Deferred Revenue –
Deferred revenue includes advance sales related to racing, events and corporate partnerships.
Revenue from these advance billings is recognized when the related event occurs or services have been performed. Deferred revenue also includes advanced Cooperative Marketing Agreement (“CMA”) promotional funds, for which revenue is recognized when expenses are incurred.
Payable to Horsepersons -
The Minnesota Pari-mutuel Horse Racing Act requires the Company to segregate a portion of funds (recorded as purse expense in the statements of operations) received from Card Casino operations and wagering on simulcast and live horse races, for future payment as purses for live horse races or other uses of the horsepersons’ association. Pursuant to an agreement with the Minnesota Horsemen’s Benevolent and Protective Association (“MHBPA”), the Company transferred into a trust account or paid directly to the MHBPA, $1,260,000 and $1,090,000 for the three months ended March 31, 2019 and 2018, respectively, related to thoroughbred races. Minnesota Statutes provide that amounts transferred into the trust account are the property of the trust and not of the Company, and therefore these amounts are not recorded on the Company’s Consolidated Balance Sheet.
Revenue Recognition
– The Company’s primary revenues with customers consist of Card Casino operations, pari-mutuel wagering on simulcast and live horse races, and food and beverage transactions. We determine revenue recognition through the following steps:
Identification of the contract, or contracts, with a customer
Identification of the performance obligations in the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligation in the contract
Recognition of revenue when, or as, we satisfy a performance obligation
The transaction price for a Card Casino contract is a set percentage of wagers and is recognized at the time that the wagering process is complete. The transaction price for pari-mutuel wagering is the commission received on a wager, exclusive of any track fees and is recognized upon occurrence of the live race that is presented for wagering and after that live race is made official by the respective state’s racing regulatory body. The transaction price for food and beverage contracts is the net amount collected from the customer for these goods. Food and beverage services have been determined to be separate, stand-alone performance obligations and the transaction price is recorded as revenue as the good is transferred to the customer when delivery is made.
Contracts for Card Casino operations and pari-mutuel wagering involve two performance obligations for those customers earning points under the Company’s loyalty program and a single performance obligation for customers who do not participate in the program. The Company applies a practical expedient by accounting for its gaming contracts on a portfolio basis as these wagers have similar characteristics and the Company reasonably expects the effects on the financial statements of applying the revenue recognition guidance to the portfolio would not differ materially from what would result if the guidance were applied on an individual wagering contract. For purposes of allocating the transaction price in a wagering contract between the wagering performance obligation and the obligation associated with the loyalty points earned, the Company allocates an amount to the loyalty point contract liability based on the stand-alone redemption value of the points earned, which is determined by the value of a point that can be redeemed for a cash voucher, food and beverage voucher, racing admission, valet parking, or racing forms. Based on past experience, the majority of customers redeem their points for cash vouchers. Therefore, there are no further performance obligations by the Company.
We have two general types of liabilities related to contracts with customers: (1) our MVP Loyalty Program and (2) outstanding chip liability. These are included in the line item card casino accruals on the consolidated balance sheet. We defer the full retail value of these complimentary reward items until the future revenue transaction occurs.
The Company offers certain promotional allowances at no charge to patrons who participate in its player rewards program.
We evaluate our on-track revenue, export revenue, and import revenue contracts to determine whether we are acting as the principal or as the agent when providing services, which we consider in determining if revenue should be
reported gross or net. An entity is a principal if it controls the specified service before that service is transferred to a customer.
The revenue we recognize for on-track revenue and import revenue is the commission we are entitled to retain for providing a wagering service to our customers. For these arrangements, we are the principal as we control the wagering service; therefore, any charges, including simulcast fees, we incur for delivering the wagering service are presented as operating expenses.
For export revenue, our customer is the third party wagering site such as a race track, OTB, or advance deposit wagering provider. Therefore, the revenue we recognize for export revenue is the simulcast host fee we earn for exporting our racing signal to the third party wagering site.
2.
ACCOUNTING STANDARDS AND SIGNIFICANT ACCOUNTING POLICIES
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02 codified as Accounting Standards Codification (“ASC”) 842, Leases, (“ASC 842”) which addresses the recognition and measurement of leases. Under the new guidance, for all leases (with the exception of short-term leases), at the commencement date, lessees will be required to recognize a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to control the use of a specified asset for the lease term. The effective date for this update is for the annual and interim periods beginning after December 15, 2018 with early adoption permitted. ASC 842 requires a transition adoption election using either (1) a modified retrospective approach with periods prior to the adoption date being recast or (2) a prospective adoption approach with a cumulative-effect adjustment recognized to the opening balance of retained earnings on the adoption date with prior periods continuing to be reported under previous lease accounting guidance.
