500)

 

(11,378,700)

 

$

27,019,400

 

$

31,343,200

The accompanying notes are an integral part of these financial statements

3

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

Three Months Ended

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

June 26, 2021

    

June 27, 2020

    

Revenue:

Royalties

$

14,716,500

$

7,805,800

$

28,765,300

$

18,978,300

Leasing income

 

2,848,600

 

3,473,800

 

6,085,600

 

9,345,000

Merchandise sales

 

683,100

 

361,500

 

1,275,500

 

1,115,600

Franchise fees

 

358,900

 

342,100

 

717,900

 

729,500

Other

 

422,500

 

406,300

 

844,200

 

821,100

Total revenue

 

19,029,600

 

12,389,500

 

37,688,500

 

30,989,500

Cost of merchandise sold

 

647,800

 

346,100

 

1,206,600

 

1,063,800

Leasing expense

 

662,400

 

516,600

 

1,051,900

 

1,932,800

Provision for credit losses

 

(62,700)

 

(111,500)

 

(111,400)

 

503,900

Selling, general and administrative expenses

 

5,805,200

 

4,960,500

 

10,907,500

 

10,709,400

Income from operations

 

11,976,900

 

6,677,800

 

24,633,900

 

16,779,600

Interest expense

 

(304,300)

 

(538,700)

 

(622,400)

 

(1,063,900)

Interest and other income

 

4,900

 

12,600

 

11,700

 

18,500

Income before income taxes

 

11,677,500

 

6,151,700

 

24,023,200

 

15,734,200

Provision for income taxes

 

(2,740,200)

 

(1,096,500)

 

(5,774,800)

 

(3,362,000)

Net income

$

8,937,300

$

5,055,200

$

18,248,400

$

12,372,200

Earnings per share - basic

$

2.42

$

1.37

$

4.91

$

3.34

Earnings per share - diluted

$

2.33

$

1.33

$

4.74

$

3.21

Weighted average shares outstanding - basic

 

3,693,503

 

3,688,248

 

3,715,088

 

3,699,923

Weighted average shares outstanding - diluted

 

3,830,844

 

3,803,807

 

3,852,534

 

3,857,779

The accompanying notes are an integral part of these financial statements.

4

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

(Unaudited)

Retained

Earnings

Common Stock

(Accumulated

    

Shares

    

Amount

    

Deficit)

    

Total

BALANCE, December 26, 2020

3,756,028

$

9,281,800

$

(20,660,500)

$

(11,378,700)

Repurchase of common stock

 

(58,255)

(9,935,800)

(519,400)

(10,455,200)

Stock options exercised

 

2,950

268,800

268,800

Compensation expense relating to stock options

 

385,200

385,200

Cash dividends ($0.25 per share)

 

(935,400)

(935,400)

Comprehensive income (Net income)

 

9,311,100

9,311,100

BALANCE, March 27, 2021

 

3,700,723

(12,804,200)

(12,804,200)

Repurchase of common stock

 

(43,833)

(1,254,400)

(7,208,600)

(8,463,000)

Stock options exercised

 

11,129

941,500

941,500

Compensation expense relating to stock options

 

312,900

312,900

Cash dividends ($0.45 per share)

 

(1,665,000)

(1,665,000)

Comprehensive income (Net income)

 

8,937,300

8,937,300

BALANCE, June 26, 2021

 

3,668,019

$

$

(12,740,500)

$

(12,740,500)

Retained

Earnings

Common Stock

(Accumulated

    

Shares

    

Amount

    

Deficit)

    

Total

BALANCE, December 28, 2019

3,947,858

$

11,929,300

$

519,000

$

12,448,300

Repurchase of common stock

 

(300,000)

(12,215,500)

(36,772,000)

(48,987,500)

Stock options exercised

 

2,895

145,900

145,900

Compensation expense relating to stock options

 

140,300

140,300

Cash dividends ($0.25 per share)

 

(912,200)

(912,200)

Comprehensive income (Net income)

 

7,317,000

7,317,000

BALANCE, March 28, 2020

 

3,650,753

(29,848,200)

(29,848,200)

Stock options exercised

 

72,434

6,013,600

6,013,600

Compensation expense relating to stock options

 

397,700

397,700

Cash dividends ($0.05 per share)

 

(184,500)

(184,500)

Comprehensive income (Net income)

 

5,055,200

5,055,200

BALANCE, June 27, 2020

 

3,723,187

$

6,411,300

$

(24,977,500)

$

(18,566,200)

The accompanying notes are an integral part of these financial statements

5

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WINMARK CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

OPERATING ACTIVITIES:

Net income

$

18,248,400

$

12,372,200

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

 

223,200

 

246,000

Provision for credit losses

 

(111,400)

 

503,900

Compensation expense related to stock options

 

698,100

 

538,000

Deferred income taxes

 

(907,400)

 

(839,900)

Loss from disposal of property and equipment

200

Deferred initial direct costs

 

(2,100)

 

(14,500)

Amortization of deferred initial direct costs

 

16,400

 

66,400

Operating lease right of use asset amortization

109,900

242,100

Tax benefits on exercised stock options

 

248,900

 

477,900

Change in operating assets and liabilities:

Receivables

 

405,600

 

(224,300)

Principal collections on lease receivables

5,332,200

7,995,000

Income tax receivable/payable

 

