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EX-31.2 - EX-31.2 - WINMARK CORPwina-20161231ex31223bbc3.htm
EX-31.1 - EX-31.1 - WINMARK CORPwina-20161231ex311f7b091.htm
EX-23.1 - EX-23.1 - WINMARK CORPwina-20161231ex231ad010b.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

(Mark one)

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

For the fiscal year ended December 31, 2016, 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, Minnesota 55441

(Address of Principal Executive Offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (763) 520-8500

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

Title of Each Class

    

Name of Each Exchange On Which Registered

Common Stock, no par value per share

 

NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ☐              No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ☐              No ☒

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).

Yes ☒             No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

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

Large accelerated filer ☐

Accelerated filer ☒

Non-accelerated filer ☐ 

(Do not check if a smaller reporting company)

Smaller reporting company ☐

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

Yes ☐              No ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter was $172,941,305.

Shares of no par value Common Stock outstanding as of March 6, 2017: 4,169,769 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the Registrant’s Annual Meeting of Shareholders to be held on April 26, 2017 have been incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III of this report

 

 

 

 


 

 

 

 

WINMARK CORPORATION AND SUBSIDIARIES

INDEX TO ANNUAL REPORT ON FORM 10-K

 

 

 

 

 

 

 

PART I 

 

PAGE

 

 

 

Item 1. 

Business

 

 

 

Item 1A. 

Risk Factors

 

 

 

Item 1B. 

Unresolved Staff Comments

12 

 

 

 

Item 2. 

Properties

12 

 

 

 

Item 3. 

Legal Proceedings

12 

 

 

 

Item 4. 

Mine Safety Disclosures

12 

 

 

 

 

 

 

 

 

 

PART II 

 

PAGE

 

 

 

Item 5. 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

13 

 

 

 

Item 6. 

Selected Financial Data

15 

 

 

 

Item 7. 

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

16 

 

 

 

Item 7A. 

Quantitative and Qualitative Disclosures About Market Risk

23 

 

 

 

Item 8. 

Financial Statements and Supplementary Data

23 

 

 

 

Item 9. 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

47 

 

 

 

Item 9A. 

Controls and Procedures

47 

 

 

 

Item 9B. 

Other Information

47 

 

 

 

 

 

 

 

 

 

PART III 

 

PAGE

 

 

 

Item 10. 

Directors, Executive Officers and Corporate Governance

48 

 

 

 

Item 11. 

Executive Compensation

48 

 

 

 

Item 12. 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

48 

 

 

 

Item 13. 

Certain Relationships and Related Transactions, and Director Independence

48 

 

 

 

Item 14. 

Principal Accounting Fees and Services

48 

 

 

 

 

 

 

 

 

 

PART IV 

 

PAGE

 

 

 

Item 15. 

Exhibits and Financial Statement Schedules

49 

 

 

 

 

SIGNATURES

50 

 

 

 


 

PART I

 

ITEM 1:     BUSINESS

 

Background

 

We are a franchisor of five value-oriented retail store concepts that buy, sell and trade gently used merchandise.  Each of our retail store brands emphasizes consumer value by offering high-quality used merchandise at substantial savings from the price of new merchandise and by purchasing customers’ used goods that have been outgrown or are no longer used.  Our concepts also offer a limited amount of new merchandise to customers.  As of December 31, 2016, we had 1,186 franchised stores across the United States and Canada.

 

We operate a middle-market equipment leasing business through our wholly owned subsidiary, Winmark Capital Corporation.  Our middle-market leasing business serves large and medium-sized businesses and focuses on technology-based assets which typically cost more than $250,000.  The businesses we target generally have annual revenue of between $30 million and several billion dollars.  We generate middle-market equipment leases primarily through business alliances, equipment vendors and directly from customers.

 

Additionally, we operate a small-ticket financing business through our wholly owned subsidiary, Wirth Business Credit, Inc.  Our small-ticket financing business serves small businesses and focuses on assets which generally have a cost of $5,000 to $100,000.

 

Our significant assets are located within the United States, and we generate all revenues from United States operations other than franchising revenues from Canadian operations of approximately $3.3 million, $2.9 million and $2.9 million for 2016, 2015 and 2014, respectively.  For additional financial information, please see Item 6 — Selected Financial Data and Item 8 — Financial Statements and Supplementary Data.  We were incorporated in Minnesota in 1988.

 

Franchise Operations

 

Our retail brands with their fiscal year 2016 system-wide sales, which we define as estimated revenues generated by all franchise locations, are summarized as follows:

 

Plato’s Closet® - $442 million.

 

We began franchising the Plato’s Closet brand in 1999.  Plato’s Closet stores buy and sell used clothing and accessories geared toward the teenage and young adult market.  Customers have the opportunity to sell their used items to Plato’s Closet stores and to purchase quality used clothing and accessories at prices lower than new merchandise.

 

Once Upon A Child® - $319 million.

 

We began franchising the Once Upon A Child brand in 1993.  Once Upon A Child stores buy and sell used and, to a lesser extent, new children’s clothing, toys, furniture, equipment and accessories.  This brand primarily targets parents of children ages infant to 12 years.  These customers have the opportunity to sell their used children’s items to a Once Upon A Child store when outgrown and to purchase quality used children’s clothing, toys, furniture and equipment at prices lower than new merchandise.

 

Play It Again Sports® - $228 million.

 

We began franchising the Play It Again Sports brand in 1988.  Play It Again Sports stores buy, sell, trade and consign used and new sporting goods, equipment and accessories for a variety of athletic activities including team sports (baseball/softball, hockey, football, lacrosse, soccer), fitness, ski/snowboard and golf among others.  The stores offer a flexible mix of merchandise that is adjusted to adapt to seasonal and regional differences.

 

Music Go Round® - $31 million.

 

We began franchising the Music Go Round brand in 1994.  Music Go Round stores buy, sell, trade and consign used and, to a lesser extent, new musical instruments, speakers, amplifiers, music-related electronics and related accessories.

1


 

Style Encore® - $28 million.

 

We began franchising the Style Encore brand in 2013.  Style Encore stores buy and sell used women’s apparel, shoes and accessories.  Customers have the opportunity to sell their used items to Style Encore stores and to purchase quality used clothing, shoes and accessories at prices lower than new merchandise. 

 

The following table presents the royalties and franchise fees contributed by our franchised retail brands for each of the past three years and the corresponding percentage of consolidated revenues for each such year:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Royalties and Franchise Fees

 

 

 

 

 

 

 

 

 

(in millions)

 

% of Consolidated Revenue

 

 

    

2014

    

2015

    

2016

    

2014

    

2015

    

2016

 

Plato’s Closet

 

$

18.0

 

$

19.1

 

$

19.5

 

29.4

%  

27.5

%  

29.2

%

Once Upon A Child

 

 

12.1

 

 

13.0

 

 

14.2

 

19.7

 

18.7

 

21.3

 

Play It Again Sports

 

 

9.4

 

 

9.5

 

 

9.2

 

15.4

 

13.6

 

13.9

 

Style Encore

 

 

0.6

 

 

1.2

 

 

1.7

 

1.0

 

1.8

 

2.6

 

Music Go Round

 

 

0.9

 

 

0.9

 

 

1.0

 

1.4

 

1.3

 

1.5

 

 

 

$

41.0

 

$

43.7

 

$

45.6

 

66.9

%  

62.9

%  

68.5

%

 

The following table presents a summary of our retail brands franchising activity for the fiscal year ended December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AVAILABLE

 

 

 

 

 

 

 

TOTAL

 

 

 

 

 

TOTAL

 

FOR

 

COMPLETED

 

 

 

 

    

12/26/2015

    

OPENED

    

CLOSED

    

12/31/2016

    

RENEWAL

    

RENEWALS

    

% RENEWED

 

Plato’s Closet

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US and Canada

 

456

 

17

 

(5)

 

468

 

31

 

30

 

97

%

Once Upon A Child

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US and Canada

 

326

 

25

 

(3)

 

348

 

29

 

29

 

100

%

Play It Again Sports

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US and Canada

 

297

 

2

 

(16)

 

283

 

13

 

12

 

92

%

Style Encore

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US

 

38

 

15

 

(1)

 

52

 

 —

 

 —

 

N/A

 

Music Go Round

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US

 

33

 

2

 

0

 

35

 

5

 

5

 

100

%

Total Franchised Stores

 

1,150

 

61

 

(25)

 

1,186

 

78

 

76

 

97

%

 

Retail Brands Franchising Overview

 

We use franchising as a business method of distributing goods and services through our retail brands to consumers.  We, as franchisor, own a retail business brand, represented by a service mark or similar right, and an operating system for the franchised business.  We then enter into franchise agreements with franchisees and grant the franchisee the right to use our business brand, service marks and operating system to manage a retail business.  Franchisees are required to operate their retail businesses according to the systems, specifications, standards and formats we develop for the business brand.  We train the franchisees how to operate the franchised business.  We also provide continuing support and service to our franchisees.