The Company adopted ASC 842 on January 1, 2019 using the prospective adoption approach, and therefore, comparative periods will continue to be reported under previous lease accounting guidance consistent with previously issued financial statements. The Company also elected to adopt the package of practical expedients
permitted under the transition guidance within ASC 842, which among other things, allows us to carry forward the historical lease identification, lease classification and treatment of initial direct costs for leases entered into prior to January 1, 2019. We have also made an accounting policy election to not record short-term leases with an initial term of 12 months or less on the balance sheet for all classes of underlying assets. The adoption of ASC 842 did not have a material impact on our consolidated financial statements. Refer to Note 11 for further detail.
Summary of Significant Accounting Policies
Except for the accounting policies for leases that were updated as a result of our recently adopted accounting pronouncements, there have been no changes to our significant accounting policies described in the Annual Report on Form 10‑K for the year ended December 31, 2018 filed with the SEC on March 29, 2019, that have had a material impact on our condensed consolidated financial statements and related notes.
3.
STOCK-BASED COMPENSATION
Long Term Incentive Plan and Award of Deferred Stock
The Long Term Incentive Plan (the “LTI Plan”) authorizes the grant of Long Term Incentive Awards that provide an opportunity to Named Executive Officers (“NEOs”) and other Senior Executives to receive a payment in cash or shares of the Company’s common stock to the extent of achievement at the end of a period greater than one year (the “Performance Period”) as compared to Performance Goals established at the beginning of the Performance
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
2019
|
|
2018
|
|
Assets
|
|
|
|
|
|
|
|
Total assets for reportable segments
|
|
$
|
85,210
|
|
$
|
84,942
|
|
Elimination of intercompany balances
|
|
|
(23,300)
|
|
|
(23,516)
|
|
Total consolidated assets
|
|
$
|
61,910
|
|
$
|
61,426
|
8.
COMMITMENTS AND CONTINGENCIES
In accordance with an Earn Out Promissory Note given to the prior owner of the Racetrack as part of the consideration paid by the Company to acquire the Racetrack in 1994, if (i) off-track betting becomes legally permissible in the State of Minnesota and (ii) the Company begins to conduct off-track betting with respect to or in connection with its operations, the Company will be required to pay to the IMR Fund, L.P. the greater of (a) $700,000 per Operating Year, as defined, or (b) 20% of the Net Pretax Profit, as defined for each of five operating years. At this time, management believes that the likelihood that these two conditions will be met and that the Company would be required to pay these amounts is remote. At the date (if any) that these two conditions are met, the five minimum payments would be discounted back to their present value and the sum of those discounted payments would be capitalized as part of the purchase price in accordance with GAAP. The purchase price will be further increased if payments become due under the “20% of Net Pretax Profit” calculation. The first payment would be due 90 days after the end of the third Operating Year in which off-track betting is conducted by the Company. Remaining payments would be made within 90 days of the end of each of the next four Operating Years.
The Company entered into a Cooperative Marketing Agreement (the “CMA”) with the Shakopee Mdewakanton Sioux Community (“SMSC”), which became effective June 4, 2012, was amended in the first quarter of each of 2015, 2016, 2017, and 2018, and will expire on December 31, 2022. The CMA contains certain covenants which, if breached, would trigger an obligation to repay a specified amount related to such covenant. At this time, management believes it unlikely that any breach of a covenant will occur, and that therefore the possibility that the Company will be required to pay the specified amount related to any covenant breach is remote.
The Company is periodically involved in various claims and legal actions arising in the normal course of business. Management believes that the resolution of any pending claims and legal actions at March 31, 2019 and as of the date of this report, will not have a material impact on the Company’s consolidated financial positions or results of operations.
In August 2018, the Company entered into a Contract for Private Redevelopment with the City of Shakopee in connection with a Tax Increment Financing District (“TIF District”). The Company is obligated to construct certain infrastructure improvements within the TIF District, and will be reimbursed by the City of Shakopee by future tax increment revenue generated from the developed property. The total amount of funding that Canterbury will be paid as reimbursement under the TIF program for these improvements is not guaranteed and will depend on future tax revenues generated from the developed property.
9.
COOPERATIVE MARKETING AGREEMENT
As discussed above in Note 8, on June 4, 2012, the Company entered into the CMA with the SMSC. The primary purpose of the CMA is to increase purses paid during live horse racing at Canterbury Park’s Racetrack in order to strengthen Minnesota’s thoroughbred and quarter horse industry. Under the CMA, as amended, this is achieved through “Purse Enhancement Payments to Horsemen” paid directly to the MHBPA. These payments have no direct impact on the Company’s consolidated financial statements or operations.