(722,900)

 

3,300,800

Inventories

 

(222,800)

 

2,200

Prepaid expenses

 

308,000

 

1,200

Other assets

17,800

17,200

Accounts payable

 

(311,600)

 

816,600

Accrued and other liabilities

 

232,100

 

(701,600)

Rents received in advance and security deposits

 

(317,700)

 

(1,145,100)

Deferred revenue

 

(120,300)

 

(412,100)

Net cash provided by operating activities

 

23,124,400

 

23,242,200

INVESTING ACTIVITIES:

Purchase of property and equipment

 

(48,600)

 

(33,700)

Purchase of equipment for lease contracts

 

(78,200)

 

(2,658,200)

Net cash used for investing activities

 

(126,800)

 

(2,691,900)

FINANCING ACTIVITIES:

Proceeds from borrowings on line of credit

 

 

45,700,000

Payments on line of credit

 

 

(45,700,000)

Payments on notes payable

(2,125,000)

(1,625,000)

Repurchases of common stock

 

(18,918,200)

 

(48,987,500)

Proceeds from exercises of stock options

 

1,210,300

 

6,159,500

Dividends paid

 

(2,600,400)

 

(1,096,700)

Proceeds from discounted lease rentals

1,157,000

Net cash used for financing activities

 

(22,433,300)

 

(44,392,700)

NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH

 

564,300

 

(23,842,400)

Cash, cash equivalents and restricted cash, beginning of period

 

6,684,000

 

25,180,300

Cash, cash equivalents and restricted cash, end of period

$

7,248,300

$

1,337,900

SUPPLEMENTAL DISCLOSURES:

Cash paid for interest

$

603,700

$

1,067,000

Cash paid for income taxes

$

7,156,200

$

423,300

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Consolidated Condensed Balance Sheets to the total of the same amounts shown above:

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

Cash and cash equivalents

$

7,223,300

$

1,287,900

Restricted cash

 

25,000

 

50,000

Total cash, cash equivalents and restricted cash

$

7,248,300

$

1,337,900

The accompanying notes are an integral part of these financial statements.

6

Table of Contents

WINMARK CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

1. Management’s Interim Financial Statement Representation:

The accompanying consolidated condensed financial statements have been prepared by Winmark Corporation and subsidiaries (the Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The Company has a 52/53 week year which ends on the last Saturday in December. The information in the consolidated condensed financial statements includes normal recurring adjustments and reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of such financial statements. The consolidated condensed financial statements and notes are presented in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q, and therefore do not contain certain information included in the Company’s annual consolidated financial statements and notes. This report should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K.

Revenues and operating results for the six months ended June 26, 2021 are not necessarily indicative of the results to be expected for the full year.

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.

2. Organization and Business:

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®. The Company also operates a middle market equipment leasing business under the Winmark Capital® mark.

3. Contract Liabilities:

The Company’s contract liabilities for its franchise revenues consist of deferred revenue associated with franchise fees and software license fees. The table below presents the activity of the current and noncurrent deferred franchise revenue during the first six months of 2021 and 2020, respectively:

    

June 26, 2021

    

June 27, 2020

Balance at beginning of period

$

8,708,300

$

9,575,500

Franchise and software license fees collected from franchisees, excluding amount earned as revenue during the period

 

755,400

 

473,500

Fees earned that were included in the balance at the beginning of the period

 

(875,700)

 

(885,600)

Balance at end of period

$

8,588,000

$

9,163,400

The following table illustrates future estimated revenue to be recognized for the remainder of 2021 and full fiscal years thereafter related to performance obligations that are unsatisfied (or partially unsatisfied) as of June 26, 2021.

Contract Liabilities expected to be recognized in

Amount

2021

$

815,800

2022

 

1,574,900

2023

 

1,403,600

2024

 

1,205,900

2025

 

989,500

Thereafter

 

2,598,300

$

8,588,000

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4. 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:

Level 1 – quoted prices in active markets for identical assets and liabilities.
Level 2 – observable inputs other than quoted prices in active markets for identical assets and liabilities.
Level 3 – unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.

Due to their nature, the carrying value of cash equivalents, receivables, payables and debt obligations approximates fair value.

5. Investment in Leasing Operations:

In May 2021, the Company made the decision to no longer solicit new leasing customers and will pursue an orderly run-off for its leasing portfolio.

Investment in leasing operations consists of the following:

    

June 26, 2021

    

December 26, 2020

Direct financing and sales-type leases:

Minimum lease payments receivable

$

8,163,200

$

12,536,300

Estimated unguaranteed residual value of equipment

 

1,983,300

 

2,950,100

Unearned lease income, net of initial direct costs deferred

 

(825,800)

 

(1,439,500)

Security deposits

 

(1,851,300)

 

(2,169,000)

Equipment installed on leases not yet commenced

 

431,800

 

1,634,400

Total investment in direct financing and sales-type leases

 

7,901,200

 

13,512,300

Allowance for credit losses

 

(158,800)

 

(270,200)

Net investment in direct financing and sales-type leases

 

7,742,400

 

13,242,100

Operating leases:

Operating lease assets

 

517,300

 

599,100

Less accumulated depreciation and amortization

 

(475,000)

 

(580,100)

Net investment in operating leases

 

42,300

 

19,000

Total net investment in leasing operations

$

7,784,700

$

13,261,100

As of June 27, 2021, the $7.8 million total net investment in leases consists of $6.0 million classified as current and $1.8 million classified as long-term. As of December 26, 2020, the $13.3 million total net investment in leases consists of $8.7 million classified as current and $4.6 million classified as long-term.

