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ITEM 2:
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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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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, 2016 and March 31, 2015:
EBITDA
EBITDA
represents earnings before interest income, income tax expense, and depreciation and amortization.
EBITDA
is not a measure of performance or liquidity calculated in accordance with accounting principles generally accepted 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 has been presented
as a supplemental disclosure because it is widely used measures of performance and basis for valuation of companies in our industry.
Moreover, other companies that provide EBITDA information may calculate EBITDA differently than we do.
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The
following table sets forth a reconciliation of net income, a GAAP financial measure, to EBITDA (defined above), which is a non-GAAP
measure, for the three months ended March 31, 2016 and 2015:
Summary
of EBITDA Data
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Three
Months Ended March 31,
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2016
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2015
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NET INCOME
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$
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310,752
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$
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388,680
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Interest income
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(945
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)
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(616
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Income tax expense
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213,186
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274,242
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Depreciation
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576,480
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564,105
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EBITDA
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$
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1,099,473
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$
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1,226,411
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EBITDA
decreased $127,000, or 10.4%, and decreased as a percentage of net revenues to 10.6% from 12.4% for the three months ended March
31, 2016 as compared to the same period in 2015. The decrease is primarily due to decreased net income and income tax expense
as compared to the same period in 2015.
Revenues:
Total
net revenues increased $512,000, or 5.2%, for the three months ended March 31, 2016 as compared to the three months ended March
31, 2015. This increase is primarily attributable to increases in Card Casino and food and beverage revenue of 4.1% and 7.7%.
The following discussion provides further information regarding our operating revenues.
Pari-mutuel
Data and Simulcasting Revenues:
As
indicated in the table below, total handle wagered increased $29,000, or 0.5%, in the three months ended March 31, 2016 compared
to the same period last year. The increase is primarily attributable to one extra simulcast racing day.
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Three
Months Ended March 31,
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2016
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2015
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Simulcast racing days
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91
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90
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Simulcast handle
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$
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6,315,000
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$
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6,286,000
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Average daily handle
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69,000
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70,000
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Pari-mutuel
revenue increased $25,000, or 1.8%, from $1,370,000 to $1,395,000 in the three months ended March 31, 2016 compared to the same
period in 2015.
Card
Casino Revenue:
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Three
Months Ended March 31,
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2016
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2015
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Poker Games
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$
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2,468,000
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$
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2,477,000
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Table Games
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3,985,000
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3,781,000
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Total Collection Revenue
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6,453,000
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6,258,000
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Other Revenue
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666,000
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583,000
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Total Card Casino Revenue
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$
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7,119,000
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$
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6,841,000
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The
primary source of Card Casino revenue is a percentage of the wagers received from the 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 and amounts earned as reimbursement of the administrative costs of maintaining
jackpot funds.
As
indicated in the table above, total Card Casino revenue increased $278,000 or 4.1%, for the three months ended March 31, 2016
compared to the same period in 2015. Table games collection revenue increased $204,000, or 5.4% compared to the first three months
of 2015. Management believes the increase in table games collection revenue was due to the continued effectiveness of our customer
relationship management system through targeted direct marketing and player acquisition, an increase in catering and event attendance,
and a strengthening economy.
Food
and Beverage Revenue:
Food
and beverage revenue increased $77,000, or 7.7%, from $1,004,000 to $1,081,000 three months ended March 31, 2016 compared to the
same period in 2015, primarily due to an increase in prices for catering and events.
Other
Revenue:
Other
revenue increased $131,000, or 18.9% for the three months ended March 31, 2016 compared to the same period in 2015. This increase
is primarily due to increased advertising revenue payments under the CMA agreement for joint marketing efforts.
Operating
Expenses:
Total
operating expenses increased $651,000, or 7.1%, for the three months ended March 31, 2016 compared to the same period in 2015.
The following paragraphs provide further detail regarding operating expenses.
Purse
expense increased $154,000, or 17.5%, for the three months ended March 31, 2016 compared to the same period in 2015. The change
is primarily due to a change in the statutory formula by which our purse expense is determined. Pursuant to legislation that took
effect January 1, purse rates are now determined based on a single rate, rather than the variable rate depending on the time of
the year that was previously in effect. This change will cause our purse expense to be higher in the first and fourth quarters
and lower in the second and third quarters when compared to payments calculated under the previous statutory structure. However,
the change is not expected to have any material impact on our purse expense on an annual basis.
