Canterbury Park Holding Corp: Form 10-Q for the period ended Sep 30, 2023

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 and its subsidiaries, 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 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 Casino at the Racetrack. The Casino typically operates 24 hours a day, seven days a week. The 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 and Nine Months Ended September 30, 2023:

Revenues:

Total net revenues for the three months ended September 30, 2023 were $19,269,000, a decrease of $3,024,000, or 13.6%, compared to total net revenues of $22,292,000 for the three months ended September 30, 2022. Total net revenues for the nine months ended September 30, 2023 were $48,910,000, a decrease of $4,795,000, or 8.9%, compared to total net revenues of $53,705,000 for the nine months ended September 30, 2022. See below for a further discussion of our sources of revenues.

Casino Revenue:

The primary source of Casino revenue is a percentage of the wagers received from players as compensation for providing the Casino facility and services, which is referred to as “collection revenue.” Other Poker Revenue and Other Table Games Revenue presented above includes fees collected for the administration of tournaments and the poker jackpot and amounts earned as reimbursement of the administrative costs of maintaining table games jackpot funds, respectively.

As indicated by the table above, total Casino revenue remained relatively flat, increasing $184,000, or 1.8%, and decreasing $72,000, or 0.2%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022.

Pari-Mutuel Revenue:

Total pari-mutuel revenue decreased $1,326,000, or 28%, and $2,589,000, or 27%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease in pari-mutuel revenues is primarily due to a decrease in live race days year-over-year (53 race days in 2023 compared to 64 race days in 2022) as well as decreased guest fees from out-state-handle on our live racing product.

Food and Beverage Revenue:

Food and beverage revenue decreased $603,000, or 15.4%, and $342,000, or 4.8%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease in food and beverage revenues for the three and nine month periods is primarily due to Twin Cities Summer Jam not taking place in the third quarter of 2023 as it did during the third quarter of 2022.

Other Revenue:

Other revenue decreased $1,280,000, or 35.5%, and $1,791,000, or 27.3%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decreases are primarily due to the expiration of the SMSC agreement as funds received from the agreement were used and subsequently recorded in other revenues as well as being recorded as operating, primarily advertising and marketing, expenses.

Operating Expenses:

Total operating expenses decreased $422,000, or 2.4%, and increased $307,000, or 0.7%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The following paragraphs provide further detail regarding certain operating expenses.

Purse expense decreased $386,000, or 12.9%, and $897,000, or 12.9%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease for the three months ended September 30, 2023 is primarily due to the decrease in pari-mutuel revenues while the decrease for the nine months ended September 30, 2023 is primarily due to decreases of both pari-mutuel and Casino revenues.

Salaries and benefits increased $385,000, or 5.6%, and $1,042,000, or 5.5%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The increase is primarily due to an increase in our wage-rate structure for seasonal as well as year-round employees to attract and retain front-line workers. The Company also increased its 401(k) match percentage, effective January 1, 2023.

Cost of food and beverage sales decreased $204,000, or 14.9%, and $204,000, or 7.4%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease is primarily due to the decreased food and beverage revenue due to Twin Cities Summer Jam not taking place in 2023 as noted above.

Advertising and marketing costs decreased $680,000, or 43.4%, and $922,000, or 33.7%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease is attributed to the expiration of the Cooperative Marketing Agreement mentioned above in the other revenues section.

Professional and contracted services increased $713,000, or 45.4%, and $1,076,000, or 28.5%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The increase in professional expense relates to long-term strategic growth initiatives being pursued as part of the execution on our five-year strategic plan focused on growing Casino revenue.

Other operating expenses decreased $213,000, or 13.3%, and increased $317,000, or 8.3%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease for the three months ended September 30, 2023 is primarily due to lower costs for promoter expenses related to our summer concert series. The increase for the nine months ended September 30, 2023 is primarily due to increased track maintenance costs, a settlement of a claim, and also the timing of miscellaneous repairs and maintenance year-over-year.