As of June 26, 2021, there were no customers with leased assets greater 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 for the remainder of fiscal 2021 and the full fiscal years thereafter as of June 26, 2021:

Direct Financing and Sales-Type Leases

 

    

Minimum Lease

    

Income

 

Fiscal Year

Payments Receivable

 Amortization

 

2021

$

4,651,400

$

558,500

2022

 

3,365,300

 

257,100

2023

143,100

10,100

2024

 

3,400

 

100

$

8,163,200

$

825,800

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The activity in the allowance for credit losses for leasing operations during the first six months of 2021 and 2020, respectively, is as follows:

    

June 26, 2021

    

June 27, 2020

    

Balance at beginning of period

$

270,200

$

580,600

Provisions charged to expense

 

(111,400)

 

503,900

Recoveries

 

 

(11,800)

Deductions for amounts written-off

 

 

(148,900)

Balance at end of period

$

158,800

$

923,800

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:

June 26, 2021

December 26, 2020

    

Investment

    

Allowance for

    

Investment

    

Allowance for

In Leases

Credit Losses

In Leases

Credit Losses

Collectively evaluated for loss potential

$

7,901,200

$

158,800

$

13,512,300

$

270,200

Individually evaluated for loss potential

 

 

 

 

Total

$

7,901,200

$

158,800

$

13,512,300

$

270,200

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. 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.

June 26, 2021

    

0-60 Days

    

61-90 Days

    

Over 90 Days

    

    

Delinquent

Delinquent

Delinquent and

and Accruing

and Accruing

Accruing

Non-Accrual

Total

Total investment in leases

$

7,901,200

$

$

$

$

7,901,200

December 26, 2020

    

0-60 Days

    

61-90 Days

    

Over 90 Days

    

    

Delinquent

Delinquent

Delinquent and

and Accruing

and Accruing

Accruing

Non-Accrual

Total

Total investment in leases

$

13,512,300

$

$

$

$

13,512,300

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 customer to maintain, service, and insure the leased equipment, the use of third party remarketers as well as the analytical review of historical asset dispositions.

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Leasing income as presented on the Consolidated Condensed Statements of Operations consists of the following:

Three Months Ended

Three Months Ended

Six Months Ended

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

June 26, 2021

    

June 27, 2020

Interest income on direct financing and sales-type leases

$

482,800

$

979,700

$

1,102,500

$

2,108,300

Selling profit (loss) at commencement of sales-type leases

 

356,300

 

872,700

 

1,430,000

 

1,185,900

Operating lease income

476,500

654,500

960,800

1,089,900

Income on sales of equipment under lease

1,479,900

903,600

2,225,500

4,164,900

Other

53,100

63,300

366,800

796,000

Leasing income

$

2,848,600

$

3,473,800

$

6,085,600

$

9,345,000

6. Earnings Per Share:

The following table sets forth the presentation of shares outstanding used in the calculation of basic and diluted earnings per share (“EPS”):

Three Months Ended

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

June 26, 2021

    

June 27, 2020

    

Denominator for basic EPS — weighted average common shares

 

3,693,503

 

3,688,248

 

3,715,088

 

3,699,923

 

Dilutive shares associated with option plans

 

137,341

 

115,559

 

137,446

 

157,856

 

Denominator for diluted EPS — weighted average common shares and dilutive potential common shares

 

3,830,844

 

3,803,807

 

3,852,534

 

3,857,779

 

Options excluded from EPS calculation — anti-dilutive

 

6,670

 

27,250

 

9,654

 

10,269

 

7. Shareholders’ Equity (Deficit):

Dividends

On January 27, 2021, the Company’s Board of Directors approved the payment of a $0.25 per share quarterly cash dividend to shareholders of record at the close of business on February 10, 2021, which was paid on March 1, 2021.

On April 14, 2021, the Company’s Board of Directors approved the payment of a $0.45 per share quarterly cash dividend to shareholders of record at the close of business on May 12, 2021, which was paid on June 1, 2021.

Repurchase of Common Stock

In the first six months of 2021, the Company repurchased 102,088 shares of its common stock. Under the Board of Directors’ authorization, as of June 26, 2021, the Company has the ability to repurchase an additional 28,516 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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Stock Option Plans and Stock-Based Compensation

Stock option activity under the Company’s option plans as of June 26, 2021 was as follows:

    

    

    

Weighted Average

    

Remaining

Number of

Weighted Average

Contractual Life

 

Shares

 

Exercise Price

 

(years)

 

 

Intrinsic Value

Outstanding, December 26, 2020

 

393,488

$

113.19

5.61

$

27,864,900

Granted

 

34,000

191.82

Exercised

 

(14,079)

85.96

Forfeited

 

(2,700)

151.06

Outstanding, June 26, 2021

 

410,709

$

120.39

5.53

$

29,093,400

Exercisable, June 26, 2021

 

288,979

$

98.91

4.17

$

26,593,700

The fair value of options granted under the Option Plans during the first six months of 2021 and 2020 were estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions and results:

Six Months Ended

    

June 26, 2021

June 27, 2020

    

Risk free interest rate

 

0.90

%

0.40

%

 

Expected life (years)

 

6

6

 

Expected volatility

 

25.07

%

25.03

%

 

Dividend yield

 

2.74

%

1.92

%

 

Option fair value

$

32.70

$

26.55

All unexercised options at June 26, 2021 have an exercise price equal to the fair market value on the date of the grant.

