UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------------------
FORM 10-Q
(Mark One)
X[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-------
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 200229, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
------- SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ------------------ --------------------_______________________
Commission File No. 0-24993
LAKES ENTERTAINMENT, INC.
-------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-1913991
--------------------------------- ---------------------------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
130 Cheshire Lane
Minnetonka, Minnesota 55305
---------------------------------------- ------------------------------- -----
(Address of principal executive offices) (Zip Code)
(952) 449-9092
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X[X] No --- ---[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of September 13, 2002,August 7, 2003, there were 10,638,09810,638,320 shares of Common Stock, $0.01 par
value per share, outstanding.
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
INDEX
PAGE OF
FORM 10-Q
---------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of
June 30,29, 2003 and December 29, 2002 3
and December 30, 2001Condensed Consolidated Statements of Earnings for the three 4
months ended June 30, 2002 and July 1, 2001 (Restated)
Consolidated Statements of Comprehensive Earnings 5(Loss)
for the three months ended June 30, 200229, 2003 and
July 1, 2001 (Restated)
Consolidated Statements of Earnings for the six months 6
ended June 30, 2002 and July 1, 2001 (Restated)4
Condensed Consolidated Statements of Comprehensive
Earnings 7(Loss) for the three months ended June 29, 2003
and June 30, 2002 5
Condensed Consolidated Statement of Loss for the six
months ended June 29, 2003 and June 30, 2002 6
Condensed Consolidated Statements of Comprehensive
Loss for the six months ended June 29, 2003 and July 1, 2001
(Restated)June 30, 2002 7
Condensed Consolidated Statements of Cash Flows for
the six 8
months ended June 29, 2003 and June 30, 2002 and July 1, 2001 (Restated)8
Notes to Condensed Consolidated Financial Statements 9
ITEM 2. MANAGEMENT'S DISCUSSION AND 20
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 19
ITEM 3. QUANTITATIVE AND QUALITATIVE 30
DISCLOSURES ABOUT MARKET RISK 31
ITEM 4. CONTROLS AND PROCEDURES 31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 3132
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 33
SECURITY HOLDERS 33
ITEM 5. OTHER INFORMATION 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 34
2
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30,29, 2003 DECEMBER 29, 2002
DECEMBER 30, 2001
------------- ------------------ -----------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 20,48123,354 $ 42,638
Short-term investments 992 2,027
Current installments of notes receivable -- 67
Related party receivables -- 4,00014,106
Accounts receivable, net -- 3,601948 116
Deferred tax asset 4,522 4,5494,481 6,771
Other current assets 2,354 1,079
---------- ----------741 547
- -----------------------------------------------------------------------------------------------------------------
Total Current Assets 28,349 57,961
---------- ----------29,524 21,540
- -----------------------------------------------------------------------------------------------------------------
Property and Equipment-Net 7,148 6,300
---------- ----------6,697 6,962
- -----------------------------------------------------------------------------------------------------------------
Other Assets:
Land held under contract for sale 28,492 30,8264,772 28,832
Land held for development 28,895 24,96529,382 27,791
Notes receivable-less current installments 62,978 53,20175,595 70,955
Cash and cash equivalents-restricted 9,230 9,175- 8,300
Investments in and notes from unconsolidated affiliates 893 8398,423 1,013
Deferred tax asset 4,849 3,8704,707 3,835
Other long-term assets 6,337 6,042
---------- ----------8,823 6,657
- -----------------------------------------------------------------------------------------------------------------
Total Other Assets 141,674 128,918
---------- ----------131,702 147,383
- -----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 177,171 $ 193,179
========== ==========$167,923 $175,885
=================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ --96 $ 105
Current maturities of long-term debt 975 1,325
Current installments of capital lease obligations -- 123226
Income taxes payable 359 3,9064,312 5,564
Litigation and claims accrual 6,197 6,572180 5,847
Accrued payroll and related 824 671418 252
Other accrued expenses 3,807 2,670
---------- ----------2,944 3,486
- -----------------------------------------------------------------------------------------------------------------
Total Current Liabilities 12,162 15,372
---------- ----------
Long-term Liabilities:
Capital lease obligations-less current installments -- 5,591
Other long-term liabilities 224 225
---------- ----------
Total Long-Term Liabilities 224 5,816
---------- ----------7,950 15,375
- -----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 12,386 21,188
---------- ----------7,950 15,375
- -----------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity:
Capital stock, $.01 par value; authorized 100,000 shares; 10,638 common
shares issued and outstanding
at June 30, 2002,29, 2003, and December 30, 200129, 2002 106 106
Additional paid-in-capital 131,525131,526 131,525
Retained Earnings 33,177 40,420
Accumulated other comprehensive loss (23) (60)
---------- ----------28,341 28,879
- -----------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 164,785 171,991
---------- ----------159,973 160,510
- -----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 177,171 $ 193,179
========== ==========$167,923 $175,885
=================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
3
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
(UNAUDITED)
THREE MONTHS ENDED
-------------------------------------------------
JUNE 29, 2003 JUNE 30, 2002
JULY 1, 2001
------------- ------------
(AS RESTATED, SEE NOTE 9)-------------
Revenues:
ManagementREVENUES:
License fee income $ --2,954 $ 9,599-
- -----------------------------------------------------------------------------------------------
Total Revenues 2,954 -
- -----------------------------------------------------------------------------------------------
COSTS AND EXPENSES:
Selling, general and administrative 4,950 9,572
2,940Reversal of litigation and claims accrual (3,212) -
Depreciation and amortization 131 120
329
--------- ---------- -----------------------------------------------------------------------------------------------
Total Costs and Expenses 1,869 9,692
3,269
--------- ---------- -----------------------------------------------------------------------------------------------
EARNINGS (LOSS) FROM OPERATIONS 1,085 (9,692)
6,330
--------- ---------- -----------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest income 314 436 593
Interest expense (24)- (24)
Equity in loss of unconsolidated affiliates (60) (108)
(153)
Write-down of investment in unconsolidated affiliates -- (666)
--------- ---------Other (1) -
- -----------------------------------------------------------------------------------------------
Total other income, net 253 304
(250)
--------- ---------- -----------------------------------------------------------------------------------------------
Earnings (loss)(Loss) before income taxes 1,338 (9,388)
6,080
Provision (benefit)(Benefit) for income taxes 549 (2,208)
2,493
--------- ---------- -----------------------------------------------------------------------------------------------
NET EARNINGS (LOSS) $ (7,180) $ 3,587
========= =========789 ($ 7,180)
===============================================================================================
BASIC EARNINGS (LOSS) PER SHARE $ (0.67) $ 0.34
========= =========0.07 ($ 0.67)
===============================================================================================
DILUTED EARNINGS (LOSS) PER SHARE $ (0.67) $ 0.33
========= =========0.07 ($ 0.67)
===============================================================================================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638
DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS -- 120
--------- ---------- -
- -----------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON AND DILUTED
SHARES OUTSTANDING 10,638 10,758
========= =========10,638
===============================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
4
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Earnings
(In thousands)
(Unaudited)CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (LOSS)
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
------------------------------------------------------------------
JUNE 29, 2003 JUNE 30, 2002
JULY 1, 2001
------------- ------------
(AS RESTATED, SEE NOTE 9)-----------------------------------
NET EARNINGS (LOSS) $ (7,180) $ 3,587
OTHER COMPREHENSIVE INCOME789 ($7,180)
OTHERCOMPREHENSIVE EARNINGS (LOSS), NET OF TAX:
Unrealized losses on securities:
Unrealized holding losses during the period - (2) (225)
Reclassification adjustment for losses included
in net earnings (loss) - 47
12
--------- -------------------------------------------
COMPREHENSIVE EARNINGS (LOSS) $ (7,135) $ 3,374
========= ========789 ($7,135)
===================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
5
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGSLOSS
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
(UNAUDITED)
SIX MONTHS ENDED
-----------------------------------------------
JUNE 29, 2003 JUNE 30, 2002
JULY 1, 2001
------------- ------------
(AS RESTATED, SEE NOTE 9)-------------
REVENUES:
Management fee income $ - $ 1,502
$ 18,822License fee income 3,504 -
- -----------------------------------------------------------------------------------------------
Total Revenues 3,504 1,502
- -----------------------------------------------------------------------------------------------
COSTS AND EXPENSES:
Selling, general and administrative 7,929 11,671
5,520Reversal of litigation and claims accrual (3,212) -
Depreciation and amortization 259 219
660
--------- ---------- -----------------------------------------------------------------------------------------------
Total Costs and Expenses 4,976 11,890
6,180
--------- ---------
EARNINGS (LOSS)- -----------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (1,472) (10,388)
12,642
--------- ---------- -----------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest income 551 1,172 1,473
Interest expense - (47) (48)
Equity in loss of unconsolidated affiliates (147) (231)