Under the terms of the CMA, as amended, the SMSC paid the horsemen $7.4 million and $7.2 million in the first three months of 2019 and 2018, respectively, primarily for purse enhancements for the live race meets in the respective years.
Under the CMA, as amended, SMSC also agreed to make “Marketing Payments” to the Company relating to joint marketing efforts for the mutual benefit of the Company and SMSC, including signage, joint promotions, player benefits and events.
In the first quarter of 2015, 2016, 2017, and 2018, the CMA was amended to adjust the payment amounts between the “Purse Enhancement Payments to Horsemen” and “Marketing Payments to Canterbury Park.” SMSC is currently obligated to make the following purse enhancement and marketing payments for 2020 through 2022:
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|
|
|
|
|
|
|
Purse Enhancement Payments to
|
|
Marketing Payments to
|
|
Year
|
|
Horsemen (1)
|
|
Canterbury Park
|
|
2020
|
|
|
7,380,000
|
|
|
1,620,000
|
|
2021
|
|
|
7,380,000
|
|
|
1,620,000
|
|
2022
|
|
|
7,380,000
|
|
|
1,620,000
|
|
|
|
|
|
|
|
|
1
Includes $100,000 each year payable to various horsemen associations
The amounts earned from the marketing payments are recorded as a component of other revenue and the related expenses are recorded as a component of advertising and marketing expense and depreciation in the Company’s condensed consolidated statements of operations. For the three months ended March 31, 2019, the Company recorded $75,000 in other revenue and incurred $18,000 in advertising and marketing expense and $57,000 in depreciation related to the SMSC marketing funds.
For the three months ended March 31, 2018, the Company recorded $106,000 in other revenue and incurred $49,000 in advertising and marketing expense and $57,000 in depreciation related to the SMSC marketing funds.
Under the CMA, the Company agreed for the term of the CMA, which is currently scheduled to terminate on December 31, 2022, that it would not promote or lobby the Minnesota legislature for expanded gambling authority and will support the SMSC’s lobbying efforts against expanding gambling authority.
10.
REAL ESTATE DEVELOPMENT
Equity Investment
On April 2, 2018, the Company’s subsidiary Canterbury Development LLC, entered into an Operating Agreement (“Operating Agreement”) with an affiliate of Doran Companies (“Doran”), a national commercial and residential real estate developer, as the two members of a Minnesota limited liability company named Doran Canterbury I, LLC (Doran Canterbury I). Doran Canterbury I was formed as part of a joint venture between Doran and Canterbury Development LLC to construct an upscale apartment complex on land adjacent to the Company’s Racetrack (the “Project”). Doran Canterbury is developing Phase I of the Project, which will include approximately 300 units, a heated parking ramp, and a clubhouse.
In connection with the execution of the Amended Doran Canterbury I Agreement, on August 18, 2018, Canterbury Development LLC entered into an Operating Agreement with Doran Shakopee, LLC as the two members of a Minnesota limited liability company entitled Doran Canterbury II, LLC (“Doran Canterbury II”). Under the Doran Canterbury II Operating Agreement, Doran Canterbury II will pursue development of Phase II of the Project, which is expected to begin upon rental stabilization of Phase I. Phase II will include an additional 300 apartment units. Canterbury Development’s equity contribution to Doran Canterbury for Phase II will be approximately 10 acres of land. In connection with its contribution, Canterbury Development became a 27.4% equity member in Doran Canterbury II with Doran owning the remaining 72.6%.
On September 27, 2018, Canterbury Development LLC contributed approximately 13 acres of land as its equity contribution in the Doran Canterbury I joint venture and became a 27.4% equity member. On December 20, 2018, financing for Doran Canterbury I was secured. As the Company is able to assert significant influence, but not
control, over Doran Canterbury I’s operational and financial policies, the Company accounts for the joint venture as an equity method investment.
Tax Increment Financing
On August 8, 2018, the City Council of the City of Shakopee, Minnesota approved a Contract for Private Redevelopment (“Redevelopment Agreement”) between the City of Shakopee Economic Development Authority (“Shakopee EDA”) and Canterbury Park Holding Corporation and its subsidiary Canterbury Development LLC in connection with a Tax Increment Financing District (“TIF District”) that the City had approved in April 2018. The City of Shakopee, the Shakopee EDA and the Company entered into the Redevelopment Agreement on August 10, 2018.
Under the Redevelopment Agreement, the Company has agreed to undertake a number of specific infrastructure improvements within the TIF District, including the development of public streets, utilities, sidewalks, and other public infrastructure. More specifically, the Company is obligated to construct improvements on Shenandoah Drive and Barenscheer Boulevard with these improvements required to be substantially complete on or before December 31, 2019 and December 31, 2020, respectively.
