CANTERBURY PARK HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED JUNE 30, 2007 AND 2006
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of significant accounting policies is included in the notes to consolidated financial statements in the 2006 Annual Report on form 10-K.
Unaudited Financial Statements - The consolidated balance sheet as of June 30, 2007 the consolidated statements of operations for the three and six months ended June 30, 2007 and 2006, the consolidated statements of cash flows for the six months ended June 30, 2007 and 2006, and the related information contained in these notes have been prepared by management without audit. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) which are necessary for a fair presentation of financial position and results of operations for such periods have been made. Results for an interim period should not be considered as indicative of results for a full year.
Revenue Recognition - Our revenues are derived primarily from the operations of a Card Club, pari-mutuel wagering on simulcast and live horse races, concession sales and related activities. Collection revenue from Card Club operations and pari-mutuel commission and fee revenues are recognized at the time that the wagering process is complete. Revenues related to concession and publication sales, and parking and admission fees are recognized as revenue when the service has been performed or the product has been delivered.
Estimates - The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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. Actual results could differ from these estimates.
Reclassifications — Certain prior year numbers have been reclassified to be consistent with current period presentation. These reclassifications had no effect on net earnings or stockholders’ equity.
The Company has reclassified promotional allowances from advertising and marketing expense to net revenues as of December 31, 2006. Prior periods were reclassified to be consistent with current period presentation.
The Company has changed its accounting treatment for presentation of cash flows related to restricted cash. The Company is now presenting all cash flows related to restricted cash within the operating activities section of the Statements of Cash Flows rather than the investing activities section. The Company believes this is a more proper presentation as it more appropriately reflects the nature of the restricted cash activities. The Company after considering the nature of this change in classification and having given appropriate weight to the guidance provided by Staff Accounting Bulletin No. 99, believes it is sufficient to incorporate this change in this current and future filings, at which time we will reclassify prior periods presented, and not treat this change in classification as an error requiring restatement.
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The following table presents the affect of the change in accounting treatment for all interim periods presented where the cash flows from restricted cash were previously presented within the investing activities section of the Statements of Cash Flows:
| | | | As Revised | | Previously Reported | |
| | | | | | Net Cash | | | | Net Cash | |
| | Increase in | | Net Cash | | Used in | | Net Cash | | Used in | |
| | Restricted | | Provided by | | Investing | | Provided by | | Investing | |
| | Cash | | Operations | | Activities | | Operations | | Activities | |
| | | | | | | | | | | |
Period Ended 6/30/2006 | | $ | (2,813,396 | ) | $ | 3,766,778 | | $ | (2,313,987 | ) | $ | 6,580,174 | | $ | (5,127,383 | ) |
| | | | | | | | | | | | | | | | |
Restricted Cash — Restricted cash represents refundable deposits and amounts due to horsemen for purses, stakes and awards, and amounts accumulated in the Player Pool and jackpot pools to be used to repay card club players in the form of promotions, giveaways, prizes, or by other means.
Income Taxes - Income tax expense is computed by applying the estimated annual effective tax rate to the year-to-date income. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to reverse.
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB No. 109, (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Based on our evaluation, we have concluded that there are no significant unrecognized tax benefits.
The Company and its consolidated subsidiaries file income tax returns in the United States (“U.S.”) federal jurisdiction. The Company is no longer subject to U.S. federal examinations by tax authorities for years prior to 2004. The Internal Revenue Service (IRS) has audited us through 2003. The Company is no longer subject to examinations by State of Minnesota tax authorities for years prior to 2003. The Minnesota Department of Revenue has audited the Company through 2002. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.
Net Income Per Share - Basic net income per common share is based on the weighted average number of common shares outstanding during each period. The weighted average number of common shares outstanding for the three and six-month periods ended June 30, 2007 were 4,069,104 and 4,060,809, respectively. The weighted average number of common shares outstanding for the three and six-month periods ended June 30, 2006 were 3,899,125 and 3,979,460, respectively. Diluted net income per common share takes into effect the dilutive effect of potential common shares outstanding. The Company’s potential common shares outstanding are stock options and shares of unvested (“restricted”) stock. After considering the dilutive effect of stock options outstanding, the weighted average shares used to calculate diluted earnings per share for the three and six-month periods ended June 30, 2007 were 4,215,833 and 4,228,088, respectively. The weighted average shares used to calculate diluted earnings per share for the three and six-month periods ended June 30, 2006 were 4,372,859 and 4,515,220, respectively.