(262)
Write-down of unconsolidated affiliates -- (666)
--------- ---------Other 158 -
- -----------------------------------------------------------------------------------------------
Total other income, net 562 894
497
--------- ---------
Earnings (loss)- -----------------------------------------------------------------------------------------------
Loss before income taxes (910) (9,494)
13,139
Provision (benefit)Benefit for income taxes (372) (2,251)
5,387
--------- ---------- -----------------------------------------------------------------------------------------------
NET EARNINGS (LOSS) $ (7,243) $ 7,752
========= =========LOSS ($ 538) ($ 7,243)
===============================================================================================
BASIC EARNINGS (LOSS)LOSS PER SHARE $ (0.68) $ 0.73
========= =========($ 0.05) ($ 0.68)
===============================================================================================
DILUTED EARNINGS (LOSS)LOSS PER SHARE $ (0.68) $ 0.72
========= =========($ 0.05) ($ 0.68)
===============================================================================================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638
DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - 132
--------- ----------
- -----------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON AND DILUTED
SHARES OUTSTANDING 10,638 10,770
========= =========10,638
===============================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
6
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGSLOSS
(IN THOUSANDS)
(UNAUDITED)
(UNAUDITED)
SIX MONTHS ENDED
-------------------------------------------------------------------
JUNE 29, 2003 JUNE 30, 2002
JULY 1, 2001
------------- ------------
(AS RESTATED, SEE NOTE 9)------------------------------------
NET EARNINGS (LOSS) $ (7,243) $ 7,752LOSS ($ 538) ($7,243)
OTHER COMPREHENSIVE INCOME (LOSS),LOSS, NET OF TAX:
Unrealized losses on securities:
Unrealized holding losses during the period - (10) (105)
Reclassification adjustment for losses included
in net earningsloss - 47
79
--------- --------------------------------------------
COMPREHENSIVE EARNINGS (LOSS) $ (7,206) $ 7,726
========= ========LOSS ($ 538) ($7,206)
====================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
7
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
(UNAUDITED)
SIX MONTHS ENDED
-----------------------------------------------
JUNE 29, 2003 JUNE 30, 2002
JULY 1, 2001
------------- ------------
(AS RESTATED, SEE NOTE 9)-------------
OPERATING ACTIVITIES:
Net earnings (loss) $ (7,243) $ 7,752loss ($ 538) ($ 7,243)
Adjustments to reconcile net earnings (loss)loss to net cash
provided byused in operating activities:
Depreciation and amortization 259 218 660
Equity in loss of unconsolidated affiliates 147 231 260
Impairment of land held under contract for sale - 3,000 --
Write down of assets held as investments -- 666
Write down of related party receivables - 4,000 --
Changes in operating assets and liabilities:
Accounts receivable (832) 3,601 (4,761)
Income taxes 167 (3,547) 3,099
Accounts payable (130) (105) 87
Accrued expenses (2,922) 915
(664)
Other (194) (1,565)
(546)
---------- ----------- -----------------------------------------------------------------------------------------------------------
Net Cash (Used in) Provided byUsed in Operating Activities (4,043) (495)
6,553
---------- ----------- -----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Short-term investments, purchases -- (11,708)
Short-term investments, sales/maturities - 1,101 33,602
Payments for land held under contract for sale (433) (666)
--Payments received on land held under contract for sale 16,765 -
Payments for land held for development (1,591) (4,910) (15,380)
Advances on notes receivable (6,642) (9,947) (16,349)
Proceeds from repayment of notes receivable - 67 5,936
Investment in and notes receivable from unconsolidated affiliates (495) (139)
(404)
IncreaseDecrease (increase) in restricted cash, net 5,906 (55) (2,940)
Increase in other long-term assets (225) (333)
(188)
Payments forReduction of (payments for) property and equipment, net 6 (716)
(553)
---------- ----------- -----------------------------------------------------------------------------------------------------------
Net Cash Used inProvided by (Used in) Investing Activities 13,291 (15,598)
(7,984)
---------- ----------- -----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Payments on capital lease obligations - (5,714) --
Payments on long-term debt - (350)
--
---------- ----------- -----------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities - (6,064)
--
---------- ----------- -----------------------------------------------------------------------------------------------------------
Net decreaseincrease (decrease) in cash and cash equivalents 9,248 (22,157) (1,431)
Cash and cash equivalents - beginning of period 14,106 42,638
10,469
---------- ----------- -----------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 23,354 $ 20,481
$ 9,038
========== =====================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 49- $ 49
Income taxes 4 5 3,995
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
8
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BUSINESS
Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")
was established as a public corporation on December 31, 1998, via a distribution
(the "Distribution") of its common stock, par value $.01 per share (the "Common
Stock") to the shareholders of Grand Casinos, Inc. ("Grand").
Lakes currently has development and management agreements with four separate
tribes for four new casino operations, one in Michigan, two in California and
one with the Nipmuc Nation on the east coast. The Company also has agreements
for the development of one additional casino on Indian owned land in California
through a joint venture.venture which is currently being disputed by the tribe. Each of
these projects is currently in the development phase.
During March 2002, theThe Company made an investment inhas also formed a joint venture with Steven
Lipscomb, a producer of televised poker tournaments. The purpose of this joint
venture is to launch the World
Poker Tour ("WPT") and establish poker as the next significant televised
mainstream sport. The termsDuring March of this investment required
Lakes to make2003, the WPT signed an investment of $0.1 million for an approximate 78% ownership
position inagreement with the
joint venture. Lakes is also required to lend up to $3.2 million
to the joint venture as needed. The joint venture has issued a note to Lakes at
6.2% interest per annum with principal payable at the end of three years. The
amount outstanding on the note was $0.7 million as of June 30, 2002. The Lakes'
note is secured by a blanket security interest in all assets of the joint
venture. If certain predetermined goals are not achieved by the joint venture,
Lakes hasTravel Channel, LLC (TRV), granting TRV the right to stop advances onbroadcast the note. If Lakes werefirst season
of the WPT series which has now been completed. During July of 2003, WPT reached
an agreement with TRV for a second season with options for five additional
seasons. WPT receives a series of fixed license payments from TRV, subject in
each case to elect to stop
funding the joint venture, all outstanding principal amounts would be due one
year from the date Lakes stopped funding.satisfaction of production milestones and other conditions. Revenue
is recognized ratably as production milestones and other conditions are met.
LAND HELD UNDER CONTRACT FOR SALE
On December 28, 2001, the Company transferred title and ownership obligations of
the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction
with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and
obligations of the adjacent Travelodge property consisting of a long-term land
lease and a motel operation. This transaction was accounted for under the
deposit method of accounting under the requirements of Statement of Financial
Accounting Standards No. 66, Accounting for Sales of Real Estate, rather than as
a sale. Therefore, the fair value of the property iswas included as land held under contract for
sale on the accompanying condensed consolidated balance sheetssheet as of June 30, 2002 and
December 30, 2001.29,
2002. The total price for this combined transaction was approximately $30.9
million. Terms of the transaction includeincluded a $1.0 million down payment, which
was received in January 2002, a contractual commitment to pay Lakes $23.3
million by December 29, 2002, and a second contractual agreement to pay Lakes
$7.5 million on June 30, 2004. Lakes' collateral forA $0.5 million payment on the two contractual commitments is the property
and lease rights described above which would revert back to Lakes in the event
of default by Metroflag. The transactionnotes receivable
was closed subject to certain
administrative post-closing conditions that must be satisfied within six months
after the closing. This post-closing period has been extended through September
27,received during 2002.
Certain of these conditions have not yet been satisfied as of
September 15, 2002. If the conditions are not satisfied or waived by Metroflag
within the prescribed period, Metroflag has the right to require Lakes to
repurchase the properties.
9
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)During 2002, Lakes and Metroflag have agreed in principle, subject to proper documentation,
to restructurerestructured the terms of the Polo Plaza and
Travelodge property transactions due to deteriorating economic conditions. The
parties have agreed in principle
to reducereduced the purchase price for the Polo Plaza property from $23.3$23.8
million to $21.3$21.8 million. On the revised payment date, which iswas scheduled to be
no later than January 31, 2003, $17.3$16.8 million of the purchase price willwas to be
paidpayable to Lakes in cash and $4.0 million willwas to be paidpayable through the issuance
to Lakes of a preferred membership interest in Metroflag.
On or before the first anniversary of the payment date, Metroflag Polo may elect
to distribute to Lakes $3.0 million in cash as full return of Lakes' preferred
interest. If Lakes' preferred interest remains outstanding at any time on or
after the fourth anniversary of the payment date, Lakes can require Metroflag to
repurchase the preferred interest for $4.0 million plus a priority return of
eight percent (8%) per annum. Effective June 30,
2002, Lakes recorded a $3.0 million impairment charge for these properties
relating to the adjustment in the purchase price and the potential discount on
the return of Lakes' preferred interest.