The Redevelopment Agreement provides that if the Company does not proceed with the improvements to Shenandoah Drive on or before December 15, 2018 or the improvements to Barenscheer Boulevard on or before December 15, 2019, the City of Shakopee has the right to construct the improvements itself and assess the Company for the costs of these improvements. As of December 2018, the Company was proceeding with the improvements to Shenandoah Drive.
Under the Redevelopment Agreement, the City of Shakopee has agreed that a portion of the tax increment revenue generated from the developed property will be paid to the Company to reimburse it for its expense in constructing infrastructure improvements. The total estimated cost of TIF eligible improvements to be borne by the Company is $23,336,500. A detailed Schedule of the Public Improvements under the Redevelopment Agreement, the timeline for their construction and the source and amount of funding is set forth on Exhibit C of the Redevelopment Agreement, which was filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended June 30, 2018. The total amount of funding that Canterbury will be paid as reimbursement under the TIF program for these improvements is not guaranteed, however, and will depend on future tax revenues generated from the developed property. As of March 31, 2019, the Company recorded a TIF receivable of $3,608,000.
The Company expects to finance its improvements under the Redevelopment Agreement with funds from its current operating resources and existing credit facility and, potentially, third-party financing sources.
11.
LEASES
The Company determines if an arrangement is a lease or contains a lease at inception. The Company leases certain office equipment under finance leases. We also lease equipment related to our horse racing operations under operating leases. For lease accounting purposes, we do not separate lease and nonlease components, nor do we record operating or finance lease assets and liabilities for short term leases.
As our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date to determine the present value of lease payments. We recognize expense for
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Canterbury Park Holding Corporation, our operations, our financial results and financial condition and our present business environment. This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to the financial statements (the “Notes”).
Overview:
Canterbury Park Holding Corporation (the “Company,” “we,” “our,” or “us”) conducts pari-mutuel wagering operations and hosts “unbanked” card games at its Canterbury Park Racetrack and Card Casino facility (the “Racetrack”) in Shakopee, Minnesota, which is approximately 25 miles southwest of downtown Minneapolis. The Racetrack is the only facility in the State of Minnesota that offers live pari-mutuel thoroughbred and quarter horse racing.
The Company’s pari-mutuel wagering operations include both wagering on thoroughbred and quarter horse races during live meets at the Racetrack each year from May through September, and year-round wagering on races held at out-of-state racetracks that are televised simultaneously at the Racetrack (“simulcasting”). Unbanked card games, in which patrons compete against each other, are hosted in the Card Casino at the Racetrack. The Card Casino operates 24 hours a day, seven days a week. The Card Casino offers both poker and table games at up to 80 tables. The Company also derives revenues from related services and activities, such as concessions, parking, advertising signage, publication sales, and from other entertainment events and activities held at the Racetrack.
Operations Review for the Three Months Ended March 31, 2019:
EBITDA
EBITDA represents earnings before interest, income tax expense, and depreciation and amortization. EBITDA is not a measure of performance or liquidity calculated in accordance with generally accepted accounting principles in the United States of America (“GAAP”), and should not be considered an alternative to, or more meaningful than, net income as an indicator of our operating performance or cash flows from operating activities as a measure of liquidity. EBITDA is presented as a supplemental disclosure because it is a widely used measure of performance and a basis for valuation of companies in our industry. Moreover, other companies that provide EBITDA information may calculate EBITDA differently than we do. Adjusted EBITDA reflects additional adjustments to net income to eliminate unusual items. For the three months ended March 31, 2019, adjusted EBITDA excluded the loss on disposal of assets.
The following table sets forth a reconciliation of net income, a GAAP financial measure, to EBITDA and to adjusted EBITDA (defined above) which are non-GAAP financial measures, for the three months ended March 31, 2019 and 2018:
Summary of EBITDA Data
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|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
2019
|
|
2018
|
|
|
NET INCOME
|
|
$
|
56,572
|
|
$
|
989,690
|
|
|
Interest income, net
|
|
|
(63,240)
|
|
|
(12,407)
|
|
|
Income tax (benefit) expense
|
|
|
(16,093)
|
|
|
379,470
|
|
|
Depreciation
|
|
|
625,520
|
|
|
635,145
|
|
|
EBITDA
|
|
|
602,759
|
|
|
1,991,898
|
|
|
Gain on insurance recoveries
|
|
|
—
|
|
|
(21,064)
|
|
|
Loss on disposal of assets
|
|
|
113,437
|
|
|
—
|
|
|
ADJUSTED EBITDA
|
|
$
|
716,196
|
|
$
|
1,970,834
|
|
Adjusted EBITDA decreased $1,255,000 or 63.7% and decreased as a percentage of net revenues to 6.2% from 16.1% for the three months ended March 31, 2019 as compared to the same period in 2018. The decrease is due to the decrease in revenues and increase in operating expenses compared to the same period in 2018.