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Fair values of Financial Instruments — Due to the current classification of all financial instruments of the Company, given the short-term nature of the related account balances, carrying amounts reported in the consolidated balance sheets approximates fair value.
Employee Termination Benefits — Management of the Company is continually re-evaluating the Company’s operating costs against its long-term strategic goals.
During the first quarter of 2007, the Company created a voluntary retirement incentive program, which provided eligible employees the opportunity to voluntarily resign their employment in exchange for severance pay and other specified benefits. Eligible employees could elect to participate in this voluntary program during the period from January 11, 2007 through February 25, 2007. In accordance with SFAS 88, Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, the Company has recognized a liability and a charge to income of approximately $182,000 associated with this special termination benefit. In addition, the Company incurred $64,000 in severance costs related to the involuntary termination of salaried and hourly personnel during the first quarter of 2007. No changes to the liability and no additional expense was incurred during the second quarter of 2007.
New Accounting Pronouncements - In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007. The Company is evaluating the impact the adoption of SFAS No. 157 will have on its consolidated results of operations and financial condition.
In March 2007, the FASB ratified the Emerging Issues Task Force (“EITF”) Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share Based Payment Awards (“EITF 06-11”). EITF 06-11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for nonvested equity-classified employee share-based awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007. The Company is evaluating the impact the adoption of EITF 06-11 will have on its consolidated results of operations and financial condition.
2. STOCK BASED COMPENSATION
Effective January 1, 2006, we adopted FASB Statement No.123(R), Share Based Payment (“SFAS 123R”), applying the modified prospective transition method. Prior to adopting SFAS 123R, we accounted for stock-based compensation in accordance with Accounting Principles Board Opinion No.25, Accounting for Stock Issued to Employees. We recognized $133,863 and $136,271 in stock-based compensation expense in salaries and benefits expense line item on the consolidated statements of operations during the six-months ended June 30, 2007 and 2006, respectively.
Our annual grant of stock-based compensation generally takes place during the first quarter of each fiscal year. Each non-employee member of the Board of Directors receives an annual recurring grant of 3,000 non-qualified stock options on the first business day in February. On February 1, 2007 15,000 options were granted to the five non-employee board members with an exercise price equal to the market price on the date of grant of $13.76. The stock options vest over a six-month period and expire in ten years. The compensation cost associated with this grant of Board of Director options is $58,400 to be recognized as expense over the six-month vesting period. On February 1, 2006, 15,000 options were granted to the five non-employee board members with an exercise price equal to the market price on the date of grant of $14.30. In addition, on February 9, 2006 we granted 15,000 incentive stock options to two executive officers of the Company and 41,000 shares of restricted stock to key management-level employees. The exercise price of these incentive stock options and the value of the restricted shares was the market value on the date of grant of $14.55. Grants of stock options and restricted stock to employees did not occur in 2007.
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The number of shares granted and the weighted average fair value per share during the periods presented were:
| | Six Months Ended | |
| | June 30, 2007 | | June 30, 2006 | |
| | | | Weighted | | | | Weighted | |
| | | | Average | | | | Average | |
| | | | Fair Value | | | | Fair Value | |
| | Grant | | Per Share | | Grant | | Per Share | |
| | | | | | | | | |
Stock options | | 15,000 | | $ | 3.89 | | 30,000 | | $ | 4.51 | |
Restricted stock | | — | | | | 41,000 | | $ | 14.55 | |
| | | | | | | | | |
Total shares | | 15,000 | | | | 71,000 | | | |
| | | | | | | | | | | |
The fair value of stock options granted under the Plan during first six months of 2007 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions and results:
| | 2007 | | 2006 | |
Dividend yield | | 1.82 | % | 1.74 | % |
Weighted-average volatility | | 22 | % | 25 | % |
Risk-free interest rate | | 4.86 | % | 4.50 | % |
Expected term of stock options in years | | 7.2 | | 8.6 | |
Fair value of stock options on grant date | | $ | 58,400 | | $ | 135,300 | |
| | | | | | | |
A summary of stock option activity as of June 30, 2007 and changes during the six months then ended is presented below:
| | | | | | Weighted | | | |
| | | | Weighted | | Average | | | |
| | | | Average | | Remaining | | Aggregate | |
| | Number of | | Exercise | | Contractual | | Grant Date | |
Stock Options | | Shares | | Price | | Term | | Fair Value | |
| | | | | | | | | |
Outstanding at January 1, 2007 | | 666,550 | | $ | 10.12 | | | | | |
| | | | | | | | | |
Granted | | 15,000 | | $ | 13.67 | | | | | |
Exercised | | (60,650 | ) | $ | 3.43 | | | | | |
| | | | | | | | | |
Outstanding at June 30, 2007 | | 620,900 | | $ | 10.85 | | 2.7 Years | | $ | 3,243,000 | |
| | | | | | | | | |
Exercisable at June 30, 2007 | | 594,550 | | $ | 10.71 | | 2.7 Years | | $ | 3,127,000 | |
3. BORROWINGS UNDER CREDIT AGREEMENT
Borrowings under the Company’s credit agreement with Bremer Bank include a commercial revolving credit line, which provides for maximum advances of $2,250,000 with interest at the prime rate. The Company had no borrowings under this credit line at June 30, 2007. The credit agreement contains certain covenants requiring the Company to maintain certain financial ratios. The Company was in compliance with these requirements as of June 30, 2007. Management believes that funds available under this line of
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credit, along with funds generated from card club and simulcast operations, will be sufficient to satisfy its liquidity and capital resource requirements during 2007.