9
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
This real estate was reported at its adjusted carrying value in Land Held Under
Contract for Sale as of December 29, 2002. Lakes' collateral is the property and
lease rights described above which would revert back to Lakes in the event of
default by Metroflag.
During March of 2003, Lakes and Metroflag agreed to additional revisions to the
terms of the Polo Plaza and Travelodge property transactions. The parties have
increased the price of the Polo Plaza property from $21.8 million to $25.8
million and extended the payment date to May 15, 2003. On the payment date,
$16.8 million of the purchase price was paid to Lakes in cash, $4.0 million was
paid through the issuance to Lakes of a preferred membership interest in
Metroflag and $4.0 million was paid through the issuance to Lakes of a
subordinated membership interest in Metroflag. On or before April 30, 2004,
Metroflag Polo may elect to distribute to Lakes $3.0 million plus interest in
cash as full return of Lakes' preferred interest. If paid after April 30, 2004,
and in no event later than December 24, 2006, the entire $4.0 million plus
interest will be payable. The subordinated interest must be repurchased for $4.0
million at the time of repayment of an outstanding $3.5 million contractual
commitment in connection with the Travelodge property, which is scheduled on or
before December 28, 2004. In March of 2003, the parties decreased the sale price
of the Travelodge property from $7.5 million to $3.5 million. At that time, the
contractual commitment to pay Lakes was also decreased from $7.5 million to $3.5
million. If the Travelodge commitment is not repaid by December 28, 2004,
ownership of the Travelodge lease rights would revert back to Lakes. If at any
time the Polo Plaza property is sold and the Travelodge commitment has not been
repaid, Metroflag is required to repurchase the subordinated interest for the
lesser of $4.0 million or any portion of the net cash proceeds from such sale or
refinancing that exceeds $60.0 million.
LAND HELD FOR DEVELOPMENT
On April 7, 2003, Lakes continuesannounced that it has signed a Letter of Intent to ownsell
the Shark Club property, which is an approximate 3.5 acre undeveloped site, adjacentknown as the Shark Club Parcel, for a
purchase price of $15.0 million in cash. The transaction closed on July 1, 2003.
In addition to the Polo Plaza shopping center and Travelodge
sites. During August 2002,$15.0 million payment, Lakes formedreceived $1.0 million as
repayment of a loan previously made by Lakes to Chateaux, LLC, a joint venture
with Diamond Resorts,
LLC,entity originally formed by Lakes and a Nevada limited liability company and time-share developer for the purpose of
developing the Shark Club parcelParcel as an upscale time-share project. The terms
of this joint venture agreement require that Diamond and Lakes each make an
initial working capital contribution of $250,000. Subject to Diamond obtaining a
financing commitment for a construction loan sufficient to fund at least the
first phase of the building improvements contemplated by the time-share project,
the joint venture agreement will require Lakes to contribute the relevant
portion of the Shark Club parcel, valued at $16 million. Diamond has agreed to
perform sales, marketing, administrative and managerial services for the
project. The terms of the joint venture agreement provide for the repayment to
Lakes of its contribution of property in cash based on the joint venture's cash
flow and time-share unit sales. It is contemplated that Lakes will be required
to make no other material contributions of cash or property to the project.
Also included in land held for development is land held for possible transfer to
Indian tribes for use in future casino resort projects in the amount of $12.8$14.4
million and $8.9$12.8 million as of June 30, 200229, 2003 and December 30, 2001,29, 2002,
respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, theThe FASB issued SFASInterpretation No. 141, Business Combinations,45, "Guarantor's Accounting and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requiresDisclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" in November 2002. This interpretation elaborates on the disclosures to
be made by a guarantor in its financial statements about its obligations under
certain guarantees that all
business combinations be accountedit has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for under a single method, the purchase
method. SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets.fair
value of the obligation undertaken in issuing the guarantee.
10
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The initial recognition and initial measurement provisions of this
interpretation are applicable to all guarantees and modification to guarantees
made after December 31, 2002. The Company's disclosure of the indemnification
and guarantee agreements of the Company is in compliance with the
interpretation. The disclosure requirements in this interpretation are effective
for financial statements of interim or annual periods ended after December 15,
2002. The adoption of the interpretation did not have a material impact on the
Company's results of operations, financial position and cash flows. The Company
does have an indemnification agreement with Grand Casinos which is fully
described in Note 8 Commitments and Contingencies.
In June 2001,January 2003, the FASB issued SFASInterpretation No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 supersedes previous guidance for financial accounting46 (FIN46), "Consolidation
of Variable Interest Entities", which addresses the consolidation of variable
interest entities. The interpretation applicable immediately to variable
interest entities created after January 31, 2003, and reporting for obligations associatedto variable interest
entities in which a Company obtains an interest after that date. For variable
interests in variable interest entities acquired before February 1, 2003, the
interpretation applicable applies in the first interim period beginning after
June 15, 2003. The Company has determined that it has no investments or other
interests in entities that may be deemed variable interest entities under the
provisions of FIN 46, as the development projects subject to the management
agreements with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies toIndian Tribes are not separate entities or legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset.structures.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets", which provides new accounting and financial
reporting guidance for the impairment or disposal of long-lived assets and the
disposal of segments of a business.
In JuneDecember 2002, the FASB issued SFAS No. 146,148, "Accounting for Costs Associated
with Exit or Disposal Activities"Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123". SFAS No. 146 requires148 provides alternative transition methods for companies that
make a liabilityvoluntary change to the fair-value-based method of accounting for
a
cost associated with an exit or disposal activity be recognized when the
liability is incurred.stock-based employee compensation. In addition, SFAS No. 146 eliminates148 amends the
definitiondisclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and requirementinterim financial statements about the method of accounting for
recognitionstock-based employee compensation and the effect of exit costs in Emerging Issues Task Force Issue No. 94-3 where
a liability for an exit is recognized at the date of an entity's commitment to
an exit plan. This statement is effective for exit or disposal activities
initiated after December 31, 2002.method used on reported
results. The Company does not believe thathas adopted the disclosure provisions of SFAS No. 148 and
its adoption of these statements will have a
materialhad no impact on itsthe Company's consolidated financial position or
results of operations.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements include
the accounts of Lakes and its wholly-owned and majority-owned subsidiaries.
Investments in unconsolidated affiliates representing 50% or less of voting
interests are accounted for on the equity method. All significant intercompany
balances and transactions have been eliminated in consolidation.
Lakes' investments in unconsolidated affiliates include a 50 percent ownership
interest in PCG Santa Rosa, LLC, a joint venture formed to develop a casino on
Indian-owned land in California. DuringCalifornia and a 49 percent voting interest in the
first quarter of 2001, Lakes wrote
off its 50 percent investment in PCG Corning,Chateaux, LLC, also a joint venture formed to develop a casino on Indian-owned landthe Shark Club Parcel in California. Additionally, as a
result of its spin-off from Grand, Lakes received a 27 percent ownership
interest in New Horizon Kids Quest, Inc. (NHKQ), a publicly held provider of
child care facilities. In June 2001, Lakes enteredLas
Vegas, Nevada, into an agreement with NHKQ
pursuant to which NHKQ acquired Lakes' interest in NHKQ. As a resultupscale timeshare project. See Note 8 for current status
of this
transaction, Lakes incurred a one time write-down charge of $0.7 million before
tax, during the second quarter of 2001.Shark Club Parcel.
11
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The condensed consolidated financial statements have been prepared by the
Company in accordance with accounting principles generally accepted in the
United States of America for interim financial information, in accordance with
the rules and regulations of the Securities and Exchange Commission. Pursuant to
such rules and regulations, certain financial information and footnote
disclosures normally included in the condensed consolidated financial statements
have been condensed or omitted.
11
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for fair presentation have been included.
Operating results for the six months ended June 30, 2002,29, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 29,
2002.28,
2003. The condensed consolidated financial statements should be read in
conjunction with the condensed consolidated financial statements and notes
thereto included in the Company's annual report on Form 10-K/A10-K for the year ended
December 30, 2001.29, 2002.
3. STOCK-BASED COMPENSATION
At June 29, 2003, the Company has two stock-based employee compensation plans.