Compensation expense of $698,100 and $538,000 relating to the vested portion of the fair value of stock options granted was expensed to “Selling, General and Administrative Expenses” in the first six months of 2021 and 2020, respectively. As of June 26, 2021, the Company had $3.2 million of total unrecognized compensation expense related to stock options that is expected to be recognized over the remaining weighted average vesting period of approximately 2.8 years.

8. Debt:

Line of Credit

As of June 26, 2021, there were no borrowings outstanding under the Company’s revolving credit facility with CIBC Bank USA (the “Line of Credit”), leaving $25.0 million available for additional borrowings.

The Line of Credit has been and will continue to be used for general corporate purposes. The Line of Credit, which terminates in August 2024 is secured by a lien against substantially all of the Company’s assets, contains customary financial conditions and covenants, and requires maintenance of minimum levels of debt service coverage and tangible net worth and maximum levels of leverage (all as defined within the Line of Credit). As of June 26, 2021, the Company was in compliance with all of its financial covenants.

Notes Payable

As of June 26, 2021, the Company had $12.0 million in principal outstanding from the $25.0 million Series A notes issued in May 2015 and $7.8 million in principal outstanding from the $12.5 million Series B notes issued in August 2017 under the Note Agreement with Prudential Investment Management, Inc., its affiliates and managed accounts (“Prudential”).

The final maturity of the Series A and Series B notes is 10 years from the issuance date. For the Series A notes, interest at a rate of 5.50% per annum on the outstanding principal balance is payable quarterly, along with required prepayments of the principal of $500,000 quarterly for the first five years, and $750,000 quarterly thereafter until the principal is paid in full. For the Series B notes, interest at a rate of 5.10% per annum on the outstanding principal balance is payable

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quarterly, along with required prepayments of the principal of $312,500 quarterly until the principal is paid in full. The Series A and Series B notes may be prepaid, at the option of the Company, in whole or in part (in a minimum amount of $1.0 million), but prepayments require payment of a Yield Maintenance Amount, as defined in the Note Agreement.

The Company’s obligations under the Note Agreement are secured by a lien against substantially all of the Company’s assets (as the notes rank pari passu with the Line of Credit), and the Note Agreement contains customary financial conditions and covenants, and requires maintenance of minimum levels of fixed charge coverage and tangible net worth and maximum levels of leverage (all as defined within the Note Agreement). As of June 26, 2021, the Company was in compliance with all of its financial covenants.

In connection with the Note Agreement, the Company incurred debt issuance costs, of which unamortized amounts are presented as a direct deduction from the carrying amount of the related liability.

9. Discounted Lease Rentals:

The Company utilized certain lease receivables and underlying equipment as collateral to borrow from financial institutions at a weighted average rate of 5.91% at June 26, 2021 on a non-recourse basis. As of June 26, 2021, $0.8 million of the $1.0 million liability balance is current.

10. Operating Leases:

As of June 26, 2021, the Company leases its Minnesota corporate headquarters in a facility with an operating lease that expires in December 2029. The remaining lease term for this lease is 8.5 years and the discount rate is 5.5%. The Company recognized $580,000 and $597,400 of rent expense for the periods ended June 26, 2021 and June 27, 2020, respectively.

Maturities of operating lease liabilities is as follows for the remainder of fiscal 2021 and full fiscal years thereafter as of June 26, 2021:

Operating Lease Liabilities expected to be recognized in

    

Amount

2021

$

364,800

2022

 

742,900

2023

 

763,300

2024

 

784,400

2025

 

806,000

Thereafter

 

3,452,600

Total lease payments

6,914,000

Less imputed interest

(1,391,200)

Present value of lease liabilities

$

5,522,800

Of the $5.5 million operating lease liability outstanding at June 26, 2021, $0.5 million is included in Accrued liabilities in the Current liabilities section of the Consolidated Condensed Balance Sheets.

Supplemental cash flow information related to our operating leases is as follows for the period ended June 26, 2021:

Six Months Ended

    

June 26, 2021

    

June 27, 2020

Cash paid for amounts included in the measurement of lease liabilities:

Operating cash flow outflow from operating leases

$

358,300

$

348,600

11. Segment Reporting:

The Company currently has two reportable business segments, franchising and leasing. The franchising segment franchises value-oriented retail store concepts that buy, sell, trade and consign merchandise. The leasing segment includes the Company’s equipment leasing business. Segment reporting is intended to give financial statement users a better view of how the Company manages and evaluates its businesses. The Company’s internal management reporting is the basis for the information disclosed for its business segments and includes allocation of shared-service costs. Segment assets are those that are directly used in or identified with segment operations, including cash, restricted cash, accounts receivable, prepaid expenses, inventory, property and equipment, investment in leasing operations and