4. OPERATING SEGMENTS
During the first six months of 2007 and 2006, the Company had three reportable operating segments: horse racing, card club and concessions. The horseracing segment primarily represents simulcast and live horse racing operations, the card club segment primarily represents operations of the Card Club and the concessions segment primarily represents concessions provided during simulcast and live racing, in the Card Club, and during special events. The Company’s reportable operating segments are strategic business units that offer different products and services. They are managed separately because the segments differ in the nature of the products and services provided as well as processes to produce those products and services. The horse racing and card club segments are regulated by the State of Minnesota Racing Commission.
The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in the 2006 Annual Report on Form 10-K.
Depreciation, interest expense and income taxes are allocated to the segments but no allocation is made to concessions for shared facilities. However, the concessions segment pays approximately 25% of gross revenues earned on live racing and special event days to the horse racing segment for use of the facilities.
The following tables provide information about the Company’s operating segments (in 000’s):
| | Six Months Ended June 30, 2007 | |
| | Horse Racing | | Card Club | | Concessions | | Total | |
| | | | | | | | | |
Net revenues from external customers | | $ | 8,673 | | $ | 14,572 | | $ | 2,850 | | $ | 26,095 | |
| | | | | | | | | |
Intersegment revenues | | 355 | | | | 973 | | 1,328 | |
| | | | | | | | | |
Net interest income | | 154 | | | | | | 154 | |
| | | | | | | | | |
Depreciation | | 593 | | 308 | | 61 | | 962 | |
| | | | | | | | | |
Segment income before income taxes | | (69 | ) | 2,437 | | 626 | | 2,994 | |
| | | | | | | | | |
Segment Assets | | $ | 33,284 | | $ | 3,795 | | $ | 5,486 | | $ | 42,565 | |
| | Six Months Ended June 30, 2006 | |
| | Horse Racing | | Card Club | | Concessions | | Total | |
| | | | | | | | | |
Net revenues from external customers | | $ | 9,205 | | $ | 14,975 | | $ | 2,762 | | $ | 26,942 | |
| | | | | | | | | |
Intersegment revenues | | 262 | | | | 1,036 | | 1,298 | |
| | | | | | | | | |
Net interest income | | 119 | | | | | | 119 | |
| | | | | | | | | |
Depreciation | | 670 | | 141 | | 58 | | 869 | |
| | | | | | | | | |
Segment income before income taxes | | (45 | ) | 2,634 | | 531 | | 3,120 | |
| | | | | | | | | | | | | |
| | At December 31, 2006 | |
| | | | | | | | | |
Segment Assets | | $ | 29,867 | | $ | 3,676 | | $ | 6,258 | | $ | 39,801 | |
| | | | | | | | | | | | | |
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The following are reconciliations of reportable segment revenue, income before income taxes, and assets, to the Company’s consolidated totals (in 000’s):
| | Six Months Ended June 30, | |
| | 2007 | | 2006 | |
Revenues | | | | | |
Total revenue for reportable segments | | $ | 27,423 | | $ | 28,240 | |
Elimination of intersegment revenues | | (1,328 | ) | (1,298 | ) |
Total consolidated net revenues | | $ | 26,095 | | $ | 26,942 | |
| | | | | |
Income before income taxes | | | | | |
Total segment income before income taxes | | $ | 2,994 | | $ | 3,120 | |
Elimination of intersegment income before income taxes | | (587 | ) | (477 | ) |
Total consolidated income before income taxes | | $ | 2,407 | | $ | 2,643 | |
| | June 30, | | December 31, | |
| | 2007 | | 2006 | |
Assets | | | | | |
Total assets for reportable segments | | $ | 45,607 | | $ | 39,801 | |
Elimination of intercompany receivables | | (5,970 | ) | (5,450 | ) |
Total consolidated assets | | $ | 39,637 | | $ | 34,351 | |
5. CONTINGENCIES
In accordance with an Earn Out 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 $700,000 per operating year, as defined, or 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 will be required to pay these amounts is remote. At the date (if any) that these two conditions are met, the five minimum payments will be discounted back to their present value and the sum of those discounted payments will be capitalized as part of the purchase price in accordance with generally accepted accounting principles. The purchase price will be further increased if payments become due under the “20% of Net Pretax Profit” calculation. The first payment is to be made 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 is periodically involved in various legal actions arising in the normal course of business. At June 30, 2007, management believes that the resolution of any legal actions outstanding will not have a material impact on the consolidated financial statements.