The Company accounts for those plans under the recognition and measurement
principles of APB Option No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost is reflected
in net income, as all options granted under those plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
SIX MONTHS ENDED THREE MONTHS ENDED
---------------- ------------------
JUNE 29, 2003 JUNE 30, 2002 JUNE 29, 2003 JUNE 30, 2002
------------- ------------- ------------- -------------
Net earnings (loss): $ (538) $ (7,243) $ 789 $ (7,180)
As reported
Less: Total stock-based compensation
expense determined under the fair
value method, net of related tax effects (767) (849) (383) (426)
Pro forma (1,305) (8,092) 406 (7,606)
Net earnings (loss) per share:
As reported -- Basic $ (0.05) $ (0.68) $ 0.07 $ (0.67)
Pro forma -- Basic (0.12) (0.76) 0.04 (0.71)
As reported -- Diluted (0.05) (0.68) 0.07 (0.67)
Pro forma -- Diluted (0.12) (0.76) 0.04 (0.71)
12
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. MANAGEMENT CONTRACTS OF LIMITED DURATIONFOR INDIAN-OWNED CASINOS
The ownership, management and operation of gaming facilities are subject to
extensive federal, state, provincial, tribal and/or local laws, regulation, and
ordinances, which are administered by the relevant regulatory agency or agencies
in each jurisdiction. These laws, regulations and ordinances vary from
jurisdiction to jurisdiction, but generally concern the responsibility,
financial stability and character of the owners and managers of gaming
operations as well as persons financially interested or involved in gaming
operations. The Company is prohibited by the Indian Gaming Regulatory Act
("IGRA") from having an ownership interest in any casino it manages for Indian
tribes.
The management contracts govern the relationship between the Company and the
tribes with respect to the construction and management of the casinos. The
construction or remodeling portion of the agreements commenced with the signing
of the respective contracts and continued until the casinos opened for business;
thereafter, the management portion of the respective management contracts
continues for a period up to seven years. Under the terms of the contracts, the
Company, as manager of the casino, receives a percentage of the distributable
profits (as defined in the contract) of the operations as a management fee after
payment of certain priority distributions, a cash contingency reserve, and
guaranteed minimum payments to the tribes.
Lakes has a contract to be the exclusive developer and manager of an
Indian-owned gaming resort near New Buffalo, Michigan with the Pokagon Band of
Potawatomi Indians. The Company has formed partnerships that hold contracts to
develop and manage two casinos to be owned by Indian tribes in California, one
near San Diego with the Jamul Indian Village, and the other near Sacramento with
the Shingle Springs Band of Miwok Indians. Lakes and another company have formed
a partnership with a contract to finance the construction of an Indian-owned
casino 60 miles north of San Francisco, California for Grand Casino Coushatta expired January 16, 2002,
whichthe Cloverdale Rancheria
of Pomo Indians. The Rancheria is seven yearscurrently disputing the agreement with the
partnership and has notified the partnership that it wishes to terminate the
contract. The Company has also signed contracts with the Nipmuc Nation of
Massachusetts for development and management of a potential future gaming resort
in the eastern United States; however, this tribe has received a negative
finding regarding federal recognition from the date the casino opened, and was not renewed. This
non-renewalBureau of Indian Affairs (BIA).
The tribe has resulted in the loss of revenues to the Company derived from
such contract, which has had a material adverse effect on the Company's results
of operations. As of June 30, 2002, the Company has no other management
contracts from which it will derive revenues in 2002.
4.submitted additional information for reconsideration.
5. NOTES RECEIVABLE
The notes receivable from Indian Tribes are generally for the development of
gaming properties to be managed by the Company. The repayment terms are specific
to each tribe and are largely dependent upon the operating performance of each
gaming property. Repayments of the aforementioned notes receivable are required
to be made only if distributable profits are available from the operation of the
related casinos. Repayments are also the subject of certain distribution
priorities specified in the management contracts. In addition, repayment of the
notes receivable and the manager's fees under the management contracts may beare
subordinated to certain other financial obligations of the respective casinos.tribes.
Through June 30, 2002,29, 2003, no amounts have been withheld under these provisions.
1213
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Notes receivable consist of the following (in thousands):
June 30,29, 2003 December 29, 2002 December 30, 2001
------------- -----------------
Properties under development:
Notes from the Pokagon Band of Potawatomi Indians with variable interest rates
(not to exceed 10%) (5.75%(5.00% at June 30, 2002)29, 2003), receivable in 60 monthly
installments subsequent to commencement date $ 38,16640,624 $ 35,23639,470
Notes from the Shingle Springs Band of Miwok Indians with variable interest
rates (6.75%(6.00% at June 30,
2002)29, 2003), receivable in 48varying monthly installments based
on contract terms subsequent to commencement date 10,007 6,68417,539 14,035
Notes from Jamul Indian Village with variable interest rates (6.75%(6.00% at June 30, 2002)29,
2003), receivable in 4812 monthly installments subsequent to commencement date 7,755 5,540
Other 7,050 5,741
Operating properties:10,795 9,492
Notes from the Coushatta TribeNipmuc Nation with variable interest rates (5.75%(6.00% at December 30, 2001),June 29,
2003) receivable in 84
monthlyvarying installments through January 2002 -- 67
------------ ------------based on contract terms subsequent to
commencement date 4,150 3,814
Other 2,487 4,144
--------- --------
Total notes receivable 62,978 53,268
Less - current installments of notes receivable -- (67)
------------ ------------
Notes receivable, less current installments $ 62,978 $ 53,201
============ ============75,595 70,955
======== ========
Interest income on notes receivable from Indian Tribes related to casino
development projects is deferred because realizability of the interest is
contingent upon the completion and positive operating cash flow from operation of the
casino. Interest deferred during the development period is recognized over the
remaining life of the note using the effective interest method. As of June 30, 200229,
2003 and December 30, 2001, $8.429, 2002, $12.2 million and $6.1$10.1 million of interest on notes
related to properties under development has been deferred.
Management periodically evaluates the recoverability of such notes receivable
based on the current and projected operating results of the underlying facility
and historical collection experience. No impairment losses on such notes
receivable have been recognized through June 30, 2002.29, 2003.
The terms of these notes require the casinos to be constructed and to generate
positive cash flows prior to the Company receiving repayment. As such, an
estimate of the fair value of these notes requires an assessment of the timing
of the construction of the related casinos and the profitability of the related
casinos. Due to the significant uncertainty involved in such an assessment, the
Company does not believe that it is practicable to accurately estimate the fair
value of these notes with the degree of precision necessary to make such
information meaningful.
1314
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. LONG-TERM DEBT
The Company currently has one note payable with a third party. This note is
collateralized by certificates of deposit, with $1.0 million outstanding at June
30, 2002 and December 30, 2001. Interest is compounded and paid on a quarterly
basis at 10%. The principal and any unpaid interest are due December 22, 2002. A
second note which was collateralized by property with $0.4 million outstanding
at June 20, 2002 and December 30, 2001 was paid off on June 20, 2002.
6. CAPITAL LEASE OBLIGATIONS
Pursuant to the terms of the Distribution Agreement, Grand assigned to Lakes,
and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes'
current corporate office space of approximately 65,000 square feet with a lease
term of fifteen years. The lease commenced on October 14, 1996. During 2001,
also pursuant to the terms of the Distribution Agreement, Lakes entered into a
capital lease arrangement for the corporate office space at which time the
operating lease was cancelled. Accordingly, Lakes recorded a capital leased
asset and liability in the amount of approximately $5.8 million. These amounts
are included in the accompanying consolidated balance sheet as of December 30,
2001. On January 2, 2002, the Company completed the purchase of its corporate
office building for $6.4 million, including transaction expenses. This
transaction resulted in the extinguishment of the Company's capital lease
obligation related to the building.
7. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company leases certain property and equipment, including an airplane, under
a non-cancelable operating lease. The airplane lease expiresexpired May 1, 2003 and was
renewed for a one-year period. The lease provides for twoone additional one-year
renewal terms.term. Approximate future minimum lease payments, due under this lease as
of June 30,
2002, considering both29, 2003, assuming the second one-year renewals arerenewal is exercised, are as
follows (in thousands):
Operating Leases
----------------
20022003 $ 300
2003 600
2004 600
2005 200
---------------
$ 1,700
=======1,100
========
PURCHASE OPTIONS
The Company has the right to purchase the airplane it leases during the base
lease term and any renewal term for approximately $8 million.
During 2001, the option to purchase the Cable property in Las Vegas, Nevada for
the purchase price of $39.1 million was allowed to lapse.
14
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
INDEMNIFICATION AGREEMENT
As a part of the transaction establishing Lakes as a separate public company on
December 31, 1998, the Company has agreed to indemnify Grand against all costs,
expenses and liabilities incurred in connection with or arising out of certain
pending and threatened claims and legal proceedings to which Grand and certain
of its subsidiaries are likely to be parties. The Company's indemnification
obligations include the obligation to provide the defense of all claims made in
proceedings against Grand and to pay all related settlements and judgments.
As security to support Lakes' indemnification obligations to Grand, Lakes has
agreed
to deposit an aggregate of $30 million, in trust for the benefit of Grand, as a
wholly owned subsidiary of Park Place, an aggregate of $30 million, to cover various commitments and
contingencies related to or arising out of Grand's non-Mississippi business and
assets (including by way of example, but not limitation, tribal loan guarantees,
real property lease guarantees for Lakes' subsidiaries and director and
executive officer indemnity obligations)
consisting of. The deposits were to be made in four
annual installments of $7.5 million, duringover the four-year period subsequent to
December 31, 1998. Any surplus proceeds remaining in this trust after all the secured
obligations arewere indefeasibly paid in full and discharged shallwere to be paid overreturned to
Lakes.