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goodwill. Unallocated assets include corporate cash and cash equivalents, current and deferred tax amounts, operating lease right of use assets and other corporate assets. Inter-segment balances and transactions have been eliminated. The following tables summarize financial information by segment and provide a reconciliation of segment contribution to operating income:

Three Months Ended

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

June 26, 2021

    

June 27, 2020

    

Revenue:

Franchising

$

16,181,000

$

8,915,700

$

31,602,900

$

21,644,500

Leasing

 

2,848,600

 

3,473,800

 

6,085,600

 

9,345,000

Total revenue

$

19,029,600

$

12,389,500

$

37,688,500

$

30,989,500

Reconciliation to operating income:

Franchising segment contribution

$

10,546,900

$

4,599,700

$

21,271,400

$

11,811,100

Leasing segment contribution

 

1,430,000

 

2,078,100

 

3,362,500

 

4,968,500

Total operating income

$

11,976,900

$

6,677,800

$

24,633,900

$

16,779,600

Depreciation and amortization:

Franchising

$

62,300

$

72,700

$

128,200

$

145,300

Leasing

 

47,100

 

50,200

 

95,000

 

100,700

Total depreciation and amortization

$

109,400

$

122,900

$

223,200

$

246,000

As of

    

June 26, 2021

    

December 26, 2020

Identifiable assets:

Franchising

$

3,662,500

$

4,848,300

Leasing

 

8,355,000

 

14,462,600

Unallocated

 

15,001,900

 

12,032,300

Total

$

27,019,400

$

31,343,200

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

COVID-19 Pandemic

The emergence of the coronavirus (COVID-19) and new variants of the virus around the world, and particularly in the United States and Canada, continues to present significant risks to the Company, not all of which the Company is able to fully evaluate or even to foresee at the current time. The pandemic affected the Company’s financial results and business operations in the Company’s first six months ended June 26, 2021 and June 27, 2020, and economic and health conditions in the United States and across most of the globe have continued to change since the beginning of the pandemic. Notably, a number of the Company’s franchised store locations were temporarily closed to in-store consumer activities from time to time due to various restrictions. Such temporary store closings may reoccur and customer traffic may continue to be impacted depending on the duration and severity of the pandemic, the length of time it takes for normal economic and operating conditions to resume, additional governmental actions that may be taken and/or re-imposition of restrictions that have been imposed to date, and numerous other uncertainties.

Even as governmental restrictions are relaxed and markets reopen, the ongoing economic impacts and health concerns associated with the pandemic may continue to affect consumer behavior, spending levels and shopping preferences. Changes in consumer purchasing patterns may increase demand at our franchised stores in one quarter, resulting in decreased demand in subsequent quarters. We continue to see shifts in product and channel preferences as markets move through varying stages of restrictions and re-opening at different times. In addition, we continue to see an increase in demand in the e-commerce channel and any failure to capitalize on this demand could adversely affect our franchised stores ability to maintain and grow sales and erode our competitive position.

Due to the above circumstances and as described generally in this Form 10-Q, the Company’s results of operations for the six-month period ended June 26, 2021 are not necessarily indicative of the results to be expected for the full fiscal year. Management cannot predict the full impact of the pandemic on the Company’s management and employees, its

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franchisees or leasing customers nor to economic conditions generally, including the effects on consumer spending. The ultimate extent of the effects of the pandemic on the Company is highly uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic might end.

Overview

We are a franchising business focused on sustainability and small business formation. As of June 26, 2021, we had 1,266 resale franchises operating under the Plato’s Closet, Once Upon A Child, Play It Again Sports, Style Encore and Music Go Round brands. Our franchise 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 the first six months of 2021, our royalties increased $9.8 million or 51.6% compared to the first six months of 2020.

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 the first six months of 2021, selling, general and administrative expenses increased $0.2 million, or 1.8% compared to the first six months of 2020.

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 franchising activity for the first six months ended June 26, 2021:

AVAILABLE

TOTAL

TOTAL

FOR

COMPLETED

    

12/26/2020

    

OPENED

    

CLOSED

    

6/26/2021

    

RENEWAL

    

RENEWALS

    

Plato’s Closet

Franchises - US and Canada

 

485

 

2

 

(1)

 

486

 

25

25

Once Upon A Child

Franchises - US and Canada

 

399

 

 

(2)

 

397

 

11

11

Play It Again Sports

Franchises - US and Canada

 

274

 

3

 

(2)

 

275

25

25

Style Encore

Franchises - US and Canada

 

69

 

2

 

 

71

 

Music Go Round

Franchises - US

 

37

 

 

 

37

Total Franchised Stores

 

1,264

 

7

 

(5)

 

1,266

 

61

61

 

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 six months of 2021, we renewed 61 of the 61 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.