 

We have developed value-oriented retail brands based on a mix of used and, to a lesser extent, new merchandise.  We franchise rights to franchisees who open franchised locations under such brands.  The key elements of our franchise strategy include:

 

·

franchising the rights to operate retail stores offering value-oriented merchandise;

·

attracting new, qualified franchisees; and

·

providing initial and continuing support to franchisees.

 

2


 

Offering Value-Oriented Merchandise

 

Our retail brands provide value to consumers by purchasing and reselling used merchandise that consumers have outgrown or no longer use at substantial savings from the price of new merchandise.  By offering a combination of high-quality used and value-priced new merchandise, we benefit from consumer demand for value-oriented retailing.  In addition, we believe that among national retail operations our retail store brands provide a unique source of value to consumers by purchasing used merchandise.  We also believe that the strategy of buying used merchandise increases consumer awareness of our retail brands.

 

Attracting Franchisees

 

Our franchise marketing program for retail brands seeks to attract prospective franchisees with experience in management and operations and an interest in being the owner and operator of their own business.  We seek franchisees who:

 

·

have a sufficient net worth;

·

have prior business experience; and

·

intend to be integrally involved with the management of the business.

 

At December 31, 2016, we had 74 signed retail franchise agreements, of which the majority are expected to open in 2017.

 

We began franchising in Canada in 1991 and, as of December 31, 2016, had 92 franchised retail stores open in Canada.  The Canadian retail stores are operated by franchisees under agreements substantially similar to those used in the United States.

 

Retail Brand Franchise Support

 

As a franchisor, our success depends upon our ability to develop and support competitive and successful franchise brands.  We emphasize the following areas of franchise support and assistance.

 

Training

 

Each franchisee must attend our training program regardless of prior experience.  Soon after signing a franchise agreement, the franchisee is required to attend new owner orientation training.  This course covers basic management issues, such as preparing a business plan, lease evaluation, evaluating insurance needs and obtaining financing.  Our training staff assists each franchisee in developing a business plan for their retail store with financial and cash flow projections.  The second training session is centered on store operations.  It covers, among other things, point-of-sale computer training, inventory selection and acquisition, sales, marketing and other topics.  We provide the franchisee with operations manuals that we periodically update.

 

Field Support

 

We provide operations personnel to assist the franchisee in the opening of a new business.  We also have an ongoing field support program designed to assist franchisees in operating their retail stores.  Our franchise support personnel visit each retail store periodically and, in most cases, a business assessment is made to determine whether the franchisee is operating in accordance with our standards.  The visit is also designed to assist franchisees with operational issues.

 

Purchasing

 

During training each franchisee is taught how to evaluate, purchase and price used goods directly from customers.  We have developed specialized computer point-of-sale systems for our brands that provide the franchisee with standardized pricing information to assist in the purchasing of used items.

 

3


 

We provide centralized buying services, which on a limited basis include credit and billing for the Play It Again Sports franchisees.  Our Play It Again Sports franchise system uses several major vendors for new product including Nautilus, Wilson Sporting Goods, Champro Sporting Goods, Easton Sports, CCM Hockey and Bauer Hockey.  The loss of any of the above vendors would change the vendor mix, but not significantly change our products offered.

 

To provide the franchisees of our Play It Again Sports, Once Upon A Child and Music Go Round systems a source of affordable new product, we have developed relationships with our significant vendors and negotiated prices for our franchisees to take advantage of the buying power a franchise system brings.

 

Our typical Once Upon A Child franchised store purchases approximately 30% of its new product from Rachel’s Ribbons, Melissa & Doug, Wild Side Accessories, North States and Nuby.  The loss of any of the above vendors would change the vendor mix, but not significantly change our products offered.

 

Our typical Music Go Round franchised store purchases approximately 50% of its new product from KMC/Musicorp, RapcoHorizon Company, D’Addario, GHS Corporation and Ernie Ball.  The loss of any of the above vendors would change the vendor mix, but not significantly change our products offered.

 

There are no significant vendors of new products to our typical Plato’s Closet and Style Encore franchised stores as new product is an extremely low percentage of sales for these brands.

 

Retail Advertising and Marketing

 

We encourage our franchisees to implement a marketing program that includes the following: television, radio, point-of-purchase materials, in store signage and local store marketing programs as well as email marketing promotions, website promotions and participation in social and digital media.  Franchisees of the respective retail brands are required to spend a minimum of 5% of their gross sales on approved advertising and marketing.  Franchisees may be required to participate in regional cooperative advertising groups.

 

Computerized Point-Of-Sale Systems

 

We require our retail brand franchisees to use a retail information management computer system in each store, which has evolved with the development of new technology.  This computerized point-of-sale system is designed specifically for use in our franchise retail stores.  The current system includes our proprietary Data Recycling System software, a dedicated server, two or more work station registers, a receipt printer, a report printer and a bar code scanner, together with software modules for inventory management, cash management and customer information management.  Our franchisees purchase the computer hardware from us.  The Data Recycling System software is designed to accommodate buying of used merchandise.  This system provides franchisees with an important management tool that reduces errors, increases efficiencies and enhances inventory control.  We provide point-of-sale system support through our Computer Support Center located at our Company headquarters.

 

The Retail Franchise Agreement

 

We enter into franchise agreements with our franchisees.  The following is a summary of certain key provisions of our current standard retail brand franchise agreement.  Except as noted, the franchise agreements used for each of our retail brands are generally the same.

 

Each franchisee must execute our franchise agreement and pay an initial franchise fee.  At December 31, 2016, the franchise fee for all brands was $25,000 for an initial store in the U.S. and $34,500CAD for an initial store in Canada.  Once a franchisee opens its initial store, it can open additional stores, in any brand, by paying a $15,000 franchise fee for a store in the U.S. and $21,000CAD for a store in Canada, provided an acceptable territory is available and the franchisee meets the brand’s additional store standards.  The franchise fee for our initial retail store and additional retail store in Canada is based upon the exchange rate applied to the United States franchise fee on the last business day of the preceding fiscal year.  The franchise fee in March 2017 for an initial retail store in Canada will be $33,500CAD, and an additional retail store in Canada will be $20,000CAD.  Typically, the franchisee’s initial store is open for business approximately 12 months from the date the franchise agreement is signed.  The franchise agreement has an initial term of 10 years, with subsequent 10-year renewal periods, and grants the franchisee an exclusive geographic area, which will vary in size depending upon population, demographics and other factors.  Under current franchise agreements,

4


 

franchisees of the respective brands are required to pay us weekly continuing fees (royalties) equal to the percentage of gross sales outlined in their Franchise Agreements, generally ranging from 4% to 5% for all of our brands except Music Go Round, which is 3%.

 

Each Franchisee is required to pay us an annual marketing fee of $500 or $1,000.  Each new or renewing franchisee is required to spend 5% of its gross sales for advertising and promoting its franchised store.  Existing franchisees with older Franchise Agreements may only be required to spend 3% to 4% of their gross sales on advertising and promotion.  Currently, for all of the retail brands except Play It Again Sports, we have the option to increase the minimum advertising expenditure requirement from 5% to 6% of the franchisee’s gross sales, of which up to 2% would be paid to us as an advertising fee for deposit into an advertising fund.  While we currently do not have the option to increase the advertising expenditure requirement for Play It Again Sports franchisees, we may also require those franchisees to pay 2% of their gross sales into an advertising fund.  This fund, if initiated, would be managed by us and would be used for advertising and promotion of the franchise system.

 

During the term of a franchise agreement, franchisees agree not to operate directly or indirectly any competitive business.  In addition, franchisees agree that after the end of the term or termination of the franchise agreement, franchisees will not operate any competitive business for a period of one year and within a reasonable geographic area.

 

Although our franchise agreements contain provisions designed to assure the quality of a franchisee’s operations, we have less control over a franchisee’s operations than we would if we owned and operated a retail store.  Under the franchise agreement, we have a right of first refusal on the sale of any franchised store, but we are not obligated to repurchase any franchise.