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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 and our present business environment. This MD&A is provided as a supplement to — and should be read in conjunction with — our consolidated financial statements and the accompanying notes to the financial statements (the “Notes”). This MD&A is divided into the following sections:
· Overview
· Operations Review
· Contingencies
· Liquidity and Capital Resources
· Critical Accounting Policies and Estimates
· Commitments and Contractual Obligations
· Legislation
· Forward-Looking Statements
Overview:
Canterbury Park Holding Corporation (the “Company”) owns and operates the Canterbury Park Racetrack and Card Club in Shakopee, Minnesota. The primary businesses of the Company are simulcast and live pari-mutuel horse racing, hosting unbanked card games, and food and beverage operations.
The Racetrack is the only pari-mutuel horse racing facility in the State of Minnesota. The Racetrack earns revenues from pari-mutuel take-out on races simulcast year-round to Canterbury Park from racetracks throughout the country and from live race meets featuring thoroughbred and quarter horse racing. Live race meets commence in the month of May and conclude in September. During live race meets, the Company televises its races to out-of-state racetracks around the country, and earns additional pari-mutuel revenue on wagers placed at the out-of-state racetracks.
Canterbury Park’s Card Club (the “Card Club”) hosts “unbanked” card games in which players compete against each other and not against the house. The Card Club is open twenty-four hours a day, seven days a week. Under Minnesota law, the Company is required to pay up to 14% of the gross Card Club revenues to the Racetrack’s purse fund and the State of Minnesota Breeders’ Fund. However, the Company has agreed with the Minnesota Horsemen’s Benevolent and Protective Association (“MHBPA”) to pay 15% of Card Club revenues into the purse fund for 2007 and 2006.
The Company also generates revenues from other activities such as admission and parking fees and from the sale of food and beverage, programs and other racing publications, and corporate sponsorships. Additional revenues are derived from an RV park and the use of the Racetrack facilities for special events such as craft shows and snowmobile racing.
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Operations Review for the Three and Six Months Ended June 30, 2007 and June 30, 2006:
Total net revenues decreased approximately $848,000, or 3.2%, during the six months ended June 30, 2007 compared to the six months ended June 30, 2006, and decreased approximately $220,000, or 1.5%, for the three months ended June 30, 2007 compared to the three months ended June 30, 2006. The decrease is due primarily to reductions of 5.3% and 2.7% in pari-mutuel and Card Club revenues, respectively, along with a decrease of 15.7% in other revenues. These decreases are partially offset by an increase of 3.8% in concession revenues and a 9.8% increase in admission revenues.
Pari-mutuel revenues were $419,000 lower in the six-month period ended June 30, 2007 compared to the same period in 2006, and decreased approximately $120,000, or 2.5%, for the three-month period ended June 30, 2007 compared to the same period in 2006. Total on-track handle for the six months and three months ended June 30, 2007 was down $2.4 million and $831,000, respectively, compared to the same six-month and three-month periods in 2006, primarily due to lower wagering on simulcast races, but also due to slightly lower on-track live racing handle.
Total handle wagered on simulcast races for the first half of 2007 is down $2.3 million, or 7.6%, compared to the same period last year, Inclement weather at East Coast tracks during the first quarter of 2007 resulted in the cancellation of a significant number of simulcast races during that period. Simulcast handle was down $831,000, or 5.1%, in the second quarter of 2007 compared to the second quarter of 2006. The Company believes this decline represents growing competition from internet wagering on simulcast races and is continuously looking for ways to make Canterbury Park the most attractive alternative when our customers want to wager on horseracing.