15
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Lakes made the first deposit of $7.5 million on December 31, 1999 and in July
2000, Lakes deposited
an additional $18 million in an escrow account in partial satisfaction
of the indemnification obligation.July 2000. The $18 million
deposit represented partial satisfaction of Lakes indemnification obligation
pursuant to a settlement agreement which was reached in June 2000 regarding both the
Stratosphere Shareholders'related to certain litigation and theclaims brought
against Grand Casinos, Inc. Shareholders'
litigation. Onby its shareholders. Upon receipt of a court order on August 14,
2001 the Court issued an order giving final approval to the settlement. As such,settlement, the $18 million in restricted cash
was removed from the Company's condensed consolidated balance sheet. In January
2001, Lakes also purchased the Shark Club property in Las Vegas for $10.1 million in
settlement of another Grand obligation that was subject to the indemnification
obligations.by Lakes. As of June 30,December 29, 2002, and December 30, 2001, $7.5 million related to security to support
Lakes' indemnification obligations to Grand iswas included as restricted cash in
the accompanying condensed consolidated balance sheets. In May 2003, $2.3
million was paid out of the trust to Stratosphere Corporation to satisfy Lakes'
indemnification obligations to Grand resulting from Grand's settlement of a
litigation claim seeking recovery of certain amounts paid by Stratosphere to
Grand and a subsidiary of Grand that were alleged to be preferential payments
under the bankruptcy laws. As this litigation claim was the last remaining known
material Grand obligation that was subject to indemnification by Lakes, the
trust account was terminated on May 8, 2003 and the remaining restricted funds
of approximately $5.9 million, including interest, were released to Lakes and
reclassified as unrestricted cash on Lakes' condensed consolidated balance sheet
as of June 29, 2003. Notwithstanding termination of the trust account, Lakes'
indemnification obligations to Grand remain in effect. Subsequent
indemnification obligations to Grand Casinos, if any, would be paid directly by
Lakes.
As part of the indemnification agreement, Lakes has agreed that it will not
declare or pay any dividends, make any distribution on account of Lakes' equity
interests, or otherwise purchase, redeem, defease or retire for value any equity
interests in Lakes without the written consent of Park Place.
LEGAL PROCEEDINGS
The following summaries describe certain known legal proceedings to which Grand
is a party which Lakes has assumed, or with respect to which Lakes may have
agreed to indemnify Grand, in connection with the Distribution.
15
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
SLOT MACHINE LITIGATION
In April 1994, William H. Poulos brought an action in the U.S. District Court
for the Middle District of Florida, Orlando Division -- William H. Poulos, et al
v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various
parties (including Grand) alleged to operate casinos or be slot machine
manufacturers were named as defendants. The plaintiff sought to have the action
certified as a class action.
A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et
al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was
consolidated with the Poulos action.
Both actions included claims under the federal Racketeering-Influenced and
Corrupt Organizations Act and under state law, and sought compensatory and
punitive damages. The plaintiffs claimed that the defendants are involved in a
scheme to induce people to play electronic video poker and slot machines based
on false beliefs regarding how such machines operate and the extent to which a
player is likely to win on any given play.
In December 1994, the consolidated actions were transferred to the U.S. District
Court for the District of Nevada.
In September 1995, Larry Schreier brought an action in the U.S. District Court
for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al
- -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier
action were similar to those made by the plaintiffs in the Poulos and Ahearn
actions, except that Schreier claimed to represent a more precisely defined
class of plaintiffs than Poulos or Ahearn.
In December 1996, the court ordered the Poulos, Ahearn and Schreier actions
consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et
al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the
plaintiffs to file a consolidated and amended complaint. In February 1997, the
plaintiffs filed a consolidated and amended complaint.
In March 1997, various defendants (including Grand) filed motions to dismiss or
stay the consolidated action until the plaintiffs submitted their claims to
gaming authorities and those authorities considered the claims submitted by the
plaintiffs.
In December 1997, the court denied all of the motions submitted by the
defendants, and ordered the plaintiffs to file a new consolidated and amended
complaint. That complaint has been filed. Grand has filed its answer to the new
complaint.
The plaintiffs have filed a motion seeking an order certifying the action as a
class action. Grand and certain of the defendants have opposed the motion. The
Court has not ruled on the motion.
16
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
STANDBY EQUITY COMMITMENT LITIGATION
In September 1997, the Stratosphere Trustee under the indenture pursuant to
which Stratosphere issued its first mortgage notes filed a complaint in the U.S.
District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company,
Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand
as defendant.
The complaint alleges that Grand failed to perform under the Standby Equity
Commitment entered into between Stratosphere and Grand in connection with
Stratosphere's issuance of such first mortgage notes in March 1995. The
complaint seeks an order compelling specific performance of what the Trustee
claims are Grand's obligations under the Standby Equity Commitment.
The Stratosphere Trustee filed the complaint in its alleged capacity as a third
party beneficiary under the Standby Equity Commitment. Pursuant to the Second
Amended Plan, a new limited liability company (the "Stratosphere LLC") was
formed to pursue certain alleged claims and causes of action that Stratosphere
and other parties may have against numerous third parties, including Grand
and/or officers and/or directors of Grand. The Stratosphere LLC has been
substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding.
In August 2000, the Court and the parties agreed to try the action upon an
amended joint pre-trial order and a series of post-trial briefs. Post-trial
briefing concluded on December 12, 2000 and oral argument was held on January
22, 2001. On April 4, 2001, the Court entered judgment in favor of Grand and
issued its findings of fact and conclusions of law.
The plaintiff filed an appeal with the Ninth Circuit Court of Appeals on May 4,
2001, Case No. 01-15947. On August 13, 2002, the Ninth Circuit affirmed the
prior ruling in favor of Grand.
STRATOSPHERE PREFERENCE ACTION
In April 1998, Stratosphere served on Grand and Grand Media & Electronics
Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a
complaint in the Stratosphere bankruptcy case seeking recovery of certain
amounts paid by Stratosphere to (i) Grand Media for electronic equipment
purchased by Stratosphere from Grand Media, and (ii) Grand as management fees
and for costs and expenses under a management agreement between Stratosphere and
Grand, and (ii)
Grand Media for electronic equipment purchased byGrand.
16
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Stratosphere from Grand Media.
Stratosphere claimsclaimed in its complaint that such amounts are recoverable by
Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand
responded to Stratosphere's complaint denying that Stratosphere is entitled to
recover the amounts described in the complaint. Discovery was completed on
December 31, 2001 and the case proceeded to trial before the United States
Bankruptcy Court for the District of Nevada on June 20, 2002.
A decision hasOn December 31, 2002, the Bankruptcy Court issued its final judgment holding
that: (i) payments to Grand Media for electronic equipment totaling
approximately $3.3 million are not yet been issued.
17
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
OTHER LITIGATIONrecoverable by Stratosphere as avoidable
preferences, and (ii) payment to Grand for management services in the
approximate amount of $2.3 million is recoverable by Stratosphere and an
avoidable preference. On May 8, 2003, this judgment was satisfied out of amounts
held in trust as security to support Lakes' indemnification obligations to
Grand. The Company hashad recorded a reserve assessment related to variousthis litigation
which exceeded the final judgment amount by $3.2 million. This amount was
reversed during the second quarter of the above
items based on management's best estimate. The reserve is reflected as2003 resulting in a litigation$3.2 million pre-tax
decrease in costs and claims accrual onexpenses in the accompanying consolidated balance sheet asstatement of
loss for the six months ended June 30, 2002.
Grand29, 2003 and the accompanying consolidated
statement of earnings for the three months ended June 29, 2003.
OTHER LITIGATION
Lakes areis involved in various other inquiries, administrative proceedings, and
litigation relating to contracts and other matters arising in the normal course
of business. While any proceeding or litigation has an element of uncertainty,
management currently believes that the final outcome of these matters is not
likely to have a material adverse effect upon Grand's or the Company's consolidated
financial position or results of operations.
8.7. RELATED PARTY TRANSACTIONS
During 2001 and 2000, Lakes made a total of $4.0 million in unsecured loans,
which were receivable in full on December 31, 2002, to ViatiCare Financial
Services, LLC, which has since been acquired by Living Benefits Financial
Services.Services ("Living Benefits"). In March 2001, the Board of Directors of Lakes
decided not to make further loans to ViatiCare. A $4.0 million impairment charge
for this note was recorded during the quarter ended June 30, 2002, due to
increased competition in the viatical insurance business and restrictions on
ability to make further policy acquisitions.