 

Renewal of the Franchise Relationship

 

At the end of the 10-year term of each franchise agreement, each franchisee has the option to “renew” the franchise relationship by signing a new 10-year franchise agreement.  If a franchisee chooses not to sign a new franchise agreement, a franchisee must comply with all post termination obligations including the franchisee’s noncompetition clause discussed above.  We may choose not to renew the franchise relationship only when permitted by the franchise agreement and applicable state law.

 

We believe that renewing a significant number of these franchise relationships is important to the success of the Company.  During the past three years, we renewed 99% of franchise agreements up for renewal.

 

Retail Franchising Competition

 

Retailing, including the sale of teenage, children’s and women’s apparel, sporting goods and musical instruments, is highly competitive.  Many retailers have substantially greater financial and other resources than we do.  Our franchisees compete with established, locally owned retail stores, discount chains and traditional retail stores for sales of new merchandise.  Full line retailers generally carry little or no used merchandise.  Resale, thrift and consignment shops and garage and rummage sales offer competition to our franchisees for the sale of used merchandise.  Also, our franchisees increasingly compete with online used and new goods marketplaces such as eBay, craigslist and many others.

 

Our Plato’s Closet franchise stores primarily compete with specialty apparel stores such as Gap, Abercrombie & Fitch, Old Navy, Hollister and Forever 21.  We compete with other franchisors in the teenage resale clothing retail market.

 

Our Once Upon A Child franchisees compete primarily with large retailers such as Babies “R” Us, Wal-Mart, Target and various specialty children’s retail stores such as Gap Kids. We compete with other franchisors in the specialty children’s resale retail market.

 

Our Play It Again Sports franchisees compete with large retailers such as Dick’s Sporting Goods, Academy Sports & Outdoors as well as regional and local sporting goods stores.  We also compete with Target and Wal-Mart.

 

Our Style Encore franchise stores compete with a wide range of women’s apparel stores. We also compete with other franchisors in the women’s resale clothing retail market.

 

5


 

Our Music Go Round franchise stores compete with large musical instrument retailers such as Guitar Center as well as local independent musical instrument stores.

 

Our retail franchises may face additional competition in the future.  This could include additional competitors that may enter the used merchandise market.  We believe that our franchisees will continue to be able to compete with other retailers based on the strength of our value-oriented brands and the name recognition associated with our service marks.

 

We also face competition in connection with the sale of franchises.  Our prospective franchisees frequently evaluate other franchise opportunities before purchasing a franchise from us.  We compete with other franchise companies for franchisees based on the following factors, among others: amount of initial investment, franchise fee, royalty rate, profitability, franchisor services and industry.  We believe that our franchise brands are competitive with other franchises based on the fees we charge, our franchise support services and the performance of our existing franchise brands.

 

Winmark Franchise Partners™

 

During 2017, we announced that we are launching an initiative to provide services, support and capital to emerging franchisors. Under the Winmark Franchise Partners mark, we intend to leverage our experience in franchising through strategic partnering with select companies interested in franchising to grow their brands.  We anticipate that this concept will create additional revenue streams while being synergistic with our existing business.

 

Equipment Leasing Operations

 

We operate a middle-market leasing business through Winmark Capital Corporation, a wholly owned subsidiary.  We operate a small-ticket financing business through Wirth Business Credit, Inc., a wholly owned subsidiary.  We incorporated both of these subsidiaries in April 2004.  To differentiate ourselves from our competitors in the leasing industry, we offer innovative lease and financing products and concentrate on building long-term relationships with our customers and business alliances.

 

Winmark Capital Corporation

 

Winmark Capital Corporation is engaged in the business of providing non-cancelable leases for high-technology and business-essential assets to both larger organizations and smaller, growing companies.  We target businesses with annual revenue between $30 million and several billion dollars.  We focus on transactions that have terms from two to three years.  Such transactions are generally larger than $250,000 and include high-technology equipment and/or business essential equipment, including computers, telecommunications equipment, storage systems, network equipment and other business-essential equipment.  The leases are retained in our portfolio to accommodate equipment additions and upgrades to meet customers’ changing needs.

 

Industry

 

The high-technology equipment industry has been characterized by rapid and continuous advancements permitting broadened user applications and reductions in processing costs.  The introduction of new equipment generally does not cause existing equipment to become obsolete but usually does cause the market value of existing equipment to decrease, reflecting the improved performance per dollar cost of the new equipment.  Users frequently replace equipment as their existing equipment becomes inadequate for their needs or as increased processing capacity is required, creating a secondary market in used equipment.

 

Generally, high-technology equipment, such as information technology equipment, does not suffer from material physical deterioration if properly maintained.  As required under our leases, our leased equipment must be kept under continual maintenance, in accordance with the manufacturer’s specifications, most often provided by the manufacturer.  The economic life and residual value of information technology equipment is subject to, among other things, the development of technological improvements and changes in sale and maintenance terms initiated by the manufacturer.

 

6


 

Business Strategy

 

Our business strategy allows us to differentiate ourselves from our competitors in the leasing industry.  Key elements of this strategy include:

 

·

Relationship Focus.  We maintain a focused, long-term, customer-service approach to our business.

·

Full Service.  We can service the equipment leasing needs of both large organizations as well as smaller, growing companies.

·

Asset Ownership.  We differentiate ourselves with our commitment to retain ownership of our leases throughout the lease term.

 

Leasing and Sales Activities

 

Our middle-market lease products are marketed nationally through our offices in Minneapolis, Minnesota and Santa Barbara, California.

 

We market our leasing services directly to end-users and indirectly through business alliances, and through vendors of equipment, software, value-added services and consulting services.  We directly market to customers and prospects by telephone canvassing and by establishing relationships with business alliances in the local business community.

 

We generally lease high-technology and other business-essential equipment.  Additionally, we may lease operating system and application software to our customers, but typically only with a hardware lease.  Our standard lease agreement, entered into with each customer, is a noncancelable “net” lease which contains “hell-or-high water” provisions under which the customer, upon acceptance of the equipment, must make all lease payments regardless of any defects or performance of the equipment, and which require the customer to maintain and service the equipment, insure the equipment against casualty loss and pay all property, sales and other taxes related to the equipment.  We retain ownership of the equipment we lease and, in the event of default by the customer, we or the financial institution to whom the lease payment has been assigned may declare the customer in default, accelerate all lease payments due under the lease and pursue other available remedies, including repossession of the equipment.  Upon expiration of the initial term or extended lease term, depending on the structure of the lease, the customer may:

 

·

return the equipment to us;

·

renew the lease for an additional term; or

·

purchase the equipment.

 

If the equipment is returned to us, it will typically be sold into the secondary-user marketplace.

 

Wirth Business Credit, Inc.

 

Our small-ticket financing operation serves the needs of small businesses.  Small-ticket financing transactions are typically between $5,000 and $100,000, have terms of between two and four years and cover business essential assets, including computers, printing equipment, security systems, telecommunications equipment, production equipment and other assets.  Our financing transactions are generally full pay out transactions, which means, after paying all required payments under the financing agreement, the customer owns the asset.  Key elements of our small-ticket business strategy include a focus on both business owners and equipment vendor relationships as well as providing fast credit decisions, flexible terms and an easy to understand process.

 

The small ticket finance industry is highly fragmented and competitive. Small business owners typically finance their businesses through one of many possible sources including banks, vendor captive finance companies, leasing brokers, credit card companies and independent leasing companies.  These sources of funding typically limit their focus to certain types of transactions and may base their decision on credit quality, geography, size of transaction, type of asset or other criteria.

 

 

7


 

Financing

 

To date, we have funded the vast majority of our leases internally using our available cash or debt.

 

Winmark Capital Corporation may from time to time arrange permanent financing of leases through non-recourse discounting of lease rentals with various financial institutions at fixed interest rates.  The proceeds from the assignment of the lease rentals will generally be equal to the present value of the remaining lease payments due under the lease, discounted at the interest rate charged by the financial institution.  Interest rates obtained under this type of financing are negotiated on a transaction-by-transaction basis and reflect the financial strength of the customer, the term of the lease and the prevailing interest rates.  In the event of a default by a customer in non-recourse financing, the financial institution has a first lien on the underlying leased equipment, with no further recourse against us.  The institution may, however, take title to the collateral in the event the customer fails to make lease payments or certain other defaults by the customer occur under the terms of the lease.  Our use of lease discounting is dependent upon having leases that are attractive to financial institutions as well as our available cash balances.