Revenues:
Total net revenues for the three months ended March 31, 2019 were $11,591,000, a decrease of $629,000, or 5.1%, compared to total net revenues of $12,220,000 for the three months ended March 31, 2018. This decrease primarily consists of decreases in card casino and other revenue of 4.6% and 22.9%, respectively. See below for a further discussion of our sources of revenues.
Pari-Mutuel Data Revenue:
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|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
2019
|
|
2018
|
|
|
Simulcast
|
|
$
|
1,217,000
|
|
$
|
1,272,000
|
|
|
Other revenue
|
|
|
274,000
|
|
|
269,000
|
|
|
Total Pari-Mutuel Revenue
|
|
$
|
1,491,000
|
|
$
|
1,541,000
|
|
|
|
|
|
|
|
|
|
|
Total pari-mutuel revenue decreased $50,000, or 3.2%, for the three months ended March 31, 2019 compared to the same period in 2018. The decrease is related to a reduction in simulcast wagering, which was partially due to the temporary shutdown during the quarter of Santa Anita, one of the most popular horse tracks in the country in terms of simulcast wagering.
Card Casino Revenue:
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
2018
|
|
|
Poker Games
|
$
|
1,930,000
|
|
$
|
2,178,000
|
|
|
Table Games
|
|
5,197,000
|
|
|
5,356,000
|
|
|
Total Collection Revenue
|
|
7,127,000
|
|
|
7,534,000
|
|
|
Other Revenue
|
|
773,000
|
|
|
743,000
|
|
|
Total Card Casino Revenue
|
$
|
7,900,000
|
|
$
|
8,277,000
|
|
The primary source of Card Casino revenue is a percentage of the wagers received from players as compensation for providing the Card Casino facility and services, which is referred to as “collection revenue.” Other Revenue presented above includes fees collected for the administration of tournaments, amounts earned as reimbursement of the administrative costs of maintaining jackpot funds, and amounts related to the outstanding chip liability that we expect will not be redeemed in the future.
Total Card Casino revenue decreased $377,000, or 4.6%, for the three months ended March 31, 2019 compared to the same period in 2018. The decrease in the 2019 first quarter is primarily due to unusually inclement weather as well as business disruption caused by construction projects. During January and February, the Company had a major remodeling and expansion of the Card Casino which included reductions in the number of gaming tables as well as food and beverage services. In addition, road construction related to the development of our property was underway during the quarter and impacted patron access and parking. As a result of these factors, there was decreased play in table games and poker for the 2019 first quarter compared to the same period in 2018.
Food and Beverage Revenue:
Food and beverage revenue increased $49,000, or 3.8%, to $1,353,000 for the three months ended March 31, 2019 compared to the same period in 2018. The increase is attributable to increased food and beverage revenues from special events and the opening of the Trifecta Café and remodeled card room in March 2019.
Other Revenue:
Other revenue decreased $251,000, or 22.9%, for the three months ended March 31, 2019 compared to the same period in 2018. The decrease is due to a short-term customer rental agreement in the first quarter of 2018, related to the Super Bowl held in Minneapolis. A portion of the revenues were reimbursed costs based on the terms of the contract. These costs are included as an expense in our Consolidated Statement of Operations.
Operating Expenses:
Total operating expenses increased $750,000, or 6.9%, for the three months ended March 31, 2019 compared to the same period in 2018. The following paragraphs provide further detail regarding certain operating expenses.
Purse expense increased $151,000, or 12.1%, for the three months ended March 31, 2019 compared to the same period in 2018. Card Casino purses increased $240,000 due to a change in the purse payment structure related to changes in our horsemen contract effective January 1, 2019. This purse expense increase, which is primarily a timing difference that will result in lower purse expenses in the second and third quarters, was partially offset by purse reductions due to lower pari-mutuel and Card Casino revenues.
Salaries and benefits increased $315,000, or 5.9% for the three months ended March 31, 2019 compared to the same period in 2018. The increase is primarily due to labor costs and inefficiencies caused by the Card Casino construction in January and February and re-opening in March. Another factor in the increased labor costs was the State of Minnesota’s mandated increase of $0.21 in the minimum wage effective January 1, 2019.
Professional and contracted services increased $106,000, or 12.3%, for the three months ended March 31, 2019 compared to the same period in 2018. The increase is partially due to professional fees for its development initiatives, as well as increased cost of table games license fees.
In the 2019 first quarter, the Company recorded a loss on disposal of assets totaling $113,000. This primarily relates to a write-off of assets disposed of in remodeling our Card Casino.
Net income for the three months ended March 31, 2019 was $57,000. Net income for the three months ended March 31, 2018 was $990,000.