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 expense for the first six months of 2021 was $5.0 million compared to $7.4 million in the first six months of 2020. During the first six months of 2021, we purchased $0.1 million in equipment for lease customers compared to $2.7 million in the first six months of 2020. Our leasing portfolio (net investment in leases – current and long-term), was $7.8 million at June 26, 2021 compared to $13.3 million at December 26, 2020. Given the decision to run-off the portfolio, we anticipate that leasing income net of leasing expense, purchases of equipment for lease customers and the size of the leasing portfolio will continue to decrease through the run-off period. See Note 5 – “Investment in Leasing

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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 Condensed Statements of Operations expressed as a percentage of total revenue:

Three Months Ended

Six Months Ended

    

June 26, 2021

    

June 27, 2020

    

June 26, 2021

    

June 27, 2020

 

  

    

    

    

Revenue:

Royalties

 

77.3

%  

63.0

%  

76.3

%  

61.2

%

 

Leasing income

 

15.0

28.0

16.2

30.2

 

Merchandise sales

 

3.6

2.9

3.4

3.6

 

Franchise fees

 

1.9

2.8

1.9

2.4

 

Other

 

2.2

3.3

2.2

2.6

 

Total revenue

 

100.0

100.0

100.0

100.0

 

Cost of merchandise sold

 

(3.4)

(2.8)

(3.2)

(3.4)

 

Leasing expense

 

(3.5)

(4.2)

(2.8)

(6.2)

 

Provision for credit losses

 

0.3

0.9

0.3

(1.6)

 

Selling, general and administrative expenses

 

(30.5)

(40.0)

(28.9)

(34.6)

 

Income from operations

 

62.9

53.9

65.4

54.2

 

Interest expense

 

(1.6)

(4.3)

(1.7)

(3.4)

 

Interest and other income

 

0.1

 

Income before income taxes

 

61.3

49.7

63.7

50.8

 

Provision for income taxes

 

(14.4)

(8.9)

(15.3)

(10.9)

 

Net income

 

46.9

%  

40.8

%  

48.4

%  

39.9

%

 

Comparison of Three Months Ended June 26, 2021 to Three Months Ended June 27, 2020

Revenue

Revenues for the quarter ended June 26, 2021 totaled $19.0 million compared to $12.4 million for the comparable period in 2020.

Royalties and Franchise Fees

Royalties increased to $14.7 million for the second quarter of 2021 from $7.8 million for the second quarter of 2020, an 88.5% increase. The increase is primarily from higher franchisee retail sales and from having additional franchise stores in the second quarter of 2021 compared to the same period in 2020. Lower franchisee retail sales in the second quarter of 2020 were directly attributable to the temporary store closings and reduced customer traffic resulting from the COVID-19 pandemic. For illustrative purposes, royalties for the second quarter of 2019 were $12.7 million.

Franchise fees of $0.4 million for the second quarter of 2021 were comparable to $0.3 million for the second quarter of 2020.

Leasing Income

Leasing income decreased to $2.8 million for the second quarter of 2021 compared to $3.5 million for the same period in 2020. The decrease is primarily due to a decrease in selling profit at the commencement of sales-type leases and lower levels of interest income from the smaller lease portfolio, partially offset by a higher level of equipment sales to customers, when compared to the same period 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 of $0.7 million for the second quarter of 2021 compared to $0.4 million in the same period of 2020. The increase is primarily due to an increase in technology 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 of $0.7 million for the second quarter of 2021 compared to $0.3 million in the same period of 2020. The increase was primarily due to the increase in Direct Franchisee Sales discussed above. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the second quarter of 2021 and 2020 was 94.8% and 95.7%, respectively.

Leasing Expense

Leasing expense of $0.7 million for the second quarter of 2021 was comparable to $0.5 million for the second quarter of 2020.

Provision for Credit Losses

Provision for credit losses of $(0.1) million for the second quarter of 2021 was comparable to $(0.1) million for the second quarter of 2020.

Selling, General and Administrative

Selling, general and administrative expenses increased 17.0% to $5.8 million in the second quarter of 2021 compared to $5.0 million in the same period of 2020. The increase was primarily due to an increase in advertising production expenses.

Interest Expense

Interest expense decreased to $0.3 million for the second quarter of 2021 compared to $0.5 million for the second quarter of 2020. The decrease is primarily due to lower average corporate borrowings when compared to the same period last year.

Income Taxes

The provision for income taxes was calculated at an effective rate of 23.5% and 17.8% for the second quarter of 2021 and 2020, respectively. The increase is primarily due to lower benefits on the exercise of non-qualified stock options and an increase in state taxes.

Comparison of Six Months Ended June 26, 2021 to Six Months Ended June 27, 2020

Revenue

Revenues for the first six months of 2021 totaled $37.7 million compared to $31.0 million for the comparable period in 2020.

Royalties and Franchise Fees

Royalties increased to $28.8 million for the first six months of 2021 from $19.0 million for the first six months of 2020, a 51.6% increase. The increase in royalties is primarily from higher franchisee retail sales in the first six months of 2021 compared to the same period last year. Lower franchisee retail sales in the first six months of 2020 were directly attributable to the temporary store closing and reduced customer traffic resulting from the COVID-19 pandemic. For illustrative purposes, royalties for the first six months of 2019 were $24.4 million.

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Franchise fees of $0.7 million for the first six months of 2021 were comparable to $0.7 million for the first six months of 2020.

Leasing Income

Leasing income decreased to $6.1 million for the first six months of 2021 compared to $9.3 million for the same period in 2020. 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 the same period last year.

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 of $1.3 million for the first six months of 2021 was comparable to $1.1 million in the same period of 2020.

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 of $1.2 million for the first six months of 2021 was comparable to $1.1 million in the same period of 2020. Cost of merchandise sold as a percentage of Direct Franchisee Sales for the first six months of 2021 and 2020 was 94.6% and 95.4%, respectively.