 

Equipment Leasing Competition

 

We compete with a variety of equipment financing sources that are available to businesses, including:  national, regional and local finance companies that provide lease and loan products; financing through captive finance and leasing companies affiliated with major equipment manufacturers; credit card companies; and commercial banks, savings and loans, and credit unions.  Many of these companies are substantially larger than we are and have considerably greater financial, technical and marketing resources than we do.

 

Some of our competitors have a lower cost of funds and access to funding sources that are not available to us.  A lower cost of funds could enable a competitor to offer leases with yields that are much less than the yields that we offer, which might cause us to lose lease origination volume.  In addition, certain of our competitors may have higher risk tolerances or different risk assessments, which could enable them to establish more origination sources and end user customer relationships and increase their market share.  We have and will continue to encounter significant competition.

 

Government Regulation

 

Fourteen states, the Federal Trade Commission and six Canadian Provinces impose pre-sale franchise registration and/or disclosure requirements on franchisors.  In addition, a number of states have statutes which regulate substantive aspects of the franchisor-franchisee relationship such as termination, nonrenewal, transfer, discrimination among franchisees and competition with franchisees.

 

Additional legislation, both at the federal and state levels, could expand pre-sale disclosure requirements, further regulate substantive aspects of the franchise relationship and require us to file our Franchise Disclosure Documents with additional states.  We cannot predict the effect of future franchise legislation, but do not believe there is any imminent legislation currently under consideration which would have a material adverse impact on our operations.

 

Although most states do not directly regulate the commercial equipment lease financing business, certain states require licensing of lenders and finance companies, and impose limitations on interest rates and other charges, and a disclosure of certain contract terms and constrain collection practices.  We believe that we are currently in compliance with all material statutes and regulations that are applicable to our business.

 

Trademarks and Service Marks

 

Plato’s Closet®, Once Upon A Child®, Play It Again Sports®, Style Encore®, Music Go Round®, Winmark®, Wirth Business Credit® and Winmark Capital®, among others, are our registered service marks.  We have filed a trademark registration for Winmark Franchise Partners™.  These marks are of considerable value to our business.  We intend to protect our service marks by appropriate legal action where and when necessary.  Each service mark registration must be renewed every 10 years.  We have taken, and intend to continue to take, all steps necessary to renew the registration of all our material service marks.

 

8


 

Seasonality

 

Our Plato’s Closet and Once Upon A Child franchise brands have experienced higher than average sales volumes during the spring months and during the back-to-school season.  Our Play It Again Sports franchise brand has experienced higher than average sales volumes during the winter season.  Overall, the different seasonal trends of our brands partially offset each other and do not result in significant seasonality trends on a Company-wide basis.  Our equipment leasing business is not seasonal; however, quarter to quarter results often vary significantly.

 

Employees

 

As of December 31, 2016, we employed 103 employees.

 

Available Information

 

We maintain a Web site at www.winmarkcorporation.com, the contents of which are not part of or incorporated by reference into this Annual Report on Form 10-K.  We make our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K (and amendments to those reports) available on our Web site via a link to the U.S. Securities and Exchange Commission (SEC) Web site, free of charge, as soon as reasonably practicable after such reports have been filed with or furnished to the SEC.

 

ITEM 1A:    RISK FACTORS

 

We are dependent on franchise renewals.

 

Each of our franchise agreements is 10 years long.  At the end of the term of each franchise agreement, each franchisee may, if certain conditions are met, “renew” the franchise relationship by signing a new 10-year franchise agreement.  As of December 31, 2016 each of our five franchised retail brands have the following number of franchise agreements that will expire over the next three years:

 

 

 

 

 

 

 

 

 

 

    

2017

    

2018

    

2019

 

Plato’s Closet

 

26

 

30

 

46

 

Once Upon A Child

 

24

 

17

 

29

 

Play It Again Sports

 

18

 

13

 

16

 

Style Encore

 

 

 

 

Music Go Round

 

5

 

3

 

4

 

 

 

73

 

63

 

95

 

 

We believe that renewing a significant number of these franchise relationships is important to our continued success.  If a significant number of franchise relationships are not renewed, our financial performance would be materially and adversely impacted.

 

We are dependent on new franchisees.

 

Our ability to generate increased revenue and achieve higher levels of profitability depends in part on increasing the number of franchises open.  Unfavorable macro-economic conditions may affect the ability of potential franchisees to obtain external financing and/or impact their net worth, both of which could lead to a lower level of openings than we have historically experienced.  There can be no assurance that we will sustain our current level of franchise openings.

 

We are in the early stages of launching a new franchising initiative.

 

We are currently investing in the launch of a new initiative to provide services, support and capital to emerging franchisors.  There can be no assurance that we will be successful in this undertaking and that it will not have a negative impact on our financial performance.

 

9


 

We may make additional investments outside of our core businesses.

 

From time to time, we have and may continue to make investments both inside and outside of our current businesses.  To the extent that we make additional investments that are not successful, such investments could have a material adverse impact on our financial results.

 

We may sell franchises for a territory, but the franchisee may not open.

 

We believe that a substantial majority of franchises awarded but not opened will open within the time period permitted by the applicable franchise agreement or we will be able to resell the territories for most of the terminated or expired franchises.  However, there can be no assurance that substantially all of the currently sold but unopened franchises will open and commence paying royalties to us.

 

Our retail franchisees are dependent on supply of used merchandise.

 

Our retail brands are based on offering customers a mix of used and new merchandise.  As a result, the ability of our franchisees to obtain continuing supplies of high quality used merchandise is important to the success of our brands.  Supply of used merchandise comes from the general public and is not regular or highly reliable. In addition, adherence to federal and state product safety and other requirements may limit the amount of used merchandise available to our franchisees.  In addition to laws and regulations that apply to businesses generally, our franchised retail stores may be subject to state or local statutes or ordinances that govern secondhand dealers.  There can be no assurance that our franchisees will avoid supply problems with respect to used merchandise.

 

We may be unable to collect accounts receivable from franchisees.

 

In the event that our ability to collect accounts receivable significantly declines from current rates, we may incur additional charges that would affect earnings.  If we are unable to collect payments due from our franchisees, it would materially adversely impact our results of operations and financial condition.

 

We operate in extremely competitive industries.

 

Retailing, including the sale of teenage, children’s and women’s apparel, sporting goods and musical instruments, is highly competitive.  Many retailers have significantly greater financial and other resources than us and our franchisees.  Individual franchisees face competition in their markets from retailers of new merchandise and, in certain instances, resale, thrift and other stores that sell used merchandise.  We may face additional competition as our franchise systems expand and if additional competitors enter the used merchandise market.

 

Our equipment leasing businesses compete with a variety of equipment financing sources that are available to businesses, including: national, regional, and local finance companies that provide leases and loan products; financing through captive finance and leasing companies affiliated with major equipment manufacturers; and commercial banks, savings and loans, credit unions and credit cards.  Many of these companies are substantially larger than we are and have considerably greater financial, technical and marketing resources than we do.  There can be no assurances that we will be able to successfully compete with these larger competitors.

 

We are subject to credit risk in our lease portfolio and our allowance for credit losses may be inadequate to absorb losses.

 

In our leasing business, if we inaccurately assess the creditworthiness of our customers, we may experience a higher number of lease defaults than expected, which would reduce our earnings.  For our middle-market customers, we serve a wide range of businesses from smaller companies that may be financed by venture capital investors to larger organizations that may be financed by private equity firms and larger independent public or private companies.  In many cases, our credit analysis relies on the customer’s current or projected financials.  If we fail to adequately assess the risks of our customer’s business plans, we may experience credit losses.  For our small-ticket customers, there is typically only limited publicly available financial and other information about their businesses.  Accordingly, in making credit decisions, we rely upon the accuracy of information from the small business owner and/or third party sources, such as credit reporting agencies. If the information we obtain from small business owners and/or third party sources is incorrect, our ability to make appropriate credit decisions will be impaired.

10


 

We may incur concentration of credit risk in our lease portfolio.  As of December 31, 2016, leased assets with two customers represented approximately 42% of our total net investment in leases.

 

If losses from leases exceed our allowance for credit losses, our operating income will be reduced.  In connection with our leases, we record an allowance for credit losses to provide for estimated losses.  Determining the appropriate level of the allowance is an inherently uncertain process and therefore our determination of this allowance may prove to be inadequate to cover losses in connection with our portfolio of leases.  Losses in excess of our allowance for credit losses would cause us to increase our provision for credit losses, reducing or eliminating our operating income.  Any such significant increase in losses could have a material adverse impact on our financial results.