Other Income (Loss), Net:

Other loss, net, for the three months ended September 30, 2023 was $137,000, an increase of $140,000, compared to a net other loss of $277,000 for the three months ended September 30, 2022. Other income, net, for the nine months ended September 30, 2023 was $1,995,000, an increase of $2,649,000, compared to a net other loss of $653,000 for the nine months ended September 30, 2022. The increase for the nine months ended September 30, 2023 is primarily due to our share of insurance proceeds received on a claim by Doran Canterbury I. Also contributing to both the three and nine month increases was increased interest income due to the Company transferring available cash into certificates of deposit and money market funds as well as increasing interest rates related to our member loans to Doran Canterbury I and Doran Canterbury II.

During the 2023 second quarter, the Company recorded a gain on sale of land of $6,490,000 as a result of the sale of approximately 37 acres of land to an affiliate of Swervo Development for approximately $8,800,000 in total consideration.

The Company recorded a provision for income taxes of $533,000 and $1,210,000 for the three months ended September 30, 2023 and 2022, respectively. The Company recorded a provision for income taxes of $3,709,000 and $2,434,000 for the nine months ended September 30, 2023 and 2022, respectively. We record our quarterly provision for income taxes based on our estimated annual effective tax rate for the year. The decrease in our tax expense for the three months ended September 30, 2023 is primarily due to a decrease in income before taxes. Our effective tax rate was 31.9% and 28.7% for the three and nine months ended September 30, 2023, respectively. Our effective tax rate was 29.3% and 27.4% for the three and nine months ended September 30, 2022, respectively. The small fluctuations in the effective tax rates are primarily the result of discrete items that occurred during the three and nine months ended September 30, 2023.

The Company recorded net income of $1,136,000 and $9,199,000 for the three and nine months ended September 30, 2023, respectively. The Company recorded net income of $2,921,000 and $6,450,000 for the three and nine months ended September 30, 2022, respectively.

EBITDA

To supplement our financial statements, we also provide investors with information about our EBITDA and Adjusted EBITDA, each of which is a non-GAAP measure, which excludes certain items from net income, a GAAP measure. See the table below, which presents reconciliations of these measures to the GAAP equivalent financial measures. We define EBITDA as earnings before interest, income tax expense, and depreciation and amortization. We also compute Adjusted EBITDA, which reflects additional adjustments to Net Income to eliminate unusual or non-recurring items, as well as items relating to our real estate development operations and we believe the exclusion of these items allows for better comparability of our performance between periods and is useful in allowing greater transparency related to a significant measure used by management in its financial and operational decision-making. Adjusted EBITDA has economic substance because it is used by management as a performance measure to analyze the performance of our business, excluding the impact of our real estate segment, and provides a perspective on the current effects of operating decisions relating to our core, non-real estate business. For the three and nine months ended September 30, 2023, Adjusted EBITDA excluded depreciation relating to equity investments, gain on sale of land and disposal of assets, a gain on insurance proceeds related to the equity investment in Doran Canterbury I, as well as depreciation and amortization relating to equity investments, and interest expense related to equity investments. Neither EBITDA nor adjusted EBITDA is a measure of performance calculated in accordance with GAAP and should not be considered an alternative to, or more meaningful than, net income as an indicator of our operating performance. EBITDA is presented as a supplemental disclosure because we believe that, when considered with measures calculated in accordance with GAAP, EBITDA and Adjusted EBITDA provide a more complete understanding of our operating results before the impact of investing and financing transactions and income taxes, and it is a widely used measure of performance and a basis for valuation of companies in our industry. Moreover, other companies that provide EBITDA or Adjusted EBITDA information may calculate EBITDA or Adjusted EBITDA differently than we do.