Subsequent to the decision by the Lakes Board to make no further loans to
ViatiCare, L. B. Acquisitions, LLC, which is owned by Lyle Berman, the Chief
Executive Officer and a Director of Lakes, has made loans to Living Benefits.
Advances outstanding were $6.0 million as of June 30, 2002 and $4.9 million as
of December 30, 2001. As an
incentive to make the loans, L. B. Acquisitions was granted an initial 9% voting
interest in Living Benefits and was given the option to convert the loan balance
into 45% of the voting interest in Living Benefits. Therefore, Lyle Berman,
through L. B. Acquisitions, beneficially owns a total of approximately 55% of
the voting interest of Living Benefits.
9. RESTATEMENT
Subsequent to the issuance of the Company's financial statements for the three
and six months ended July 1, 2001, management of the Company determined that the
interest on notes receivable related to the development of casinos should have
been deferred because the interest is not payable until the casinos are open and
generating operating cash flow. As a result, the accompanying consolidated
financial statements for the three and six month periods ended July 1, 2001 have
been restated to correct the accounting for these transactions.
1817
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
A summaryPreviously, Lakes formed two joint venture partnerships with Kean Argovitz
Resorts, LLC ("KAR"), a limited liability company based in Houston, Texas for
the purpose of developing and managing casino resort projects with the Shingle
Springs Band of Miwok Indians and the Jamul Indian Village, both in California.
On January 30, 2003, Lakes restructured a series of arrangements with KAR and
its individual members such that Lakes has effectively acquired 100% ownership
of the significant effectsjoint ventures in exchange for restructuring indebtedness of $1.8 million
from the joint venture partnerships to Lakes and an agreement to make certain
conditional payments to the individual KAR members from profits received under
the respective management contracts. While these conditional payments could
total up to $2 million per year for each project, Lakes believes these payments
will be substantially less than KAR would have received under their original
interest. The individual KAR members have options to repurchase their interest
or obtain a comparable financial interest, in the event they are found suitable
by relevant gaming regulatory authorities.
A subsidiary of Lakes and Land Baron West, LLC are partners in a joint venture
formed to develop or sell land purchased by the joint venture near San Diego,
California. Land Baron West, LLC owed the joint venture $0.5 million, and $0.2
million, as of June 29, 2003 and December 29, 2002, respectively. These amounts
are included in accounts receivable on the accompanying condensed consolidated
balance sheets.
During 2002, Lakes rented the use of Company equipment to another company that
had a mutual Board member during a portion of 2001. The transaction was for full
value of the restatement isassociated use and all payments totaling $0.02 million for such use
have been received.
8. SUBSEQUENT EVENT
SHARK CLUB
On July 1, 2003, Lakes completed the sale of its Shark Club property in Las
Vegas, Nevada to an entity to be managed and operated by Marriott Ownership
Resorts, Inc. As consideration for this sale, Lakes received $15.0 million in
cash, plus $1.0 million as follows:
Three Months Ended Six Months Ended
July 1, 2001 July 1, 2001
------------------------------ ------------------------------
As previously As previously
reported Restated reported Restated
------------- ------------ ------------- ------------
Statements of Earnings (Loss):
Interest Income $ 1,599 $ 593 $ 3,414 $ 1,473
Earnings before income taxes 7,086 6,080 15,081 13,139
Provision for income taxes 2,906 2,493 6,184 5,387
Net earnings 4,180 3,587 8,897 7,752
Basic Earnings Per Share $ 0.39 $ 0.34 $ 0.84 $ 0.73
Diluted Earnings Per Share 0.39 0.33 0.83 0.72
19repayment of a loan previously made to Chateaux by
Lakes.
18
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(UNAUDITED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As discussed in Note 9 to the consolidated financial statements included in Item
1, the accompanying consolidated financial statements have been restated. The
following Management's Discussion and Analysis reflects this restatement.
OVERVIEW
Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")
was established as a public corporation on December 31, 1998, via a distribution
(the "Distribution") of its Common Stock, to the shareholders of Grand Casinos,
Inc. ("Grand").
As a result of the Distribution, Lakes operates the Indian casino management
business and holds various other assets previously owned by Grand. Lakes' main
business is the development, construction and management of casinos and related
hotel and entertainment facilities in emerging and established gaming
jurisdictions. Lakes has entered into the following contracts for the
development, management and/or financing of new casino operations, all of which
are subject to various regulatory approvals before construction can begin: (1)
Lakes has a contract to be the exclusive developer and manager of an
Indian-owned gaming resort near New Buffalo, Michigan.Michigan for the Pokagon Band of
Potawatomi Indians. (2) Lakes and another
company have formed partnerships withhas entered into contracts to develop and manage
two casinos to be owned by Indian tribes in California, one near San Diego with
the Jamul Indian Village and the other near Sacramento.Sacramento with the Shingle Springs
Band of Miwok Indians. (3) Lakes and another company have formed a partnership
with a contract to finance the construction of an Indian-owned casino approximately 7560 miles
north of San Francisco, California. The Cloverdale Rancheria has notified the
partnership that the Rancheria wishes to terminate the relationship between the
two parties. The partnership has advised the Rancheria that the partnership
believes the contract is enforceable. The Rancheria acknowledges that the
partnership has loaned the Rancheria money and that the Rancheria will endeavor
to repay the money in a timely manner. (4) Lakes has also signed contracts with
the Nipmuc Nation, a Massachusetts Indian tribe, for development and management
of a potential future gaming resort in the eastern United States; however, this
tribe has received a negative finding regarding federal recognition from the
Bureau of Indian Affairs (BIA). The tribe has indicated
that it will submitsubmitted additional information
to the BIA for reconsideration.
Additionally, in March 2002, the Company made an investment in World Poker Tour,
LLC, a joint venture formed to film and produce poker tournaments for television
broadcast.In addition, Lakes owns options to purchase various new casino games and is
actively marketing these new games to the Shark Club property which iscasino industry in an approximate 3.5 acre undeveloped
site onattempt to have
a casino accept the Las Vegas Stripgames for use in Las Vegas, Nevada. During August 2002,their operations. Lakes has also formed a
joint venture with Diamond Resorts, LLC, a Nevada limited liabilityanother company and experienced time-share developer for the purpose of developing the
Shark Club parcel as an upscale time-share project. The terms of this joint
venture agreement require that Diamond and Lakes each make an initial working
capital contribution of $250,000. Subject to Diamond obtaining a financing
commitment for a construction loan sufficient to fund at least the first phase
of the building improvements contemplateddevelop approximately 2,000 acres owned by the time-share project,
the joint venture in eastern San Diego County in California. It is possible the
land will be sold in lieu of a development by the joint venture. Lakes has also
formed a joint venture with a producer to launch the World Poker Tour ("WPT")
and establish poker as the next significant televised mainstream sport. The
joint venture signed an agreement will require Lakes to contributewith the relevant portionTravel Channel ("TRV") in March 2003,
for broadcast of the Shark Club parcel, valued at $16 million. Diamond has agreed to perform sales,
marketing, administrative and managerial services for the project. The termsfirst season of the WPT series which has now been
completed. During July of 2003, WPT reached an agreement providewith TRV for a second
season with options for five additional seasons. Revenue is recognized ratably
as production milestones and other conditions are met. During the repaymentfirst two
quarters of 2003, Lakes recognized approximately $3.5 million in revenue related
to Lakes of its contribution of property
in cash based on the joint venture's cash flow and time-share unit sales. It is
contemplated that LakesWorld Poker Tour. Revenues related to the second season will be
required to make no other material contributions
of cash or property to the project.
20recognized during 2004.
19
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Lakes' historical revenues have been derived almost exclusively from management
fees. During 2001, Lakes managed a land-based, Indian-owned casino, Grand Casino
Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta"). Pursuant to the
Coushatta management contract, Lakes received a fee based on the net
distributable profits (as defined in the contracts) generated by Grand Casino
Coushatta. The management contract expired January 16, 2002, and was not
renewed. This non-renewal has resulted in the loss of revenues to the Company
derived from such contract, which has had a material adverse effect on the
Company's results of operations.
Lakes' limited operating history may not be indicative of Lakes' future
performance. In addition, a comparison of results from year to year may not be
meaningful due to the opening of new facilities and the buy-out and/or cessation
of other casino management contracts.
Lakes' growth strategy contemplates the development of existing projects, the
pursuit of opportunities to develop and manage additional gaming facilities and
the pursuit of new business opportunities. The successful implementation of this
growth strategy is contingent upon the satisfaction of various conditions,
including obtaining governmental approvals, the impact of increased competition,
and the occurrence of certain events, many of which are beyond the control of
Lakes.
CRITICALSIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies, which Lakes believes are the most critical
to aid in fully understanding and evaluating its reported financial results,
include the following: revenue recognition and realizability of notes
receivable.