 

Deterioration in economic or business conditions may negatively impact our leasing business.

 

In an economic slowdown or recession, our equipment leasing businesses may face an increase in delinquent payments, lease defaults and credit losses.  The volume of leasing business for our new and existing customers may decline, as well as the credit quality of our customers.  Because we extend credit to many emerging and leveraged companies through our subsidiary Winmark Capital Corporation and primarily to small businesses through our subsidiary Wirth Business Credit, Inc., our customers may be particularly susceptible to economic slowdowns or recessions.   Any protracted economic slowdowns or recessions may make it difficult for us to maintain the volume of lease originations for new and existing customers, and may deteriorate the credit quality of new leases.  Any of these events may slow the growth of our leasing portfolio and impact the profitability of our leasing operations.

 

We are subject to restrictions in our line of credit and note facilities.  Additionally, we are subject to counter party risk in our line of credit facility.

 

The terms of our $55.0 million line of credit and $25.0 million note facility impose certain operating and financial restrictions on us and require us to meet certain financial tests including tests related to minimum levels of debt service coverage and tangible net worth and maximum levels of leverage.  As of December 31, 2016, we were in compliance with all of our financial covenants under these facilities; however, failure to comply with these covenants in the future may result in default under one or both of these sources of capital and could result in acceleration of the related indebtedness.  Any such acceleration of indebtedness would have an adverse impact on our business activities and financial condition.

 

Sustained credit market deterioration could jeopardize the counterparty obligations of one or both of the banks participating in our line of credit facility, which could have an adverse impact on our business if we are not able to replace such credit facility or find other sources of liquidity on acceptable terms.

 

We have indebtedness.

 

We incurred indebtedness in connection with the purchase of shares in the Tender Offer (see Note 6 — “Shareholders’ Equity (Deficit)” and Note 7 — “Debt”).  We expect to generate the cash necessary to pay our expenses, finance our leasing business and to pay the principal and interest on all of 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, finance our leasing business and meet our debt service obligations depends on our future performance, which may be affected by financial, business, economic, and other factors.  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.

 

11


 

We are subject to government regulation.

 

As a franchisor, we are subject to various federal and state franchise laws and regulations.  Fourteen states, the Federal Trade Commission and six Canadian Provinces impose pre-sale franchise registration and/or disclosure requirements on franchisors.  In addition, a number of states have statutes which regulate substantive aspects of the franchisor-franchisee relationship such as termination, nonrenewal, transfer, discrimination among franchisees and competition with franchisees.

 

Additional legislation, both at the federal and state levels, could expand pre-sale disclosure requirements, further regulate substantive aspects of the franchise relationship and require us to file our franchise offering circulars with additional states.  Future franchise legislation could impose costs or other burdens on us that could have a material adverse impact on our operations.  In addition, evolving labor and employment laws, rules and regulations could result in potential claims against us as a franchisor for labor and employment related liabilities that have historically been borne by franchisees.

 

Although most states do not directly regulate the commercial equipment lease financing business, certain states require licensing of lenders and finance companies, impose limitations on interest rates and other charges, constrain collection practices and require disclosure of certain contract terms.  Laws or regulations may be adopted with respect to our equipment leases or the equipment leasing industry, and collection processes. Any new legislation or regulation, or changes in the interpretation of existing laws, which affect the equipment leasing industry could increase our costs of compliance.

 

We may be unable to protect against data security risks.

 

We have implemented security systems with the intent of maintaining the physical security of our facilities and protecting our employees, franchisees, lessees, customers’, clients’ and suppliers’ confidential information and information related to identifiable individuals against unauthorized access through our information systems or by other electronic transmission or through the misdirection, theft or loss of physical media.  These include, for example, the appropriate encryption of information.  Despite such efforts, we are subject to potential breach of security systems which may result in unauthorized access to our facilities or the information we are trying to protect.  Because the techniques used to obtain unauthorized access are constantly changing and becoming increasingly more sophisticated and often are not recognized until launched against a target, we may be unable to anticipate these techniques or implement sufficient preventative measures.  If unauthorized parties gain physical access to one of our facilities or electronic access to our information systems or such information is misdirected, lost or stolen during transmission or transport, any theft or misuse of such information could result in, among other things, unfavorable publicity, governmental inquiry and oversight, difficulty in marketing our services, allegations by our customers and clients that we have not performed our contractual obligations, litigation by affected parties and possible financial obligations for damages related to the theft or misuse of such information, any of which could have a material adverse effect on our business.

 

ITEM 1B:  UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2:     PROPERTIES

 

We lease 41,016 square feet at our headquarters facility in Minneapolis, Minnesota.  We are obligated to pay rent monthly under the lease, and will pay an average of $658,000 annually over the remaining term that expires in 2019.  We are also obligated to pay estimated taxes and operating expenses as described in the lease, which change annually.  The total rentals, taxes and operating expenses paid may increase if we exercise any of our rights to acquire additional space described in the lease.  Our facilities are sufficient to meet our current and immediate future needs.

 

ITEM 3:     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 4:     MINE SAFETY DISCLOSURES

 

Not applicable.

 

12


 

PART II

 

ITEM 5:     MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information, Holders, Dividends

 

Winmark Corporation’s common stock trades on the NASDAQ Global Market under the symbol “WINA”.  The table below sets forth the high and low sales prices of our common stock as reported by NASDAQ for the quarterly periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FY 2016:

    

First

    

Second

    

Third

    

Fourth

 

High

 

$

101.61

 

$

102.00

 

$

109.49

 

$

133.08

 

Low

 

$

88.00

 

$

91.26

 

$

106.58

 

$

102.55

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FY 2015:

    

First

    

Second

    

Third

    

Fourth

 

High

 

$

89.08

 

$

105.09

 

$

108.28

 

$

103.91

 

Low

 

$

79.02

 

$

84.42

 

$

94.68

 

$

82.69

 

 

At March 6, 2017, there were 4,169,769 shares of common stock outstanding held by approximately 75 shareholders of record.  Shareholders of record do not include holders who beneficially own common stock held in nominee or “street name”.

 

We declared and paid cash dividends per common share of the following amounts in each of the quarterly periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

First

    

Second

    

Third

    

Fourth

 

FY 2016:

 

$

0.07

 

$

0.10

 

$

0.10

 

$

0.10

 

FY 2015:

 

$

0.06

 

$

0.07

 

$

0.07

 

$

0.07

 

 

Any future declaration of dividends will be subject to the discretion of our Board of Directors and subject to our results of operations, financial condition, cash requirements, compliance with loan covenants and other factors deemed relevant by our Board of Directors.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

September 25, 2016 to October 29, 2016

 

 

$

 

 

142,988

 

October 30, 2016 to November 26, 2016

 

 

$

 

 

142,988

 

November 27, 2016 to December 31, 2016

 

 

$

 

 

142,988

 


(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 is currently limited to 5,000,000 shares, of which 142,988 may still be repurchased under the existing authorization.

 

13


 

Performance Graph

 

In accordance with the rules of the SEC, the following graph compares the performance of our common stock on the NASDAQ Stock Market to the NASDAQ US Benchmark TR composite index and to the NASDAQ US Benchmark Retail TR industry index, of which we are a component.  The graph compares on an annual basis the cumulative total shareholder return on $100 invested on December 30, 2011 through our fiscal year ended December 31, 2016 and assumes reinvestment of all dividends.  The performance graph is not necessarily indicative of future investment performance.