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 and nine months ended September 30, 2023 and 2022:

Summary of EBITDA Data

Adjusted EBITDA decreased $2,491,000, or 46.6%, and $5,101,000, or 41.0%, for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decrease in Adjusted EBITDA is primarily due to decreased Pari-mutuel and Casino revenues noted above. Furthermore, for the nine months ended September 30, 2023, Adjusted EBITDA was reduced by insurance proceeds received by the Company's equity investment related to an insurance claim by the Doran Canterbury I, LLC joint venture as well as the gain on sale of land to Swervo Development, which were not present in other periods. For the three and nine months ended September 30, 2023, Adjusted EBITDA as a percentage of net revenue was 14.8% and 15.0%, respectively. For the three and nine months ended September 30, 2022, Adjusted EBITDA as a percentage of net revenue was 24.0% and 23.2%, respectively.

Contingencies:

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:

The Company's primary source of liquidity and capital resources have been and are expected to be cash flow from operations and cash available under our revolving line of credit. The Company has a general credit and security agreement with a financial institution, which provides a revolving credit line up to $10,000,000 and allows for letters of credit in the aggregate amount of up to $2,000,000 to be issued under the credit agreement which matures January 31, 2024. The line of credit is collateralized by all receivables, inventory, equipment, and general intangibles of the Company. The line of credit also includes collateral in the form of a Mortgage, Security Agreement, Fixture Financing Statement and Assignment of Leases and Rents. As of September 30, 2023, the outstanding balance on the line of credit was $0. The Company did not borrow on the revolving line of credit during the quarter ended September 30, 2023. As of September 30, 2023, the Company was in compliance with the financial covenants of the general credit and security agreement.

The Company’s cash, cash equivalents, and restricted cash balance at September 30, 2023 was $28,076,000 compared to $16,106,000 as of December 31, 2022. 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 and future land sales, will be sufficient to satisfy its ongoing liquidity and capital resource requirements for regular operations, as well as its planned development expenses for at least the next twelve months. The Company intends to allocate substantially all of the net proceeds from the sale of the 37 acres of land to Bloomington Investments, LLC, an entity related to Swervo Development ("Swervo"), for total consideration of $8,800,000, to the redevelopment of the horse stabling area, which serves its racing business, with new barns and a new dormitory complex. The Company may seek additional financing to complete the redevelopment of the horse stabling area. In August 2023, the Company received approval for the first phase of the barn relocation and redevelopment plan, which is expected to take approximately one year to complete. Furthermore, if the Company engages in additional significant real estate development, significant improvements to its facilities, the Racetrack or surrounding grounds, or strategic growth or diversification transactions, additional financing would more than likely be required and the Company may seek this additional financing through joint venture arrangements, through incurring debt, or through an equity financing, or a combination of any of these.

Operating Activities

Trends in our operating cash flows tend to follow trends in operating income but can be affected by changes in working capital, the timing of significant interest payments, and tax payments or refunds. Net cash provided by operating activities for the nine months ended September 30, 2023 was $10,201,000, primarily as a result of the following: the Company reported net income of $9,199,000, depreciation of $2,308,000, deferred income taxes of $776,000, and stock-based compensation and 401(k) match totaling $1,043,000, offset by a gain from equity investment of $562,000 and a gain on land sale of $6,490,000. The Company experienced an increase in cash related to an employee retention credit receivable of $6,103,000, offset by a decrease in amounts payable to horsepersons of $768,000 and an increase in accounts receivable of $1,002,000 for the nine months ended September 30, 2023.

Net cash provided by operating activities for the nine months ended September 30, 2022 was $9,869,000, primarily as a result of the following: the Company reported net income of $6,450,000, depreciation of $2,235,000, a loss from equity investment of $1,274,000, and stock-based compensation and 401(k) match totaling $795,000. Primarily due to timing of our live racing season, the Company also experienced an increase in accounts payable of $1,595,000 and an increase to payable to horsepersons of $558,000, offset by a decrease in accounts receivable of $1,499,000 and income taxes receivable and prepaid income taxes of $1,287,000 for the nine months ended September 30, 2022.