Contingencies:
The Company entered into a Cooperative Marketing Agreement (the “CMA”) with the Shakopee Mdewakanton Sioux Community which became effective on June 4, 2012, and was amended in January 2015, 2016, 2017 and 2018, and will expire December 31, 2022. The CMA contains specific covenants that, if breached, would trigger an obligation to repay a specified amount related to these covenants. At this time, management believes that the likelihood that the breach of a covenant would occur and that the Company would be required to pay the specified amount related to a covenant is remote.
The Company continues to analyze the feasibility of various options related to the development of our underutilized land. The Company may incur substantial costs during the feasibility and predevelopment process, but the Company believes available funds are sufficient to cover the near-term costs. See Liquidity and Capital Resources for more information on liquidity and capital resource requirements.
Liquidity and Capital Resources:
Net cash provided by operating activities for the three months ended March 31, 2019 was $1,461,000 primarily as a result of the following: The Company reported net income of $57,000, which included a loss on disposal of assets of $113,000. Cash from operating activities was increased by noncash charges from depreciation of $626,000 and stock-based compensation and 401(k) match totaling $206,000. The Company also experienced an increase in accounts payable of $303,000, card casino accruals of $417,000, and a decrease in income taxes receivable of $357,000. This was partially offset by a decrease in accrued wages and payroll taxes of $889,000.
Net cash provided by operating activities for the three months ended March 31, 2018 was $2,422,000 primarily from net income of $990,000, depreciation of $635,000, and stock-based compensation and 401(k) match totaling $220,000. The Company also experienced an increase in card casino accruals and accrued property taxes of $285,000 and $243,000, respectively, as well as a decrease in accounts receivable of $665,000. This was partially offset by a decrease in accrued wages and payroll taxes of $1,140,000.
Net cash used in investing activities for the first three months of 2019 and 2018 was $4,801,000 and $1,226,000, respectively, primarily for additions to land, buildings, and equipment.
Net cash used in financing activities during the first three months of 2019 was $228,000, relating primarily to cash dividends paid to shareholders, partially offset by proceeds from purchases of stock through the Employee Stock Purchase Plan and the exercise of stock options. Net cash provided by financing activities during the first three months of 2018 was $17,000.
The Company has a general credit and security agreement with a financial institution. This agreement was amended and restated effective as of September 30, 2018 to extend the maturity date to September 30, 2019, increase the revolving credit line to $8,000,000, and allow for letters of credit in the aggregate amount of up to $2,000,000 to be issued under the credit agreement. The line of credit is collateralized by all receivables, inventory, equipment, and general intangibles of the Company. The Company had no borrowings under the credit line during the three months ended March 31, 2019.
The Company’s cash, cash equivalents, and restricted cash balance at March 31, 2019 was $7,636,000 compared to $11,204,000 at December 31, 2018. The Company believes that unrestricted funds available in its cash accounts, amounts available under its revolving line of credit, along with funds generated from operations, will be sufficient to satisfy its liquidity and capital resource requirements for regular operations, as well as its planned development expenses during 2019. However, if the Company engages in any additional significant real estate development, additional financing would more than likely be required.
Critical Accounting Policies and Estimates:
The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors that management believes to be relevant at the time the consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates, and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our significant accounting policies are included in Note 2 to our consolidated financial statements in our 2018 Annual Report on Form 10‑K. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Property and Equipment
- We have significant capital invested in our property and equipment, which represents 66% of our total assets at March 31, 2019. We use our judgment in various ways including: determining whether an expenditure
is considered a maintenance expense or a capital asset; determining the estimated useful lives of assets; and determining if or when an asset has been impaired or has been disposed. Management periodically reviews the carrying value of property and equipment for potential impairment by comparing the carrying value of these assets with their related expected undiscounted future net cash flows. If the sum of the related expected future net cash flows is less than the carrying value, management would determine how much of an impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset. We have determined that no impairment of these assets exists at March 31, 2019.
Stock-Based Compensation –
Accounting guidance requires measurement of services provided in exchange for a share-based payment based on the grant date fair market value. We use our judgment in determining the assumptions used to determine the fair value of equity instruments granted using a Black-Scholes model. The Company also grants Long Term Incentive Awards under the Long Term Incentive Plan (the “LTI Plan”) under which Company executive officers and other senior executives have the opportunity to receive a payout of shares of the Company’s common stock at the end of a three-year period. Management must make a number of assumptions to estimate future results to determine the compensation expense of the LTI Plan.
Commitments and Contractual Obligations:
The Company entered into the CMA with the SMSC on June 4, 2012, that was amended in January 2015, 2016, 2017, and 2018 and expires December 31, 2022. See “Cooperative Marketing Agreement” below.