 

Picture 2

 

 

14


 

ITEM 6:     SELECTED FINANCIAL DATA

 

The following table sets forth selected financial information for the periods indicated.  The information should be read in conjunction with the consolidated financial statements and related notes discussed in Items 8 and 15, and Management’s Discussion and Analysis of Financial Condition and Results of Operations discussed in Item 7.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended

 

 

 

(in thousands except per share data)

 

 

 

December 31,

 

December 26,

 

December 27,

 

December 28,

 

December 29,

 

 

    

2016

    

2015

    

2014

    

2013

    

2012

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Royalties

 

$

43,995

 

$

41,908

 

$

38,972

 

$

36,344

 

$

33,760

 

Leasing income

 

 

17,283

 

 

21,566

 

 

16,247

 

 

14,524

 

 

13,212

 

Merchandise sales

 

 

2,217

 

 

2,817

 

 

2,729

 

 

2,327

 

 

2,751

 

Franchise fees

 

 

1,625

 

 

1,788

 

 

1,990

 

 

1,459

 

 

1,291

 

Other

 

 

1,460

 

 

1,369

 

 

1,241

 

 

1,077

 

 

929

 

Total revenue

 

 

66,580

 

 

69,448

 

 

61,179

 

 

55,731

 

 

51,943

 

Cost of merchandise sold

 

 

2,101

 

 

2,653

 

 

2,620

 

 

2,206

 

 

2,622

 

Leasing expense

 

 

2,324

 

 

5,759

 

 

1,631

 

 

1,592

 

 

1,790

 

Provision for credit losses

 

 

18

 

 

(150)

 

 

63

 

 

(45)

 

 

(48)

 

Selling, general and administrative expenses

 

 

23,836

 

 

24,095

 

 

23,806

 

 

22,198

 

 

20,280

 

Income from operations

 

 

38,301

 

 

37,091

 

 

33,059

 

 

29,780

 

 

27,299

 

Loss from equity investments(1)

 

 

 

 

 

 

 

 

 

 

(2,493)

 

Impairment of investment in notes

 

 

 

 

 

 

 

 

 

 

(1,324)

 

Interest expense

 

 

(2,343)

 

 

(1,802)

 

 

(484)

 

 

(213)

 

 

(392)

 

Interest and other income (expense)

 

 

(12)

 

 

(64)

 

 

14

 

 

23

 

 

66

 

Income before income taxes

 

 

35,946

 

 

35,225

 

 

32,589

 

 

29,590

 

 

23,156

 

Provision for income taxes

 

 

(13,728)

 

 

(13,425)

 

 

(12,522)

 

 

(11,358)

 

 

(10,218)

 

Net income

 

$

22,218

 

$

21,800

 

$

20,067

 

$

18,232

 

$

12,938

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share - diluted

 

$

5.13

 

$

4.69

 

$

3.85

 

$

3.48

 

$

2.47

 

Weighted average shares outstanding - diluted

 

 

4,330

 

 

4,652

 

 

5,217

 

 

5,241

 

 

5,238

 

Cash dividends per common share

 

$

0.37

 

$

0.27

 

$

5.23

 

$

0.19

 

$

5.15

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Working capital

 

$

15,436

 

$

16,920

 

$

3,857

 

$

24,376

 

$

1,971

 

Total assets

 

 

48,582

 

 

47,406

 

 

54,728

 

 

53,036

 

 

43,539

 

Total debt

 

 

45,400

 

 

66,400

 

 

18,500

 

 

 

 

10,800

 

Shareholders’ equity (deficit)

 

 

(7,852)

 

 

(30,674)

 

 

21,610

 

 

38,145

 

 

17,928

 

Selected Financial Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

 

46.3

%  

 

42.7

%  

 

37.2

%  

 

37.8

%  

 

28.3

%

Return on average equity

 

 

N/A

%

 

N/A

%  

 

67.2

%  

 

65.0

%  

 

48.8

%


(1)

Included in loss from equity investments is a $1.8 million impairment charge for the Company’s investment in Tomsten, Inc. in 2012.  As of December 31, 2016, the Company has no remaining carrying value for this investment.

 

 

15


 

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

 

Overview

 

As of December 31, 2016, we had 1,186 franchises operating under the Plato’s Closet, Once Upon A Child, Play It Again Sports, Style Encore and Music Go Round brands and had a leasing portfolio of $41.4 million.  Management closely tracks the following financial criteria to evaluate current business operations and future prospects: royalties, leasing activity, and selling, general and administrative expenses.

 

Our most significant source of franchising revenue is royalties received from our franchise partners.  During 2016, our royalties increased $2.1 million or 5.0% compared to 2015.

 

Leasing income net of leasing expense in 2016 was $15.0 million compared to $15.8 million in 2015.  Fluctuations in period-to-period leasing income and leasing expense result primarily from the manner and timing in which leasing income and leasing expense is recognized over the term of each particular lease in accordance with accounting guidance applicable to leasing.  For this reason, we believe that more meaningful levels of leasing activity are the purchases of equipment for lease customers and the medium- to long-term trend in the size of the leasing portfolio.  During 2016, we purchased $26.2 million in equipment for lease customers compared to $22.2 million in 2015 and $27.5 million in 2014.  Our leasing portfolio (net investment in leases — current and long-term) was $41.4 million at December 31, 2016 compared to $39.0 million at December 26, 2015 and $44.0 million at December 27, 2014.

 

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 2016, selling, general and administrative expense decreased $0.3 million, or 1.1%, 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 franchising activity for the fiscal year ended December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AVAILABLE

 

 

 

 

 

 

 

TOTAL

 

 

 

 

 

TOTAL

 

FOR

 

COMPLETED

 

 

 

 

    

12/26/2015

    

OPENED

    

CLOSED

    

12/31/2016

    

RENEWAL

    

RENEWALS

    

% RENEWED

 

Plato’s Closet

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US and Canada

 

456

 

17

 

(5)

 

468

 

31

 

30

 

97

%

Once Upon A Child

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US and Canada

 

326

 

25

 

(3)

 

348

 

29

 

29

 

100

%

Play It Again Sports

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US and Canada

 

297

 

2

 

(16)

 

283

 

13

 

12

 

92

%

Style Encore

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US

 

38

 

15

 

(1)

 

52

 

 

 

N/A

 

Music Go Round

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchises - US

 

33

 

2

 

0

 

35

 

5

 

5

 

100

%

Total Franchised Stores

 

1,150

 

61

 

(25)

 

1,186

 

78

 

76

 

97

%

 

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 2016, we renewed 97% of franchise agreements up for renewal.  This percentage of renewal has ranged between 97% and 100% during the last three years.

 

16


 

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, (iii) increase lease originations and minimize write-offs in our leasing portfolios, and (iv) 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”.

 

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 2016

 

Fiscal 2015

 

 

  

December 31,

 

December 26,

 

December 27,

 

over (under)

 

over (under)

 

 

    

2016

    

2015

    

2014

    

2015

    

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

Royalties

 

66.1

%  

60.3

%  

63.7

%  

5.0

%  

7.5

%

Leasing income

 

26.0

 

31.0

 

26.6

 

(19.9)

 

32.7

 

Merchandise sales

 

3.3

 

4.1

 

4.5

 

(21.3)

 

3.2

 

Franchise fees

 

2.4

 

2.6

 

3.2

 

(9.1)

 

(10.1)

 

Other

 

2.2

 

2.0

 

2.0

 

6.6

 

10.3

 

Total revenue

 

100.0

 

100.0

 

100.0

 

(4.1)

 

13.5

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of merchandise sold

 

(3.2)

 

(3.8)

 

(4.3)

 

(20.8)

 

1.3

 

Leasing expense

 

(3.5)

 

(8.3)

 

(2.7)

 

(59.7)

 

253.2

 

Provision for credit losses

 

 —

 

0.2

 

(0.1)

 

112.4

 

(338.0)

 

Selling, general and administrative expenses

 

(35.8)

 

(34.7)

 

(38.9)

 

(1.1)

 

1.2

 

Income from operations

 

57.5

 

53.4

 

54.0

 

3.3

 

12.2

 

Interest expense

 

(3.5)

 

(2.6)

 

(0.8)

 

30.0

 

272.0

 

Interest and other income (expense)

 

 —

 

(0.1)

 

 

(80.8)

 

555.0

 

Income before income taxes

 

54.0

 

50.7

 

53.2

 

2.0

 

8.1

 

Provision for income taxes

 

(20.6)

 

(19.3)

 

(20.4)

 

2.3

 

7.2

 

Net income

 

33.4

%  

31.4

%  

32.8

%  

1.9

%  

8.6

%

 

Revenue

 

Revenues for the year ended December 31, 2016 totaled $66.6 million compared to $69.4 million and $61.2 million for the comparable periods in 2015 and 2014, respectively.

 

Royalties and Franchise Fees

 

Royalties increased to $44.0 million for 2016 from $41.9 million for the same period in 2015, a 5.0% increase.  The increase was due to higher Once Upon A Child, Plato’s Closet and Style Encore royalties of $1.0 million, $0.5 million and $0.5 million, respectively.  The increase in royalties for these brands is primarily from having 22 additional Once Upon A Child, 12 additional Plato’s Closet and 14 additional Style Encore franchise stores in 2016 compared to 2015.  Fiscal 2016 was a 53-week year compared to a 52-week year in fiscal 2015, which also contributed to the increase in royalty revenue.  In 2015, royalties increased $2.9 million compared to 2014.  This increase was primarily due to having 58 additional franchise stores in 2015 compared to 2014.