REVENUE RECOGNITION: Revenue from the management of Indian-owned casino gaming
facilities is recognized when earned according to the terms of the management
contracts. Currently all of the Indian-owned casino projects that Lakes is
involved with are in development stages and are not yet open. Therefore, until a
project is open and operating, Lakes iswill not currently recognizingrecognize revenue related to
Indian casino management. REALIZABILITYInterest income on notes receivable for Indian tribes
related to casino development projects is deferred because realizability of the
interest is contingent upon the completion and generation of cash flow from the
operation of the casino. Interest deferred during the development period is
recognized over the remaining life of the note using the effective interest
method. Revenue from the World Poker Tour series is recognized ratably as
production milestones and other conditions are met.
IMPAIRMENT OF NOTES RECEIVABLE:LONG-TERM ASSETS: The Company's notes receivable from Indian
Tribes are generally for the development of gaming properties to be managed by
the Company. The repayment terms are specific to each tribe and are largely
dependent upon the operating performance of each gaming property. Repayments of
the notes receivable are required to be made only if distributable profits are
available from the operation of the related casinos. Repayments are also the
subject of certain distribution priorities specified in the management
contracts. In addition, repayment of the notes receivable and the manager's fees
under the management contracts may be subordinated to certain other financial
obligations of the respective casinos.tribes. Through December 30, 2001,June 29, 2003, no amountsimpairments have
been withheldrecorded under these provisions. Management periodically evaluates the
recoverability of such notes receivable based on the current and projected
operating results of the underlying facility and historical collection
experience.
21The Company currently holds land held for development and land held under
contract for sale. The Company periodically evaluates whether events and
circumstances have occurred that may affect the recoverability of the net book
value of these assets. If such events or circumstances indicate that the
carrying amount of an asset may not be recoverable, the Company estimates the
future cash flows expected to result from the use of the asset. If the sum of
the expected future undiscounted cash flows does not exceed the carrying value
of the asset, the Company will recognize an impairment loss.
20
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Interest income on notes receivable from Indian Tribes related to casino
development projects is deferred because realizability of the interest is
contingent upon the completion and operating cash flow of the casino. Interest
deferred during the development period is recognized over the remaining life of
the note using the effective interest method. As of June 30, 2002 and December
30, 2001, $8.4 million and $6.1 million of interest on notes related to
properties under development has been deferred.
The following discussion and analysis should be read in conjunction with the
condensed consolidated financial statements and notes thereto and management's
discussion and analysis included in the Company's Annual Report on Form 10-K/A10-K for
the year ended December 30, 2001.29, 2002.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" in November 2002. This interpretation elaborates on the disclosures to
be made by a guarantor in its financial statements about its obligations under
certain guarantees that it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee.
The initial recognition and initial measurement provisions of this
interpretation are applicable to all guarantees and modification to guarantees
made after December 31, 2002. The Company's disclosure of the indemnification
and guarantee agreements of the Company is in compliance with the
interpretation. The disclosure requirements in this interpretation are effective
for financial statements of interim or annual periods ended after December 15,
2002. The adoption of the interpretation did not have a material impact on the
Company's results of operations, financial position and cash flows. The Company
does have an indemnification agreement with Grand Casinos which is fully
described in the Financial Condition section of this Management's Discussion and
Analysis.
In July 2001,January 2003, the FASB issued SFASInterpretation No. 141, Business Combinations,46 (FIN46), "Consolidation
of Variable Interest Entities", which addresses the consolidation of variable
interest entities. The interpretation applicable immediately to variable
interest entities created after January 31, 2003, and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requiresto variable interest
entities in which a Company obtains an interest after that all
business combinationsdate. For variable
interests in variable interest entities acquired before February 1, 2003, the
interpretation applicable applies in the first interim period beginning after
June 15, 2003. The Company has determined that it has no investments or other
interests in entities that may be accounted fordeemed variable interest entities under a single method, the
purchase
method. SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets.
In June 2001,provisions of FIN 46, as the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 supersedes previous guidance for financial accounting
and reporting for obligations associateddevelopment projects subject to the management
agreements with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies toIndian Tribes are not separate entities or legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset.structures.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets", which provides new accounting and financial
reporting guidance for the impairment or disposal of long-lived assets and the
disposal of segments of a business.
In JuneDecember 2002, the FASB issued SFAS No. 146,148, "Accounting for Costs Associated
with Exit or Disposal Activities"Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123". SFAS No. 146 requires148 provides alternative transition methods for companies that
make a liabilityvoluntary change to the fair-value-based method of accounting for
a
cost associated with an exit or disposal activity be recognized when the
liability is incurred.stock-based employee compensation. In addition, SFAS No. 146 eliminates148 amends the
definitiondisclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and requirementinterim financial statements about the method of accounting for
recognitionstock-based employee compensation and the effect of exit costs in Emerging Issues Task Force Issue No. 94-3 where
a liability for an exit is recognized at the date of an entity's commitment to
an exit plan. This statement is effective for exit or disposal activities
initiated after December 31, 2002.method used on reported
results. The Company does not believe thathas adopted the disclosure provisions of SFAS No. 148 and
its adoption of these statements will have a
materialhad no impact on itsthe Company's consolidated financial position or
results of operations.
2221
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
RESULTS OF OPERATIONS
Revenues are calculated in accordance with accounting principles generally
accepted in the United States of America and are presented in a manner
consistent with industry practice. Historically, net distributable profits by
the Indian casinos were computed using a modified cash basis of accounting in
accordance with the management contracts to calculate management fees. Under
this modified cash basis of accounting prescribed by the management contracts,
the write-off of capital equipment and leased assets for the casino operations
was accelerated, which thereby impacted the timing of net distributable profits.
SIX MONTHS ENDED JUNE 30, 200229, 2003 COMPARED TO THE SIX MONTHS ENDED JULY 1, 2001JUNE 30, 2002
Revenues
Total revenues were $1.5$3.5 million for the six months ended June 30, 200229, 2003 compared
to $18.8$1.5 million for the same period in the prior year. Revenues in both yearsfor the current
year period were derived entirely from license fees related to the WPT series,
which has now completed its first full season. An agreement for a WPT second
season was reached during July of 2003. Under the new agreement, WPT will
receive a series of fixed license payments for the second season. These payments
will commence in 2004 and are subject to satisfaction of production milestones
and other conditions. WPT is also entitled to a portion of the revenues from
other sources including international distribution, merchandising and certain
sponsorships, and WPT is currently exploring these opportunities. Revenues for
the prior year period were derived entirely from management fees from the
management of Grand Casino Coushatta. Revenues and earnings for the current year were less than the same period last
year primarily due to the expiration of theThe management contract with the Coushatta
Tribe of Louisiana for Grand Casino Coushatta expired on January 16, 2002. The
Company's revenues and earnings will not include contributions from the
Coushatta operation going forward. As of June 30, 2002, the Company currently has no other management contracts from which it will derive
revenues in 2002.2003.
Costs and Expenses
Total costs and expenses were $11.9$5.0 million for the six months ended June 30,
2002,29,
2003, compared to $6.2$11.9 million for the same period in the prior year. Selling,
general and administrative expenses increaseddecreased from $5.5$11.7 million for the six
months ended July 1, 2001June 30, 2002 to $11.7$7.9 million for the six months ended June 29,
2003. This decrease is the result of impairment charges taken in the prior year
period of $4.0 million relating to a note receivable from Living Benefits, LLC,
and $3.0 million relating to the Polo Plaza and Travelodge properties, which was
partially offset by an increase in professional fees of approximately $1.4
million related to the property sales in Las Vegas, Nevada, as well as an
increase in costs incurred associated with WPT in the amount of $2.2 million
during the current year period. Also during the current year period, the Company
reversed a reserve assessment related to Stratosphere litigation which exceeded
the final judgment amount resulting in a reversal of litigation and claims
accrual in the amount of $3.2 million.
22
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Other
Interest income was $0.6 million for the six months ended June 29, 2003 compared
to $1.2 million for the same period in the prior year. This decrease is
primarily due to lower cash balances during the period.
Losses Per Common Share and Net Losses
For the six months ended June 29, 2003, basic and diluted losses per common
share were $0.05, compared to basic and diluted losses of $0.68, for the same
period in the prior year. Losses for the period ended June 29, 2003 were $0.5
million compared to $7.2 million for the six months ended June 30, 2002. This
increasedecrease in losses is primarily due to anthe impairment charges of $7.0 million
taken in the prior year period discussed above. Also contributing to the
decrease was the WPT revenue of $3.5 million recognized in 2003, compared to
management fee income of $1.5 million related to the management of Grand Casino
Coushatta, recognized in the prior year period.
THREE MONTHS ENDED JUNE 29, 2003 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2002
Revenues
Total revenues were $3.0 million for the three months ended June 29, 2003. There
were no revenues in the same period in the prior year. Revenues for the current
year period were derived entirely from license fees related to the WPT series,
which has now completed its first full season. An agreement for a WPT second
season was reached during July 2003. Revenue from the second season will be
recognized in 2004 as production milestones and other conditions are met.