Investing Activities

Net cash provided by investing activities for the nine months ended September 30, 2023 was $2,895,000, primarily due to net proceeds received from the sale of land of $8,337,000, offset by $5,577,000 in additions to land, buildings, and equipment.

Net cash used in investing activities for the first nine months of 2022 was $2,078,000, primarily due to $2,663,000 in additions to land, buildings, equipment, and $398,000 in equity investment contributions, which was somewhat offset by $1,160,000 in net proceeds received from the sale of land .

Financing Activities

Net cash used in financing activities for the nine months ended September 30, 2023 was $1,126,000, primarily due to cash dividends paid to shareholders and payments for taxes of equity awards. The Company declared a cash dividend of $0.07 per share payable each quarter during the nine months ended September 30, 2023.

Net cash used in financing activities during the first nine months of 2022 was $1,180,000, primarily due to cash dividends paid to shareholders and payments for taxes of equity awards. The Company declared a cash dividend of $0.14 per share payable during the first quarter followed by a $0.07 per share payable for the second and third quarters during the nine months ended September 30, 2022.

Critical Accounting Estimates:

The preparation of the Condensed Consolidated Financial Statements in accordance with GAAP requires us to make estimates and judgments that are subject to an inherent degree of uncertainty. The nature of the estimates and assumptions are material due to the levels of subjectivity and judgment necessary to account for highly uncertain factors or the susceptibility of such factors to change.

These accounting estimates are described in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. Management made no changes to the Company’s critical accounting estimates during the quarter ended September 30, 2023. In applying its critical accounting estimates, management reassesses its estimates each reporting period based on available information. Changes in these estimates did not have a significant impact on earnings for the quarter ended September 30, 2023.

The development and selection of critical accounting estimates, and the related disclosures, have been reviewed with the Audit Committee of our Board of Directors. We believe the current assumptions and other considerations used to estimate amounts reflected in our Condensed Consolidated Financial Statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in our Condensed Consolidated Financial Statements, the resulting changes could have a material adverse effect on our financial condition, results of operations and cash flows.

Estimate of the allowance for doubtful accounts - Property Tax Increment Financing "TIF" Receivable

As of September 30, 2023, the Company recorded a TIF receivable on its Consolidated Balance Sheet of approximately $13,801,000, which represents $11,305,000 of principal and $2,496,000 of interest. The TIF receivable requires significant management estimates and judgement pertaining to whether an allowance for doubtful accounts is necessary. The TIF receivable was generated in connection with the Contract for Private Redevelopment, in which the City of Shakopee has agreed that a portion of the future tax increment revenue generated from the developed property around the Racetrack will be paid to the Company to reimburse it for expenses in constructing public infrastructure improvements.

The Company typically performs an annual collectability analysis of the TIF receivable in the fourth quarter of each year, or more frequently if indicators of potential uncollectability exist. The Company utilizes the assistance of a third party to assist with the projected tax increments. The quantitative analysis includes assumptions based on the market values of the completed development projects within Canterbury Commons, which derives the future projected tax increment revenue. The Company uses the analysis to determine if the future tax increment revenue will exceed the Company's development costs on infrastructure improvements. As a result of our analysis for the year ended December 31, 2022, management believes the TIF receivable will be fully collectible and no allowance related to this receivable is necessary. There were no indicators of potential uncollectability for the three and nine months ended September 30, 2023.

Cooperative Marketing Agreement:

On June 4, 2012, the Company entered into a Cooperative Marketing Agreement (the "CMA") with the SMSC. The primary purpose of the CMA was 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 was achieved through “Purse Enhancement Payments to Horsemen” paid directly to the MHBPA. These payments had no direct impact on the Company’s consolidated financial statements or operations.

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.

As noted above and affirmed in the Fifth Amendment, SMSC paid the required annual purse enhancement of $7,380,000 and annual marketing payment of $1,620,000 for 2022.