Legislation:
Minimum Wage Legislation
In 2014, Minnesota legislation enacted into law an increase in the minimum wage that must be paid to most Company employees. Beginning January 1, 2018, the minimum wage was set to increase at the beginning of each year by the rate of inflation with a maximum increase of up to 2.5% per year. The minimum wage for 2019 is $9.86 per hour. Prior to August 1, 2014, the Company employed a large number of individuals who received an hourly wage equal to or slightly above $7.25 per hour. As a result, this legislation had an adverse financial impact on the Company in 2014 through 2018, and will continue to have an adverse impact on the Company. We have implemented measures to partially mitigate the impact of this increase by raising our prices and reducing our employee count. These measures could themselves have an adverse effect because higher prices and diminished service levels may discourage customers from visiting the Racetrack.
Cooperative Marketing Agreement:
On June 4, 2012, the Company entered into the CMA with the SMSC. The primary purpose of the CMA is to increase purses paid during live horse racing at Canterbury Park’s Racetrack in order to strengthen Minnesota’s thoroughbred and quarter horse industry. Under the CMA, as amended, this is achieved through “Purse Enhancement Payments to Horsemen” paid directly to the MHBPA. These payments have no direct impact on the Company’s consolidated financial statements or operations.
Under the terms of the CMA, as amended, the SMSC paid the horsemen $7.4 million and $7.2 million in the first three months of 2019 and 2018, respectively, primarily for purse enhancements for the live race meets in the respective years.
Under the CMA, as amended, SMSC also agreed to make “Marketing Payments” to the Company relating to joint marketing efforts for the mutual benefit of the Company and SMSC, including signage, joint promotions, player benefits and events.
In each of January 2015, 2016, 2017, and 2018 the CMA was amended to adjust the payment amounts between the “Purse Enhancement Payments to Horsemen” and “Marketing Payments to Canterbury Park.” SMSC is currently obligated to make the following purse enhancement and marketing payments for 2020 through 2022:
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Purse Enhancement Payments to
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Marketing Payments to
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Year
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Horsemen (1)
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Canterbury Park
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2020
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7,380,000
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1,620,000
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2021
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7,380,000
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1,620,000
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2022
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7,380,000
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1,620,000
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1
Includes $100,000 each year payable to various horsemen associations
The amounts earned from the marketing payments are recorded as a component of other revenue and the related expenses are recorded as a component of advertising and marketing expense and depreciation in the Company’s condensed consolidated statements of operations. For the three months ended March 31, 2019, the Company recorded $75,000 in other revenue and incurred $18,000 in advertising and marketing expense and $57,000 in depreciation related to the SMSC marketing funds.
For the three months ended March 31, 2018, the Company recorded $106,000 in other revenue and incurred $49,000 in advertising and marketing expense and $57,000 in depreciation related to the SMSC marketing funds.
Under the CMA, the Company has agreed for the 10‑year term of the CMA expiring December 31, 2022 that it will not promote or lobby the Minnesota legislature for expanded gambling authority and will support the SMSC’s lobbying efforts against expanding gambling authority.
Redevelopment Agreement:
As mentioned above in note 10 of Notes to Financial Statements, on August 10, 2018, the City of Shakopee, the City of Shakopee Economic Development Authority, and the Company entered into a Redevelopment Agreement in connection with a Tax Increment Financing District (“TIF District”) that the City had approved in April 2018. Under the Redevelopment Agreement, the Company has agreed to undertake a number of specific infrastructure improvements within the TIF District, including the development of public streets, utilities, sidewalks, and other public infrastructure and the City of Shakopee agreed that a portion of the tax revenue generated from the developed property will be paid to the Company to reimburse it for its expense in constructing these improvements. The Company expects to finance its improvements under the Redevelopment Agreement with funds from its current operating resources and existing credit facility and, potentially, third-party financing sources.