Leasing Expense

Leasing expense decreased to $1.1 million for the first six months of 2021 compared to $1.9 million for the first six months of 2020. The decrease was due to a decrease in the associated cost of equipment sales to customers discussed above.

Provision for Credit Losses

Provision for credit losses was $(0.1) million for the first six months of 2021 compared to $0.5 million for the first six months of 2020. Provision levels for the first six months of 2020 reflected the then estimated impact of the COVID-19 pandemic on the credit quality of customers in our lease portfolio at that time.

Selling, General and Administrative

Selling, general and administrative expenses increased 1.8% to $10.9 million in the first six months of 2021 compared to $10.7 million in the same period of 2020. The increase was primarily due to an increase in advertising production expenses.

Interest Expense

Interest expense was $0.6 million for the first six months of 2021 compared to $1.1 million for the first six months of 2020. The decrease is primarily due to lower average corporate borrowings when compared to the same period last year.

Income Taxes

The provision for income taxes was calculated at an effective rate of 24.0% and 21.4% for the first six months of 2021 and 2020, respectively. The increase is primarily due to lower tax benefits on the exercise of non-qualified stock options and an increase in state taxes. 

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Segment Comparison of Three Months Ended June 26, 2021 to Three Months Ended June 27, 2020

Franchising Segment Operating Income

The franchising segment’s operating income for the second quarter of 2021 increased to $10.5 million from $4.6 million for the second quarter of 2020. The increase in segment contribution was 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 the second quarter of 2021 decreased to $1.4 million from $2.1 million for the second quarter of 2020. The decrease in segment contribution was due to a decrease in leasing income net of leasing expenses, partially offset by a decrease in selling, general and administrative expenses.

Segment Comparison of Six Months Ended June 26, 2021 to Six Months Ended June 27, 2020

Franchising Segment Operating Income

The franchising segment’s operating income for the first six months of 2021 increased to $21.3 million from $11.8 million for the first six months of 2020. The increase in segment contribution was 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 the first six months of 2021 decreased to $3.4 million from $5.0 million for the first six months of 2020. The decrease in segment contribution was due to a decrease in leasing income net of leasing expenses, partially offset by a decrease in provision for credit losses and a decrease in selling, general and administrative expenses.

Liquidity and Capital Resources

Our primary sources of liquidity have historically been cash flows 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 compensation expense related to stock options.

We ended the second quarter of 2021 with $7.2 million in cash, cash equivalents and restricted cash compared to $1.3 million in cash, cash equivalents and restricted cash at the end of the second quarter of 2020.

Operating activities provided $23.1 million of cash during the first six months of 2021, comparable to $23.2 million provided during the same period last year.

Investing activities used $0.1 million of cash during the first six months of 2021. The 2021 activities consisted primarily of the purchase of equipment for lease customers of $0.1 million.

Financing activities used $22.4 million of cash during the first six months of 2021. Our most significant financing activities during the first six months of 2021 consisted of $18.9 million to repurchase 102,088 shares of our common stock, $2.6 million for the payment of dividends, and payments on notes payable of $2.1 million; partially offset by $1.2 million of proceeds from exercise of stock options (See Note 7 — “Shareholders’ Equity (Deficit),” and Note 8 — “Debt”).

As of June 26, 2021, we had no off balance sheet arrangements.

As of June 26, 2021, our borrowing availability under our Line of Credit was $25.0 million (the lesser of the borrowing base or the aggregate line of credit). There were no borrowings outstanding at June 26, 2021 under the Line of Credit leaving $25.0 million available for additional borrowings.

The Line of Credit has been and will continue to be used for general corporate purposes. The Line of Credit is secured by a lien against substantially all of our assets, contains customary financial conditions and covenants, and requires

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maintenance of minimum levels of debt service coverage and tangible net worth and maximum levels of leverage (all as defined within the Line of Credit).

As of June 26, 2021, we had $12.0 million in principal outstanding from the $25.0 million Series A notes issued in May 2015 and $7.8 million in principal outstanding from the $12.5 million Series B notes issued in August 2017 under our Note Agreement with Prudential.

The final maturity of the Series A and Series B notes is 10 years from the issuance date. For the Series A notes, interest at a rate of 5.50% per annum on the outstanding principal balance is payable quarterly, along with required prepayments of the principal of $500,000 quarterly for the first five years, and $750,000 quarterly thereafter until the principal is paid in full. For the Series B notes, interest at a rate of 5.10% per annum on the outstanding principal balance is payable quarterly, along with required prepayments of the principal of $312,500 quarterly until the principal is paid in full. The Series A and Series B notes may be prepaid, at our option, in whole or in part (in a minimum amount of $1.0 million), but prepayments require payment of a Yield Maintenance Amount, as defined in the Note Agreement.

Our obligations under the Note Agreement are secured by a lien against substantially all of our assets, and the Note Agreement contains customary financial conditions and covenants, and requires maintenance of minimum levels of fixed charge coverage and tangible net worth and maximum levels of leverage (all as defined within the Note Agreement).

As of June 26, 2021, we were in compliance with all of the financial covenants under the Line of Credit and Note 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 ended December 26, 2020 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.