The amounts earned from the marketing payments were recorded as a component of other revenue and the related expenses were recorded as a component of advertising and marketing expense and depreciation in the Company’s condensed consolidated statements of operations. For the three and nine months ended September 30, 2022, the Company recorded $977,000 and $1,764,000 in other revenue, incurred $916,000 and $1,603,000 in advertising and marketing expense, and incurred $61,000 and $161,000 in depreciation related to the SMSC marketing funds. The excess of amounts received over revenue is reflected as deferred revenue on the Company’s consolidated balance sheets.

Under the CMA, the Company agreed for the term of the CMA 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.

The CMA expired by its terms on December 31, 2022. Accordingly, for the three and nine months ended September 30, 2023, there were no purse enhancement payments or marketing payments under the CMA.

Redevelopment Agreement:

As mentioned above in Note 8 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.

On January 25, 2022, the Company received the fully executed First Amendment to the Contract for Private Redevelopment among the Company, the City of Shakopee, and the Shakopee EDA, which is effective as of September 7, 2021. Under the First Amendment and as part of the authorized changes regarding the responsibilities of the Company and the City, improvements on Unbridled Avenue will be primarily constructed by the City of Shakopee. As a result, the total estimated cost of TIF eligible improvements to be borne by the Company was reduced by $5,744,000 to an amount not to exceed $17,592,881.

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:

• Our business is sensitive to reductions in discretionary consumer spending as a result of downturns in the economy and other factors outside of our control.
• Because purse enhancement payments and marketing payments under our CMA with SMSC did not continue after December 31, 2022, we have experienced decreased revenue and profitability from live racing.
• We may not be able to attract a sufficient number of horses and trainers to achieve above average field sizes.
• We face significant competition, both directly from other racing and gaming operations and indirectly from other forms of entertainment and leisure time activities, which could have a material adverse effect on our operations.
• Nationally, the popularity of horse racing has declined
• A lack of confidence in the integrity of our core businesses could affect our ability to retain our customers and engage with new customers.
• Horse racing is an inherently dangerous sport and our racetrack is subject to personal injury litigation.
• Our business depends on using totalizator services.
• Inclement weather and other conditions may affect our ability to conduct live racing.
• Our business and operations have been, and may in the future, be adversely affected by epidemics, pandemics, outbreaks of disease, and other adverse public health developments, including COVID-19.
• We are subject to changes in the laws that govern our business, including the possibility of an increase in gaming taxes, which would increase our costs, and changes in other laws may adversely affect our ability to compete.
• We are subject to extensive regulation from gaming authorities that could adversely affect us.
• We rely on the efforts of our partner Doran for the development and profitable operation of our Triple Crown Residences at Canterbury Park joint venture.
• We rely on the efforts of our partner Greystone Construction for a new development project.
• We may not be successful in executing our real estate development strategy.
• We are obligated to make improvements in the TIF district and will be reimbursed only to the extent of future tax revenue.
• An increase in the minimum wage mandated under Federal or Minnesota law could have a material adverse effect on our operations and financial results.
• We may be adversely affected by the effects of inflation
• The payment and amount of future dividends is subject to Board of Director discretion and to various risks and uncertainties.
• Our information technology and other systems are subject to cyber security risk including misappropriation of customer information or other breaches of information security.
• We process, store, and use personal information and other data, which subjects us to governmental regulation and other legal obligations related to privacy, and our actual or perceived failure to comply with such obligations could harm our business.
• Other factors that are beyond our ability to control or predict.

(a) Evaluation of Disclosure Controls and Procedures:

The Company’s President and Chief Executive Officer, Randall D. Sampson and Chief Financial Officer, Randy J. Dehmer, have reviewed the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based upon this review, these officers have concluded that the Company’s disclosure controls and procedures are effective.

(b) Changes in Internal Control over Financial Reporting:

There have been no significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) that occurred during our fiscal quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

OTHER INFORMATION

The most significant risk factors applicable to the Company are described in Part I, Item 1A "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no material changes from the risk factors previously disclosed.