On-track live handle decreased by $104,000 or 1.6% compared to the same period in 2006 despite the same number of live race days. In 2007 the Company pushed back the start time of live racing on Saturdays which has resulted in slightly lower average daily handle on Saturdays but increased out-of-state live handle by over $1.1 million, or 18.5%, compared to the same period last year. For further information, see “Summary of Pari-mutuel Data” below.
| | Six Months Ended June 30, | |
Summary of Pari-mutuel Data: | | 2007 | | 2006 | |
| | | | | |
Racing Days | | | | | |
Simulcast only | | 152 | | 152 | |
Live and Simulcast | | 29 | | 29 | |
Total Number of Racing Days | | 181 | | 181 | |
| | | | | |
On-Track Handle | | | | | |
Simulcast racing handle on simulcast only days | | $ | 20,444,000 | | $ | 22,178,000 | |
Live and Simulcast days: | | | | | |
Live racing handle | | 6,490,000 | | 6,594,000 | |
Simulcast racing handle | | 7,597,000 | | 8,172,000 | |
Total On-Track Handle | | 34,531,000 | | 36,944,000 | |
| | | | | |
Out-of-State Live Handle | | 7,134,000 | | 6,022,000 | |
| | | | | |
Total Handle | | $ | 41,665,000 | | $ | 42,966,000 | |
| | | | | |
On-Track Average Daily Handle | | | | | |
Simulcast only racing days | | $ | 134,500 | | $ | 145,908 | |
Live and simulcast racing days | | $ | 485,759 | | $ | 509,172 | |
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Total Card Club revenue decreased $402,000 for the first six months of 2007 and $126,000 for the second quarter of 2007compared to the same periods in 2006. The primary source of Card Club revenue is a percentage of the wagers received from the players as compensation for providing the Card Club facility and services, referred to as “collection revenue”. The Company also receives a specified percentage of the jackpot funds collection as reimbursement for administrative costs of maintaining the jackpot funds, and collects fees for administering tournaments, which represents “other revenue”. The decrease in revenue is due primarily to lower patronage in the poker room, but the Company also experienced a reduction in Casino Games revenue during the six-month period ended June 30, 2007 compared to the same period last year. The Card Club is experiencing growing competition from online poker websites and Native American owned casinos, which have expanded their gaming options to include many of the same unbanked card games as those offered at the Card Club. Card Club revenues represented 55.8% and 48.4% of net revenues for the six-month and three-month periods ended June 30, 2007, respectively. The three-month percentage is usually lower in the second quarter of any calendar year due to increased revenue from live racing. For further information, see the “Summary of Card Club Data” below.
| | Six Months Ended June 30, | |
Summary of Card Club Data: | | 2007 | | 2006 | |
| | | | | |
Poker Games | | $ | 8,840,000 | | $ | 9,250,000 | |
Casino Games | | 5,213,000 | | 5,390,000 | |
Total Collection Revenue | | 14,053,000 | | 14,640,000 | |
| | | | | |
Other Revenue | | 519,000 | | 335,000 | |
Total Card Club Revenue | | $ | 14,572,000 | | $ | 14,975,000 | |
| | | | | |
Number of Days Offered | | 181 | | 181 | |
Average Revenue per Day | | $ | 80,508 | | $ | 82,735 | |
Concessions revenues increased $104,000, or 3.8%, and $96,000, or 5.2%, for the six-month and three-month periods ended June 30, 2007, respectively, compared to the prior year. The increase is primarily attributable to higher concession sales on Thursday and Friday evenings of live racing and larger group sales during the second quarter of 2007 compared to the same period in 2006.
Daily admission revenues increased $30,000, or 11.7%, during the second quarter of 2007 compared to 2006. This is due partly to higher attendance for live racing during the second quarter of 2007 compared to 2006 and to a reduction in free admission offers in 2007.
Total operating expenses decreased approximately $577,000, or 2.4%, during the six-month period ended June 30, 2007 compared to the six-month period ended June 30, 2006, and $485,000, or 3.4%, during the three months ended June 30, 2007 compared to the three-month period ended June 30, 2006.