While significant uncertainty exists as to the full impact of the COVID-19 pandemic on our liquidity and capital resources, 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 and our Line of Credit will be adequate to fund our planned operations through 2022.

Critical Accounting Policies

The Company prepares the consolidated condensed 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 the first six months of 2021, the Company collected $1,900 more than it estimated at December 26, 2020. As of June 26, 2021, the Company’s royalty receivable was $1,105,400.

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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 condensed balance sheet. As of June 26, 2021, deferred franchise fee revenue was $6,662,000.

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 (where 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.

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, specific and overall impacts of the COVID-19 pandemic on the Company’s financial condition or results of operations, 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. Additionally, many of these risks and uncertainties are currently elevated by and may or will continue to be elevated by the COVID-19 pandemic. 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 ended December 26, 2020 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.

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

The Company incurs financial market 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 June 26, 2021, the Company had available a $25.0 million line of credit with CIBC Bank USA. The interest rates applicable to this agreement are based on either the bank’s base rate or LIBOR for short-term borrowings (twelve months or less). The Company had no debt outstanding at June 26, 2021 under this line of credit. The Company’s earnings would be affected by changes in these short-term interest rates only in the event that it were to borrow amounts under this facility. With the Company’s borrowings at June 26, 2021, 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 June 26, 2021.

None of the Company’s cash and cash equivalents at June 26, 2021 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 six months ended June 26, 2021. During fiscal 2020, less than 7% of the Company’s total revenues and 1% of expenses were denominated in a foreign currency. Based upon these revenues and expenses, a 10% increase or decrease in the

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foreign currency exchange rates would impact annual pretax earnings by approximately $388,000. 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 4: Controls and Procedures

As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of its disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon, and as of the date of that evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. There was no change in the Company’s internal control over financial reporting during its most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

PART II.          OTHER INFORMATION

ITEM 1: Legal Proceedings

We are not a party to any material litigation and are not aware of any threatened litigation that would have a material adverse effect on our business.

ITEM 1A: Risk Factors

In addition to the other information set forth in this report, including the important information in “Forward-Looking Statements,” you should carefully consider the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended December 26, 2020.  If any of those factors were to occur, they could materially adversely affect our financial condition or future results, and could cause our actual results to differ materially from those expressed in its forward-looking statements in this report.  We are aware of no material changes to the Risk Factors discussed in our Annual Report on Form 10-K for the year ended December 26, 2020.

ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

The following table summarizes the Company’s common stock repurchases during the second quarter of 2021.

Total Number of

Maximum Number

 

Shares Purchased as

of Shares that may

 

Total Number of

Average Price

Part of a Publicly

yet be Purchased

 

Period

    

Shares Purchased

    

Paid Per Share

    

Announced Plan(1)

    

Under the Plan

 

March 28, 2021 to May 1, 2021

 

6,778

 

$

184.67

 

6,778

 

65,571

May 2, 2021 to May 29, 2021

 

16,519

 

$

192.14

 

16,519

 

49,052

May 30, 2021 to June 26, 2021

 

20,536

 

$

196.60

 

20,536

 

28,516

(1)The Board of Directors’ authorization for the repurchase of shares of the Company’s common stock was originally approved in 1995 with no expiration date. The total shares approved for repurchase has been increased by additional Board of Directors’ approvals and as of June 26, 2021 was limited to 5,000,000 shares, of which 28,516 may still be repurchased.

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ITEM 3: Defaults Upon Senior Securities

None.

ITEM 4: Mine Safety Disclosures

Not applicable.

ITEM 5: Other Information

All information required to be reported in a report on Form 8-K during the period covered by this Form 10-Q has been reported.

ITEM 6: Exhibits

3.1

    

Articles of Incorporation, as amended (Exhibit 3.1)(1)

3.2

By-laws, as amended and restated to date (Exhibit 3.2)(2)

31.1

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*

31.2

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*

32.1

Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.2

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

101

Interactive Data Files Pursuant to Rule 405 of Regulation S-T: Financial statements from the Quarterly Report on Form 10-Q of Winmark Corporation and Subsidiaries for the quarter ended June 26, 2021, formatted in Inline XBRL: (i) Consolidated Condensed Balance Sheets, (ii) Consolidated Condensed Statements of Operations, (iii) Consolidated Condensed Statements of Shareholders’ Equity (Deficit), (iv) Consolidated Condensed Statements of Cash Flows, and (v) Notes to Consolidated Condensed Financial Statements.

104

The cover page from the Quarterly Report on Form 10-Q of Winmark Corporation and Subsidiaries for the quarter ended June 26, 2021, formatted in Inline XBRL (contained in Exhibit 101).

*Filed Herewith

(1)Incorporated by reference to the specified exhibit to the Registration Statement on Form S-1, effective August 24, 1993 (Reg. No. 333-65108).

(2)Incorporated by reference to the specified exhibit to the Annual Report on Form 10-K for the fiscal year ended December 30, 2006.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

WINMARK CORPORATION

Date: July 20, 2021

By:

/s/ Brett D. Heffes

Brett D. Heffes
Chairman of the Board and

Chief Executive Officer
(principal executive officer)

Date: July 20, 2021

By:

/s/ Anthony D. Ishaug

Anthony D. Ishaug

Executive Vice President
Chief Financial Officer and Treasurer
(principal financial and accounting officer)

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