 

Franchise fees decreased to $1.6 million for 2016 from $1.8 million for 2015 primarily as a result of opening 12 fewer franchises in 2016 compared to 2015.  Franchise fees in 2015 decreased $0.2 million compared to 2014 primarily due to opening 22 fewer franchises in 2015 compared to 2014.  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 when the franchise opens or when the franchise agreement is assigned to a buyer of a franchise.  An overview of retail brand franchise fees is presented in the Franchising subsection of the Business section (Item 1).

 

17


 

Leasing Income

 

Leasing income decreased to $17.3 million in 2016 compared to $21.6 million for the same period in 2015.  The decrease is primarily due to a lower level of equipment sales to customers.  Leasing income in 2015 increased $5.3 million compared to 2014 primarily due to a higher level of equipment sales to customers.

 

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 decreased to $2.2 million in 2016 from $2.8 million in 2015.  The decrease is primarily due to a decrease in technology purchases by our franchisees.  Direct Franchisee Sales in 2015 increased $0.1 million compared to 2014 as a result of increased 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 decreased to $2.1 million in 2016 from $2.7 million in 2015.  The decrease was due to a decrease in Direct Franchisee Sales in 2016 discussed above.  Cost of merchandise sold in 2015 increased $0.1 million compared to 2014 due to an increase in Direct Franchisee Sales in 2015 discussed above.  Cost of merchandise sold as a percentage of Direct Franchisee Sales for 2016, 2015 and 2014 was 94.8%, 94.2% and 96.0%, respectively.

 

Leasing Expense

 

Leasing expense decreased to $2.3 million in 2016 compared to $5.8 million in 2015.  The decrease is primarily due to a decrease in the associated costs of equipment sales to customers discussed above.  Leasing expense in 2015 increased $4.1 million compared to 2014 due to an increase in the associated cost of equipment sales to customers discussed above.

 

Provision for Credit Losses

 

Provision for credit losses was $18,500 in 2016 compared to $(149,700) in 2015 and $62,900 in 2014.  The provision level for 2015 was impacted by net recoveries in the leasing portfolio.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased 1.1% to $23.8 million in 2016 from $24.1 million in 2015.  The decrease was primarily due to decreases in compensation and benefit expenses.  The $0.3 million, or 1.2%, increase in selling, general and administrative expenses in 2015 compared to 2014 was primarily due to an increase in compensation expenses.

 

Interest Expense

 

Interest expense increased to $2.3 million in 2016 compared to $1.8 million in 2015.  The increase is primarily due to higher average corporate borrowings during 2016 when compared to 2015.  Interest expense in 2015 increased $1.3 million compared to 2014 due to higher average corporate borrowings during 2015 when compared to 2014.

 

Interest and Other Income (Expense)

 

During 2016, we had interest and other income (expense) of $(12,200) compared to $(63,700) and $14,000 of interest and other income (expense) in 2015 and 2014, respectively.  Income and other income (expense) in 2015 included losses on sales of marketable securities while interest and other income in 2014 included higher investment income and gains on sales of marketable securities.

 

18


 

Income Taxes

 

The provision for income taxes was calculated at an effective rate of 38.2%, 38.1% and 38.4% for 2016, 2015 and 2014, respectively.  The higher effective rate in 2016 compared to 2015 is primarily due to an increase in state taxes.  The lower effective rate for 2015 compared to 2014 is primarily due to a decrease in state taxes.

 

Segment Comparison of Fiscal Years 2016, 2015 and 2014

 

We currently have 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 (i) Winmark Capital Corporation, our middle-market equipment leasing business and (ii) Wirth Business Credit, Inc., our small-ticket financing 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, 2016

    

December 26, 2015

    

December 27, 2014

 

Revenue:

 

 

 

 

 

 

 

 

 

 

Franchising

 

$

49,296,700

 

$

47,882,100

 

$

44,931,400

 

Leasing

 

 

17,283,600

 

 

21,565,700

 

 

16,247,300

 

Total revenue

 

$

66,580,300

 

$

69,447,800

 

$

61,178,700

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation to income from operations:

 

 

 

 

 

 

 

 

 

 

Franchising segment contribution

 

$

28,650,400

 

$

26,891,000

 

$

23,631,800

 

Leasing segment contribution

 

 

9,650,600

 

 

10,199,700

 

 

9,427,500

 

Total income from operations

 

$

38,301,000

 

$

37,090,700

 

$

33,059,300

 

 

Franchising Segment Operating Income

 

The franchising segment’s 2016 operating income increased by $1.8 million, or 6.5%, to $28.7 million from $26.9 million for 2015.  The increase in segment contribution was primarily due to increased royalty revenues.  The $3.3 million increase in the franchising segment’s 2015 operating income from 2014 was primarily due to increased royalty revenues.

 

Leasing Segment Operating Income

 

The leasing segment’s operating income for 2016 decreased by $0.5 million, or 5.4%, to $9.7 million from $10.2 million for 2015.  The decrease in segment contribution was due to a decrease in leasing income net of leasing expense.  The $0.8 million increase in the leasing segment’s 2015 operating income from 2014 was due to an increase in leasing income net of leasing expense partially offset by an increase 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 compensation expense related to stock options.

 

We ended 2016 with $1.3 million in cash and cash equivalents compared to $1.0 million in cash and cash equivalents at the end of 2015.

 

Operating activities provided $25.7 million of cash during 2016 compared to $22.3 million provided during 2015 and $18.0 million provided during 2014.  The increase in cash provided by operating activities in 2016 compared to 2015 was primarily due to a decrease in cash paid for income taxes.  A contributing factor to the increase in cash provided by operating activities in 2015 compared to 2014 was an increase in net income and a decrease in cash paid for income taxes.

19


 

Investing activities used $3.2 million of cash during 2016 compared to $4.5 million provided during 2015 and $7.1 million used during 2014.  Our most significant investing activities consist of the purchase of equipment for lease contracts and principal collections on lease receivables, as our franchising business is not capital intensive.  Purchase of equipment for lease customers in 2016 was $26.2 million compared to $22.2 million in 2015 and $27.5 million in 2014. 

During 2016, principal collections on lease receivables were $23.0 million compared to $26.6 million during 2015 and $20.7 million during 2014.

 

Financing activities used $22.2 million of cash during 2016 compared to $27.9 million used during 2015 and $19.5 million used during 2014.  Our most significant financing activities over the past three years have consisted of net borrowings/payments on our debt facilities, the payment of dividends, repurchase of common stock, and net proceeds and tax benefits received from the exercise of stock options.  During 2014, we paid $26.9 million in cash dividends (including a $5.00 per share special cash dividend) and used $11.6 million to purchase 166,030 shares of our common stock.  Net borrowings on our line of credit of $18.5 million during 2014 were associated with these activities.  During 2015, we paid $1.2 million in cash dividends and used $74.9 million to purchase 881,518 shares of our common stock including $74.3 million to repurchase 875,000 shares of our common stock in a tender offer (the “Tender Offer”).  Net borrowings on our line of credit and notes payable of $47.9 million during 2015 were associated with these activities. During 2016, we made net payments on our Line of Credit and notes payable of $21.0 million, paid $1.5 million in cash dividends, repurchased 17,194 shares of our common stock for $1.6 million and received net proceeds and tax benefits from the exercise of stock options of $1.9 million.  (See Note 6 — “Shareholders’ Equity (Deficit)” and Note 7 — “Debt”).

 

We have debt obligations and future operating lease commitments for our corporate headquarters and satellite office space.  As of December 31, 2016, we had no other material outstanding commitments.  (See Note 10 — “Commitments and Contingencies”).  The following table summarizes our significant future contractual obligations at December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payments due by period

 

 

 

 

 

 

Less than 1

 

 

 

 

 

 

 

More than 5

 

 

    

Total

    

year

    

1-3 years

    

3-5 years

    

years

 

Contractual Obligations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Line of Credit(1)(3)

 

$

23,400,000

 

$

 

$

23,400,000

 

$

 

$

 

Notes payable(2)(3)

 

 

27,775,000

 

 

3,168,800

 

 

6,007,500

 

 

7,015,900

 

 

11,582,800

 

Operating Lease Obligations

 

 

1,874,900

 

 

705,000

 

 

1,169,900

 

 

 

 

 

Total Contractual Obligations

 

$

53,049,900

 

$

3,873,800

 

$

30,577,400

 

$

7,015,900

 

$

11,582,800

 


(1)

In addition to the principal payments noted in the table, the Company will incur interest expense on such variable rate debt.  Interest rates on amounts outstanding under the Line of Credit at December 31, 2016, ranged from 2.95% to 3.75%.