Total purse expense increased slightly to $3,912,000 for the six months ended June 30, 2007 compared to the same period in the prior year. An increase in simulcast purse expense of $59,000, or 4.7%, during the six month period of 2007 compared to the 2006 period was partially offset by a $54,000 reduction in Card Club purse expense due to lower Card Club revenues in 2007 as illustrated in the table below. This increase in simulcast purse expense results from the phase in of a renegotiation of the purse expense rate for out-of-season simulcast racing. Total purse expense was down $14,000, or .6%, for the second quarter of 2007 compared to the second quarter of 2006. This decrease was due entirely to lower purse expense for the Card Club resulting from lower revenues in the first half of 2007 period compared to the same period in 2006. Pari-mutuel purse expense was unchanged in the second quarter of 2007compared to 2006, despite lower handle, due to the renegotiated increase in the purse rate. Minnesota Breeders Fund expense decreased $30,000 in the six months ended June 30, 2007 compared to 2006 due to lower revenues in the Card Club and lower wagering on pari-mutuel racing in 2007. Fluctuations in the related revenue categories are discussed above.
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| | | | Minnesota | |
| | Purse Expense | | Breeders’ Fund Expense | |
| | Six Months Ended June 30, | | Six Months Ended June 30, | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
| | | | | | | | | |
Card Club | | $ | 1,967,000 | | $ | 2,021,000 | | $ | 219,000 | | $ | 224,000 | |
| | | | | | | | | |
Simulcast Horse Racing | | 1,322,000 | | 1,263,000 | | 313,000 | | 337,000 | |
| | | | | | | | | |
Live Horse Racing | | 623,000 | | 620,000 | | 65,000 | | 66,000 | |
| | | | | | | | | |
| | $ | 3,912,000 | | $ | 3,904,000 | | $ | 597,000 | | $ | 627,000 | |
Salaries and benefits decreased approximately $140,000, or 1.3%, in the 2007 six-month period and approximately $155,000, or 2.6%, in the three-month period ended June 30, 2007 compared to the same periods last year. The decreases are due primarily to the Company’s proactive efforts to reduce labor costs including involuntary terminations and voluntary retirements occurring in the first quarter of 2007. The decrease is also attributable to reductions of direct labor costs in the pari-mutuel and Card Club operations because of lower patronage in 2007 compared to 2006.
Depreciation expense increased $93,000, or 10.7%, during the first half of 2007 compared to 2006, and $16,000, or 3.6%, for the second quarter compared to the second quarter last year due to continued investments in the stable area and grandstand during 2006 and into 2007. The increase for the second quarter is relatively lower compared to the increase year to date as assets put into service seven years ago upon opening of the Card Club became fully depreciated in April 2007. Utilities expense increased $68,000, or 10.7%, and $44,000, or 13.5%, for the six-month and three-month periods ended June 30, 2007, respectively, due to continuous increases in energy costs for electricity and natural gas in 2007 compared to the same period in 2006. Repairs, maintenance and supplies expense decreased $181,000, or 24.7%, and $140,000, or 28.7%, in the six-month and three-month periods ended June 30, 2007 compared to the same periods in 2006. These reductions are the result of proactive efforts to minimize spending as opportunities arise. Advertising and marketing expenses have decreased by $253,000 during the first six months of 2007 compared to 2006 and $192,000, or 25.6%, for the three months ended June 30, 2007 compared to the same period in 2006 due primarily to the benefits achieved by maximizing utilization of in-house production capabilities in 2007. Other operating expenses declined $95,000, or 4.8%, and $22,000, or 1.8%, in the six-month and three-month periods ended June 30 2007 and 2006, respectively, primarily due to reduced use of professional services in 2007 for lobbying efforts.
Total operating expenses as a percentage of total net revenues increased to 91.4% for the six-month period ended June 30, 2007 compared to 90.6% for 2006, as the 3.1% decrease in net revenues outpaced the 2.4% reduction in fixed and variable expenses.
Income before income taxes was $2,407,170 for the six months ended June 30, 2007 compared to $2,643,014 for the six months ended June 30, 2006. After income tax expense of $1,011,800 for the six months ended June 30, 2007, net income was $1,395,370 in 2007 compared to $1,508,005 in 2006, a decrease of $112,635 or 7.5%. Income before income taxes for the quarter ended June 30, 2007 was $883,709 compared to $603,867 for the quarter ended June 30, 2006, an increase of $279,842 or 46.3%. After income tax expense of $380,716 in the second quarter of 2007, net income was $502,993 compared to $345,358 for the second quarter of 2006, an increase of $157,635 or 45.6%. The effective income tax rate year-to-date in 2007 is 42.0% compared to 42.9% for the year-to-date period in 2006.