Salaries
and benefits increased $461,000, or 10.1%, for the three months ended March 31, 2016 compared to the same period in 2015. The
increase is primarily due to the State of Minnesota mandated increase in the minimum wage from $8.00 per hour to $9.00 per hour
that became effective August 1, 2015 and adding personnel to support catering and events initiatives.
Cost
of food and beverage and other sales expense increased $26,000, or 5.0%, three months ended March 31, 2016, compared to the same
period in the prior year. The increase is primarily due to the increased level of food and beverage sales.
Advertising
and marketing costs increased $14,000, or 6.8%, for the three months ended March 31, 2016, compared to the same period in the
prior year. This increase is primarily due to increased marketing expenditures funded by marketing payments received under the
CMA, including marketing expense to fund an area wide marketing initiative called RiverSouth, which is designed to increase visitors
to Shakopee’s entertainment, hospitality and retail businesses.
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 and 2016. 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 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 such covenant
is remote.
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The
Company continues to analyze the feasibility of various options related to the development of our underutilized land. Subject
to shareholder approval, as well as approval of the Minnesota Racing Commission, the Company is in the process of reorganizing
the corporate structure into a new holding company with two subsidiaries, one that will continue to operate the current racing
and gaming business, and a real estate subsidiary to hold the excess land for development. The Company may incur substantial costs
during the feasibility and predevelopment process, but the Company believes available funds are sufficient to cover the 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, 2016 was $2,683,000 primarily as a result of the following:
The Company reported net income of $311,000 and depreciation of $576,000. The Company also experienced an increase in accounts
payable of $1,469,000 and Card Casino accruals of $481,000. This was partially offset by an increase in restricted cash of $435,000
and account receivables of $312,000.
Net
cash provided by operating activities for the three months ended March 31, 2015 was $2,199,000 primarily as a result of the following:
The Company reported net income of $389,000 and depreciation of $564,000. The Company also experienced an increase in accounts
payable and accrued wages and payroll taxes of $1,304,000 and Card Casino accruals of $656,000. This was partially offset by an
increase in restricted cash of approximately $724,000.
Net
cash used in investing activities for the first three months of 2016 was $978,000, primarily for a variety of equipment purchases
and building remodel projects. Net cash used in investing activities for the first quarter of 2015 of $1,448,000 was used primarily
for a variety of equipment purchases and building remodel projects.
Net
cash used in financing activities during the first three months of 2015 was $111,000, primarily for principal payments of capital
lease obligations, partially offset by proceeds from purchases of stock through the Employee Stock Purchase Plan and proceeds
received upon the exercise of stock options. Net cash provided by financing activities during the first three months of 2015 consisted
of purchases of stock through the Employee Stock Purchase Plan and proceeds received upon the exercise of stock options of $33,000.
The
Company has a general credit and security agreement with Bremer Bank, which provides a revolving credit line of up to $3,000,000
and expires on September 30, 2016. The line of credit is collateralized by all receivables, inventory, equipment, general intangibles,
products and proceeds, together with all other assets and properties of the Company. The Company had no borrowings under the credit
line during the three months ended March 31, 2016 or the year ended December 31, 2015. The credit agreement contains covenants
requiring the Company to maintain certain financial ratios and limits capital lease obligations to $250,000. The Company was in
compliance with these requirements, after receiving a limited waiver for the capital lease obligation exception, for the three
months ended March 31, 2016.
The
Company’s cash and cash equivalent balance at March 31, 2016 was $ 9.9 million compared to $ 8.3 million at December 31,
2015. 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 predevelopment expenses during 2016. However, if the Company engages in real estate development,
additional financing maybe 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 1 to our consolidated financial statements in our 2015 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.
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Property and Equipment
- We have significant capital invested
in our property and equipment, which represents approximately 72.2% of our total assets at March 31, 2016. 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 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. To date, we have determined that no impairment of these assets exists.
Stock-Based Compensation –
Accounting guidance requires
recognition of services provided in exchange for a share-based payment based on the grant date fair market value. We utilize our
judgment in determining the assumptions used to determine the fair value of equity instruments granted using a Black-Scholes model.
Commitments and Contractual Obligations:
On June 4, 2012, and amended in January 2015 and 2016, the Company
entered into the CMA with the SMSC that expires December 31, 2022. See “Cooperative Marketing Agreement” below.