Forward-Looking Statements:
From time-to-time, in reports filed with the Securities and Exchange Commission, in press releases, and in other communications to shareholders or the investing public, we may make forward-looking statements concerning possible or anticipated future financial performance, prospective business activities or plans that are typically preceded by words such as “believes,” “expects,” “anticipates,” “intends” or similar expressions. For these forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in federal securities laws. Shareholders and the investing public should understand that these forward-looking statements are subject to risks and uncertainties that could affect our actual results and cause actual results to differ materially from those indicated in the forward-looking statements. These risks and uncertainties include, but are not limited to:
material fluctuations in attendance at the Racetrack;
decline in interest in wagering on horse races at the Racetrack, at other tracks, or on unbanked card games offered at the Card Casino;
competition from other venues offering unbanked card games or other forms of wagering;
greater-than-anticipated expenses or a lower-than-anticipated return on the development of our underutilized land, including our joint venture to develop a luxury apartment complex;
competition from other sports and entertainment options;
increases in compensation and employee benefit costs;
increases in the percentage of revenues allocated for purse fund payments;
higher-than-expected expenses related to new marketing initiatives;
the impact of wagering products and technologies introduced by competitors;
legislative and regulatory decisions and changes, including decision or actions related to sports betting that would adversely affect our betting environment;
any legal, judicial, legislative or regulatory action or event that would adversely affect our ten-year Cooperative Marketing Agreement with the Shakopee Mdewakanton Sioux Community, which enhances the purses for daily racing at Canterbury Park and supports cooperative marketing programs for the two organizations, benefiting the stability and quality of live horse racing;
the fact that under the Redevelopment Agreement with the City of Shakopee, the Company has agreed to undertake a number of specific infrastructure improvements within the TIF District, and the funding that Canterbury Park will be paid as reimbursement under the TIF program for these improvements is not guaranteed, but will depend in part on future tax revenues generated from the developed property;
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the success of the Company’s Canterbury Commons real estate development, including our reliance upon our joint venture partner Doran Companies to construct and profitably operate the upscale apartment complex;
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the general health of the gaming sector; and
other factors that are beyond our ability to control or predict.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Canterbury Park is not required to provide the information requested by this Item as it qualifies as a smaller reporting company.
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures:
The Company maintains disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(e) under the Securities Exchange Act of 1934) that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In connection with the filing of this Form 10‑Q, management evaluated, under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) Randall D. Sampson, the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of March 31, 2019. Due to the
material weakness in internal controls described below, management concluded that as of March 31, 2019, our internal control over financial reporting was not effective.
Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Rule 13a‑15(f) and 15d‑15(f) of the Securities Exchange Act. Under the supervision and with the participation of the Company’s management, including the CEO and CFO, the Company conducted an evaluation of the effectiveness of internal control over financial reporting based on the Framework. Based on management’s testing and evaluation, we concluded that our internal control over financial reporting was not effective, and as a result, resulted in a material weakness in internal controls.
Based on management’s testing and evaluation, we concluded that our internal control over financial reporting was not effective in the quarter ended September 30, 2018, and as a result, resulted in a material weakness in internal controls. The identified material weakness arose as a result of management’s incorrect initial determination of the effective date to recognize the gain associated with the Company’s transfer of land to the Doran Canterbury, I joint venture described in Note 10 of Notes to Financial Statements in the Form 10-Q for the quarter ended September 30, 2018. On September 27, 2018, the Company’s subsidiary Canterbury Development LLC contributed approximately 13 acres of land to Doran Canterbury I as its equity contribution to the joint venture and became a 27.4% equity member. Under the Doran Canterbury I Operating Agreement, Doran was responsible for securing financing for Doran Canterbury I, and if financing were not secured for Doran Canterbury I, the Company had the ability to withdraw from Doran Canterbury I. As long as the Company has the right to withdraw its land contribution, the Company was not able to recognize the gain. As of November 14, 2018, financing for Doran Canterbury I had not been secured. Therefore, as of September 30, 2018, the Company could not record (i) any gain associated with investment in this joint venture, or (ii) its interest in this joint venture.
Because management initially determined the Company would recognize a gain associated the Company’s transfer of land to the Doran Canterbury I joint venture and corrected this determination later in connection with finalizing the Form 10-Q, the Company concluded that a reasonable possibility existed that a material misstatement in the Company’s consolidated financial statements would not have been prevented or detected on a timely basis. The Doran Canterbury I joint venture is the Company’s first significant venture into real estate development and the agreements associated with these transactions are complex. The Company initially erred in making and recording the gain for the contribution of land because management did not realize that its ability to reclaim the property if the financing is not secured prevented it from recognizing the income on a current basis.
On December 20, 2018, financing for Doran Canterbury I was secured and the Company included a $2.2 million gain on its transfer of land to the Doran Canterbury I joint venture
Remediation Plan for Material Weaknesses in Internal Control over Financial Reporting
During our 2018 fiscal fourth quarter and 2019 fiscal first quarter, we began implementing a remediation plan to address the material weakness described above. The Company believes that it must acquire additional technical expertise either within the Company or by engaging a third party to help it understand the intricacies of some of the applicable revenue recognition rules in connection with the Doran joint venture and any future joint venture agreements or future Company development efforts. The Company engaged a third party to assist in the process, but has determined that the remediation plan is not complete as the date of this Form 10-Q.
(b) Changes in Internal Control over Financial Reporting:
There have been no changes in internal control over financial reporting that occurred during the fiscal 2019 first quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting, except that as noted above, the Company is taking steps to remediate the material weakness in internal control over financial reporting.