Contingencies:
There have been no material changes in our contingencies since those reported at December 31, 2006.
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Liquidity and Capital Resources:
Cash provided by operating activities during the period January 1, 2007 through June 30, 2007 was $3,365,484, resulting primarily from net income of $1,395,370, depreciation of $962,290, and an increase in accounts payable and accrued wages and payroll taxes of $3,650,849, caused by a seasonal increase of $2.7 million in horsemen payables, a $630,000 increase in trade accounts payable and a $231,000 increase in deferred revenues for corporate sponsorships, These items are partially offset by an increase in restricted cash of $2,499,116 resulting primarily from the increase in horsemen payables of $2.7 million.
Cash provided by operating activities during the period January 1, 2006 through June 30, 2006 was $3,766,778, resulting primarily from net income of $1,508,005; depreciation of $869,650; and an increase in accounts payable and accrued wages and payroll taxes of $4,256,737, caused by a seasonal increase of $2.5 million in horsemen payables, a $987,000 increase in trade accounts payable, a $258,000 increase in deferred revenues for corporate sponsorships, a $175,000 increase in amounts payable to out-of-state tracks for settlements and an increase of $299,801 in the card club’s jackpot and player pools caused by timing differences due to jackpots, prizes and giveaways paid to the players. These items are partially offset by an increase in restricted cash of $2,813,396 resulting primarily from a $2.5 million seasonal increase in payables to horsemen.
Pursuant to an agreement with the MHBPA, during the six months ended June 30, 2007 and 2006, the Company transferred into a trust account or paid directly to the MHBPA approximately $3,575,000 and $3,500,000, respectively. At June 30, 2007, the Company had an additional liability to the MHBPA of $89,821. This liability will be paid in 2007, including interest earned.
Net cash used in investing activities for the first six months of 2007 of $1,155,590 resulted primarily from the acquisition of equipment for food and beverage operations of $221,000, a poker room management system of $295,000, upgrades to the grandstand building of $402,000, and improvements to backside barns of $149,000. During the six-month period ended June 30, 2006, net cash used for investing activities was $2,313,987 related primarily to improvements to the backside barns and facilities related to live racing.
During the period January 1, 2007 through June 30, 2007, cash provided by financing activities was $253,099 representing the exercise of stock options. During the period January 1, 2006 through June 30, 2006, cash provided by financing activities was $271,437 also a result of the exercise of stock options.
The Company has renewed a general credit agreement with Bremer Bank, which provides a revolving credit line of up to $2,250,000 with interest at the prime rate until April 20, 2009. The Company had no borrowings under the line of credit at June 30, 2007 or December 31, 2006. The credit agreement contains certain covenants requiring the Company to maintain certain financial ratios. The Company was in compliance with these requirements at all times throughout the quarter ended June 30, 2007.
Unrestricted cash balances at June 30, 2007 were $8,208,549 compared to $5,745,556 at December 31, 2006. The Company believes that the funds available in its cash accounts, amounts available under the general credit and security agreement, along with funds generated from operations, will be sufficient to satisfy its liquidity and capital resource requirements for the balance of 2007 for regular operations including the special cash dividend paid in July 2007.
Critical Accounting Policies and Estimates:
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates that effect the amounts reported and disclosed in the consolidated financial statements. By their nature, these estimates are subject to an inherent degree of uncertainty. These estimates are based on our experience and various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the
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carrying values of assets and liabilities. On an ongoing basis, we evaluate our estimates. However, actual results could differ from those estimates.
Our significant accounting policies are included in Note 1 to our consolidated financial statements in our 2006 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.
Land, Buildings and Equipment - We have significant capital invested in our property and equipment, which represents approximately 63.2% of our total assets. We utilize 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. Our property and equipment is evaluated for impairment whenever circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value and is charged to operations in the period in which such impairment is determined by management. We do not believe that any impairment has occurred or is likely to occur in the near future.
Regulation - - Our business can be materially impacted both positively and negatively by legislative and regulatory changes, such as those described below. Significant negative changes resulting from these activities could result in an impairment of our property and equipment in accordance with generally accepted accounting standards. Additional information regarding how our business can be impacted by legislative and regulatory changes are included in Item 1 (vi), and Item 1 (vii), respectively, in our 2006 Annual Report on Form 10-K.