Legislation:
Minimum Wage Legislation
Legislation that was enacted into law in 2014 increased the minimum
wage that must be paid to most company employees from $7.25 to $8.00 on August 1, 2014, and from $8.00 to $9.00 per hour on August
1, 2015. A further increase to $9.50 per hour is scheduled for August 1, 2016. In addition, starting January 1, 2018, the minimum
wage will increase at the beginning of each year by the rate of inflation with a maximum increase of up to 2.5% per year. 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 impact in 2014 and 2015 and will continue to have an adverse impact in 2016
and beyond. We have implemented measures, and will continue to implement measures, to mitigate the impact of this increase by raising
our prices or reducing our employee count. However, these measures could themselves have an adverse effect because higher prices
and diminished service levels may discourage customers from visiting the Racetrack. To the extent we are not able to implement
such price increases and other cost cutting measures, the increase in the minimum wage will adversely affect our net income.
Potential Horseracing Legislation
In July 2015, the Thoroughbred Horseracing Integrity Act of 2015
was introduced in Congress. Under the terms of this proposed legislation, the United States Anti-Doping Agency (“USADA”)
is designated as the organization responsible for regulating drugs, medications and treatments used in racing and would prohibit
interstate wagering without consent from USADA. If enacted into law, the legislation could have an adverse impact on our business.
Advanced Deposit Wagering Legislation
On March 29, 2016, the Advanced Deposit Wagering (“ADW”)
bill was approved by the House of Commerce Committee in the State of Minnesota. The bill will establish licensing criteria and
regulatory oversight of ADW providers doing business in the State of Minnesota. This would allow the Minnesota Racing Commission
(“MRC”) to regulate pari-mutuel wagering already occurring in Minnesota. The recapture of ADW funds would benefit the
Company’s purse funds, the MRC, Minnesota horseracing industry and Minnesota breeders. Currently, the Company is assessing
the financial impact and cannot estimate it at this time, if the law is enacted.
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. Such payments have no direct impact on the Company’s
consolidated financial statements or operations.
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Under the terms of the CMA, the SMSC paid the horsemen $6.7 million
and $6.2 million in the first three months of 2016 and 2015, 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. Under the CMA, the SMSC paid the Company $1,197,000 and $944,000 for marketing purposes
during the three months ended March 31, 2016 and 2015, respectively.
During January 2015 and 2016, the CMA was amended to adjust the
payment amounts between the “Purse Enhancement Payments to Horsemen” and “Marketing Payments to Canterbury Park.”
SMSC has currently agreed to make the following purse enhancement
and marketing payments for 2017 through 2022:
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Year
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Purse
Enhancement Payments to Horsemen
1
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Marketing
Payments to Canterbury Park
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2017
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$
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7,466,910
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$
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1,317,690
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2018
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7,650,000
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1,350,000
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2019
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7,650,000
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1,350,000
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2020
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7,650,000
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1,350,000
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2021
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7,650,000
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1,350,000
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2022
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7,650,000
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1,350,000
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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 consolidated statements of operations. For the three months ended March 31, 2016, the Company recorded $126,000
in other revenue and incurred $69,000 in advertising and marketing expense and $57,000 in depreciation related to the SMSC marketing
payment. For the three months ended March 31, 2015, the Company recorded $65,000 in other revenue and incurred $8,000 in advertising
and marketing expense and $57,000 in depreciation related to the SMSC marketing payment. The excess of amounts received over revenue
is reflected as deferred revenue which is included in accounts payable on the 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.
As part of the CMA, and pursuant to a related SAR Agreement dated
June 14, 2012, the Company issued stock appreciation rights to the SMSC. For the three months ended March 31, 2015, the Company
recognized $83,000 of expense related to these stock appreciation rights, of which $83,000 was recorded as an offset to other revenue.
On July 30, 2015, the Company sold the land and buildings related to the Shakopee Valley RV Park located in Shakopee, Minnesota
to SMSC for $100,000 plus the cancellation of the vested and unvested SARs. As a result, there was no expense for the three months
ended March 31, 2016.
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 which are
typically preceded by words such as “believes,” “expects,” “anticipates,” “intends”
or similar expressions. For such 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 such forward-looking statements
are subject to risks and uncertainties which could affect our actual results and cause actual results to differ materially from
those indicated in the forward-looking statements. Such 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, a
greater than anticipated expenses or lower than anticipated return on our development of our underutilized land. 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, the general health of the gaming
sector, and other factors that are beyond our ability to control or predict.
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