 

(2)

Includes interest payable quarterly at 5.50% assuming principal payments in accordance with amortizing schedule.

 

(3)

Refer to Part II, Item 8 in this report under Note 7 — “Debt” for additional information regarding long-term debt.

 

As of December 31, 2016, we had no off-balance sheet arrangements.

 

We have a revolving credit with The PrivateBank and Trust Company and BMO Harris Bank N.A. (the “Line of Credit”).  The Line of Credit, which has a termination date of May 14, 2019, has been and will continue to be used for general corporate purposes.  In May 2016 and each subsequent May thereafter through the term of the facility, the aggregate commitments under the Line of Credit automatically reduce by $5.0 million.  The Line of Credit 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 December 31, 2016, our borrowing availability under our Line of Credit was $55.0 million (the lesser of the borrowing base or the aggregate Line of Credit).  There were $23.4 million in borrowings outstanding under the Line of Credit bearing interest ranging from 2.95% to 3.75%, leaving $31.6 million available for additional borrowings.

 

 

 

20


 

The Line of Credit allows us to choose between two interest rate options in connection with our borrowings.  The interest rate options are the Base Rate (as defined) and the LIBOR Rate (as defined) plus an applicable margin of 0% and 2.25%, respectively.  Interest periods for LIBOR borrowings can be one, two, three, six or twelve months, as selected by us.  The Line of Credit also provides for non-utilization fees of 0.25% per annum on the daily average of the unused commitment.

 

In May 2015, we entered into a $25.0 million Note Agreement (the “Note Agreement”) with Prudential.  Proceeds from the Note Agreement of $25.0 million were used to fund in part the Tender Offer.  As of December 31, 2016, we had $22.0 million in principal outstanding under the Note Agreement.

 

The final maturity of the notes is 10 years.  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.  The 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 December 31, 2016, 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, finance our leasing business and to pay the principal and interest on all of 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, finance our leasing business and meet our debt service obligations depends on our future performance, which may be affected by financial, business, economic, and other factors including the risk factors described under Item 1A of this report.  If we do not have enough money to pay our debt service obligations, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or raise equity.  In such an event, we may not be able to refinance our debt, sell assets, borrow more money or raise equity on terms acceptable to us or at all.  Also, our ability to carry out any of these activities on favorable terms, if at all, may be further impacted by any financial or credit crisis which may limit access to the credit markets and increase our cost of capital.

 

We may utilize discounted lease financing to provide funds for a portion of our leasing activities.  Rates for discounted lease financing reflect prevailing market interest rates and the credit standing of the lessees for which the payment stream of the leases are discounted.  We believe that discounted lease financing will continue to be available to us at competitive rates of interest through the relationships we have established with financial institutions.

 

We believe that the combination of our cash on hand, the cash generated from our franchising business, cash generated from discounting sources and our Line of Credit will be adequate to fund our planned operations through 2017.

 

Critical Accounting Policies

 

The Company prepares the consolidated financial statements of Winmark Corporation and Subsidiaries in conformity with accounting principles generally accepted in the United States of America.  As such, the Company is required to make certain estimates, judgments and assumptions that it believes are reasonable based on information available.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented.  There can be no assurance that actual results will not differ from these estimates.  The critical accounting policies that the Company believes are most important to aid in fully understanding and evaluating the reported financial results include the following:

 

Revenue Recognition — Royalty Revenue and Franchise Fees

 

The Company collects royalties from each retail franchise based on a percentage of retail store gross sales.  The Company recognizes royalties as revenue when earned.  At the end of each accounting period, estimates of royalty amounts due are made based on applying historical weekly sales information to the number of weeks of unreported

21


 

franchisee sales.  If there are significant changes in the actual performance of franchisees versus the Company’s estimates, its royalty revenue would be impacted.  During 2016, the Company collected $104,100 less than it estimated at December 26, 2015.  As of December 31, 2016, the Company’s royalty receivable was $1,234,600.

 

The Company collects initial franchise fees when franchise agreements are signed and recognizes the initial franchise fees as revenue when the franchise is opened, which is when the Company has performed substantially all initial services required by the franchise agreement.  Franchise fees collected from franchisees but not yet recognized as income are recorded as deferred revenue in the liability section of the consolidated balance sheet.  As of December 31, 2016, deferred franchise fees were $1,545,900.

 

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.  Generally, when a lease is more than 90 days delinquent (when more than three monthly payments are owed), the lease is classified as being on non-accrual and the Company stops recognizing leasing income on that date.  Payments received on leases in non-accrual status generally reduce the lease receivable.  Leases on non-accrual status remain classified as such until there is sustained payment performance that, in the Company’s judgment, would indicate that all contractual amounts will be collected in full.

 

In certain circumstances, the Company may re-lease equipment in its existing portfolio.  As this equipment may have a fair value greater than its carrying amount when re-leased, the Company may be required to account for the lease as a sales-type lease.  At inception of a sales-type lease, revenue is recorded that consists of the present value of the future minimum lease payments discounted at the rate implicit in the lease.  In subsequent periods, 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.

 

Allowance for Credit Losses

 

The Company maintains an allowance for credit losses at an amount that it believes to be sufficient to absorb losses inherent in its existing lease portfolio as of the reporting dates.  Leases are collectively evaluated for potential loss.  The Company’s methodology for determining the allowance for credit losses includes consideration of the level of delinquencies and non-accrual leases, historical net charge-off amounts and review of any significant concentrations.

 

A provision is charged against earnings to maintain the allowance for credit losses at the appropriate level.  If the actual results are different from the Company’s estimates, results could be different.  The Company’s policy is to charge-off against the allowance the estimated unrecoverable portion of accounts once they reach 121 days delinquent.  (See Note 4 — “Investment in Leasing Operations”).

 

Stock-Based Compensation

 

The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options.  The determination of the fair value of the awards on the date of grant using an option-pricing model is affected by stock price as well as assumptions regarding a number of complex and subjective variables.  These variables include implied volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

 

The Company evaluates the assumptions used to value awards on an annual basis.  If factors change and the Company employs different assumptions for estimating stock-based compensation expense in future periods or if the Company decides to use a different valuation model, the future periods may differ significantly from what it has recorded in the current period and could materially affect operating income, net income and earnings per share.

 

Recent Accounting Pronouncements

 

See Note 2, “Significant Accounting Policies — Recent Accounting Pronouncements”.

22


 

 

Outlook

 

Forward Looking Statements

 

The statements contained Item 1 “Business”, Item 1A “Risk Factors”, in this Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and in Item 8 “Financial Statements and Supplemental Data” that are not strictly historical fact, including without limitation, the Company’s statements relating to growth opportunities, its ability to open new franchises, its ability to manage costs in the future, the number of franchises it believes will open, growth and performance of its lease portfolio, prospects for and anticipated revenue streams for its new Winmark Franchise Partners initiative, its future cash requirements, allowance for credit losses and its 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 which may cause actual results to differ materially from those contemplated by such forward looking statements.  Investors are cautioned to consider these forward looking statements in light of important factors which may result in material variations between results contemplated by such forward looking statements and actual results and conditions including, but not limited to, the risk factors discussed in Section 1A of this report.  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 statement for any reason.

 

ITEM 7A:  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company incurs financial markets risk in the form of interest rate risk.  Risk can be quantified by measuring the financial impact of a near-term adverse increase in short-term interest rates.  At December 31, 2016, the Company had available a $55.0 million line of credit with The PrivateBank and Trust Company and BMO Harris Bank N.A.  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 $23.4 million of debt outstanding at December 31, 2016 under this line of credit, all of which was in the form of short-term borrowings subject to daily changes in the bank’s base rate or LIBOR.  The Company’s earnings would be affected by changes in these short-term interest rates.  With the Company’s borrowings at December 31, 2016, a one percent increase in short-term rates would reduce annual pretax earnings by $234,000.  The Company had no interest rate derivatives in place at December 31, 2016.

 

None of the Company’s cash and cash equivalents at December 31, 2016 was invested in money market mutual funds, which are subject to the effects of market fluctuations in interest rates.  The Company’s portfolio of marketable securities is subject to customary equity market risk.