Commitments and Contractual Obligations:
On June 7, 2007 the Company’s Board of Directors declared a special cash dividend of $.25 per share of common stock payable on July 13, 2007 to shareholders of record on June 22, 2007. The Company has not adopted any policies regarding dividend payments and there can be no assurance that any dividend will be paid in the future.
There have been no additional material changes in our outstanding commitments and contingencies since those reported at December 31, 2006.
Legislation:
The Company did not propose or support any legislation during the 2007 biannual session of the Minnesota Legislature to pursue our Racino proposal that has been discussed in our previous flings with the SEC, mainly because the composition of the Minnesota Legislature following the November 2006 elections was viewed as unlikely to favorably entertain our Racino proposal. Based on the success of several Racinos in other states, we continue to believe that if a Racino was authorized at the Racetrack, it would enhance horseracing with increased purses, provide growth and development opportunities for the Company, and provide significant new tax revenues for state and local governments.
In May 2007 a bill passed in the Minnesota Legislature severely restrict smoking in all public places in Minnesota, including at the Racetrack, effective October 1, 2007. Minnesota’s tribal casinos are not covered by this legislation and will continue to offer various gaming alternatives, including card games, in an environment that allows smoking. Therefore, the Company anticipates revenues and profits will be adversely affected to the extent that current and potential Racetrack customers who smoke decide to patronize tribal casinos, where smoking is permitted.
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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, the Company may make forward-looking statements concerning possible or anticipated future financial performance, business activities or plans which are typically preceded by the words “believes,” “expects,” “anticipates,” “intends” or similar expressions. For such forward-looking statements, the Company claims the protection of the safe harbor for forward-looking statements contained in federal securities laws. Shareholders and the investing public should understand that such forward-looking statements are subject to risks and uncertainties which could cause actual performance, activities or plans to differ significantly from those indicated in the forward-looking statements. Such risks and uncertainties include, but are not limited to: fluctuations in attendance at the Racetrack, material changes in the level of wagering by patrons, decline in interest in the unbanked card games offered at the Card Club, legislative and regulatory changes, the impact of wagering products and technologies introduced by competitors; increases in the percentage of revenues allocated for purse fund payments; increase in compensation and employee benefit costs; the general health of the gaming sector; higher than expected expense related to new marketing initiatives; and other factors discussed from time to time in the Company’s filings with the Securities and Exchange Commission, including risk factors described in the Company’s Report on Form 10-K for the 2006 fiscal year.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on borrowings under our commercial revolving credit line that bears interest at the prime rate. At June 30, 2007 we have no debt borrowings under our credit facility.
We have no derivative financial instruments or derivative commodity instruments in our cash and cash equivalents and marketable securities. We invest cash and cash equivalents in investment grade, highly liquid investments, consisting of money market instruments, bank certificates of deposit, and short-term government and corporate bonds.
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures:
Management, with the participation of the Company’s principal executive officer, Randall D. Sampson, and principal financial officer, David C. Hansen, has evaluated the effectiveness of the design and operation of the disclosure controls and procedures, as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report. Management has concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that the disclosure controls are also effective to ensure that information required to be disclosed in the Company’s Exchange Act reports is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Control Over Financial Reporting:
There have been no changes in internal control over financial reporting that occurred during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the registrant’s internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Not Applicable
Item 1A. Risk Factors
There have been no material changes to the Risk Factors since those reported in the Form 10-K for the year ended December 31, 2006.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on June 7, 2007. Shareholders reelected the following directors for a one year term: Patrick R. Cruzen, Burton F. Dahlberg, Carin J. Offerman, Curtis A. Sampson, Randall D. Sampson, and Dale H. Schenian. Not less than 3,734,380 shares were voted in favor of each of the reelected directors (approximately 94.7% of all shares present and voting).
Item 5. Other Information
Not Applicable
Item 6. Exhibits
(a) The following exhibits are included herein:
11 Statement re computation of per share earnings — See Net Income Per Share under Note 1 of Notes to Consolidated Financial Statements under Part 1, Item 1, which is incorporated herein by reference.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (rules 13a-14 and 15d-14 of the Exchange Act).
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (rules 13a-14 and 15d-14 of the Exchange Act).
32 Certfications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Canterbury Park Holding Corporation |
| |
Dated: August 14, 2007 | /s/ Randall D. Sampson |
| Randall D. Sampson, |
| President, and Chief Executive Officer |
| |
Dated: August 14, 2007 | /s/ David C. Hansen |
| David C. Hansen, |
| Vice President, and Chief Financial Officer |
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