Costs and Expenses
Total costs and expenses were $1.9 million for the three months ended June 29,
2003, compared to $9.7 million for the same period in the prior year. Selling,
general and administrative expenses decreased from $9.6 million for the three
months ended June 30, 2002 to $5.0 million for the three months ended June 29,
2003. This decrease is primarily due to a second quarter 2002 impairment of the $4.0
million relating to a note receivable from Living Benefits Financial Services,
LLC, as well as thea $3.0 million additional impairment charge taken on the Polo Plaza and
Travelodge properties, during the second quarter of 2002. The impairment charge is described
under "Liquidity and Capital Resources" below. This increase iswhich was partially offset by a decline in rent expense resulting from the purchase of the corporate office
building in January 2002. Fewer costs relating to travel also partially offset
thean increase in selling, general and administrative expensesprofessional
fees of approximately $1.4 million related to the property sales in Las Vegas,
Nevada, as well as an increase in costs incurred associated with WPT in the
amount of $1.2 million during the current year period. Other
Interest income was $1.2 million for the six months ended June 30, 2002 compared
to $1.5 million for the six months ended July 1, 2001. Equity in loss of
unconsolidated affiliates was $0.2 million and $0.3 million for the six months
ended June 30, 2002 and July 1, 2001, respectively. Write-down of unconsolidated
affiliates was $0.7 million for the six months ended July 1, 2001. In June 2001,
Lakes entered into an agreement with New Horizon Kids Quest (NHKQ), pursuant to
which NHKQ acquired Lakes' interest in NHKQ. As a result, Lakes incurred a
one-time write-down charge of $0.7 million before tax. There were no such
write-downsAlso during the current
year period.period, the Company reversed a reserve assessment related to Stratosphere
litigation which exceeded the final judgment amount resulting in a reversal of
litigation and claims accrual in the amount of $3.2 million.
23
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Earnings per Common Share and Net Earnings
For the six months ended June 30, 2002, basic and diluted losses per common
share were ($0.68). This compares to basic and diluted earnings per common share
of $0.73 and $0.72, respectively, for the six months ended July 1, 2001. Net
losses totaled $7.2 million for the six months ended June 30, 2002 compared to
earnings of $7.8 million for the six months ended July 1, 2001. The decrease in
earnings relates primarily to the expiration of the management contract for
Grand Casino Coushatta on January 16, 2002 described above, as well as the
ViatiCare note receivable impairment and impairment on Polo Plaza and Travelodge
properties described above.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THE THREE MONTHS ENDED JULY 1, 2001
Revenues
Total revenues were $9.6 million for the three months ended July 1, 2001, which
were derived from fees related to the management of Grand Casino Coushatta.
There were no revenues during the current year quarter due to the expiration of
the management contract with the Coushatta Tribe of Louisiana for Grand Casino
Coushatta on January 16, 2002. The Company's revenues and earnings will not
include contributions from the Coushatta operation going forward. As of June 30,
2002, the Company has no other management contracts from which it will derive
revenues in 2002.
Costs and Expenses
Total costs and expenses were $9.7Other
Interest income was $0.3 million for the three months ended June 30,
2002,29, 2003
compared to $3.3$0.4 million for the same period in the prior year. Selling,
generalThis decrease is
primarily due to lower cash balances during the period.
Earnings Per Common Share and administrative expenses increased from $2.9 millionNet Earnings
For the three months ended June 29, 2003, basic and diluted earnings per common
share were $0.07, compared to basic and diluted losses of $0.67, for the same
period in the prior year. Earnings for the three months ended July 1, 2001June 29, 2003 were
$0.8 million compared to $9.6losses of $7.2 million for the three months ended June
30, 2002. This increase isin earnings relates primarily due to anthe impairment charges
of $7.0 million taken in the $4.0 million note
receivable from Living Benefits Financial Services, LLC, as well as the $3.0
million additional impairment charge taken on the Polo Plaza and Travelodge
properties during the second quarter of 2002. This increase is partially offset
by a decline in rent expense resulting from the purchase of the corporate office
building in January 2002. Fewer costs relatingprior year period discussed above. Also
contributing to travel also partially offset the increase was the WPT revenue recognized in selling, general and administrative expenses during the current year
period.
Other
Interest income was $0.4 millionquarter.
Outlook
It is currently contemplated that there will be no operating revenues for the
threeremainder of 2003 from existing casino development projects or from the World
Poker Tour. Although none of the existing casino development projects are
expected to produce revenue in 2003, Lakes continues to evaluate potential new
revenue-generating business opportunities. The Company recently signed an
agreement with TRV for a second season of the WPT series. Costs associated with
WPT are expected to remain primarily consistent during the third and fourth
quarters of 2003. However, revenues related to the second season will not be
recognized until 2004, as production milestones and other conditions are met.
Lakes anticipates that second season revenues from all sources will allow WPT to
be profitable in 2004 and future years, thereby being incremental to Lakes'
earnings and reducing financial risks associated with this venture. Lakes
continues to closely monitor its operating expenses.
FINANCIAL CONDITION
At June 29, 2003, Lakes had $23.4 million in unrestricted cash and cash
equivalents. Subsequent to June 29, 2003, Lakes has received $15.0 million in
cash related to the sale of the Shark Club property and $1.0 million as
repayment of a loan previously made to Chateaux by Lakes. Lakes considers its
cash position, which includes the payments received upon the sale of the Shark
Club property, adequate to cover expected remaining 2003 operating expenses. For
the six months ended June 29, 2003, net cash used in operating activities
totaled $4.0 million. For the six months ended June 30, 2002, compared to $0.6 million fornet cash used in
operating activities totaled $0.5 million. For the samecurrent year period, innet cash
provided by investing activities totaled $13.3 million. For the prior year. Equity in loss
of unconsolidated affiliates was $0.1 million and $0.2 million for the threesix months ended
June 30, 2002, net cash used in investing activities totaled $15.6 million.
Included in these investing activities for the periods ended June 29, 2003 and
July 1, 2001,June 30, 2002 are advances on notes receivable of $6.6 million and $9.9 million,
respectively. Net receipts from land held under contract for sale were $16.3
million during the six months ended June 29, 2003. Payments for land held under
contract for sale were $0.7 million for the six months ended June 30, 2002.
24
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Earnings per Common ShareUnrestricted cash increased by $5.9 million during the 2003 period as a result
of the reclassification of restricted cash as unrestricted. During the periods
ended June 29, 2003 and Net Earnings
For the three months ended June 30, 2002, basicpayments for land held for development
amounted to $1.6 million and diluted losses per common
share were ($0.67). This compares$4.9 million, respectively.
Lakes plans to basic and diluted earnings of $0.34 and
$0.33, respectively, per common share,use its cash for the three months ended July 1, 2001.
Losses totaled $7.2 million for the three months ended June 30, 2002 compared to
earnings of $3.6 million for the three months ended July 1, 2001. The decrease
in earnings relates primarily to the expiration of the management contract for
Grand Casino Coushatta on January 16, 2002 described above, as well as the
Living Benefits note receivable impairment and impairment on Polo Plaza and
Travelodge properties described above.
Outlook
Except for fees earned from the management of Grand Casino Coushatta through
January 16, 2002, it is currently contemplated that there will be no additional
operating revenues for the remainder of 2002. Although none of the existing
casino development projects are expected to produce revenue in 2002, Lakes
continues to evaluate potential new revenue-generating business opportunities.
Lakes continues to closely monitor its operating expenses. Currently, operating
expenses are expected to remain consistent for the remainder of 2002, except for
the non-recurring effect of the Living Benefits note receivable impairment and
impairment on Polo Plaza and Travelodge properties described above. The
Company's cash position is considered adequate to cover expected 2002 operating
expenses.
CAPITAL RESOURCES, CAPITAL SPENDING, AND LIQUIDITY
At June 30, 2002, Lakes had $29.7 million in restricted and unrestricted cash
and cash equivalents. The Company also had $1.0 million in short-term,
available-for-sale investments, consisting primarily of a fixed income portfolio
made up of various types of bonds which are rated A1 or better. The cash and
short-term investment balances are planned to be used to fund operating expenses
and forcontinuing operations, loans to current joint
ventureventures and tribal partners to develop existing and anticipated Indian casino
operations, the pursuit of additional business opportunities, and settlement of
pending litigation matters. The amount and timing of Lakes' cash outlays for
casino development loans will depend on the timing of the regulatory approval
process and the availability of external financing. When approvals are received,
additional financing will be needed to complete the projects. It is currently
planned that this third-party financing will be obtained by each individual
tribe. However, there can be no assurance that if third-party financing is not
available, Lakes will not be required to finance these projects directly. If
Lakes must provide this financing, Lakes expects to obtain debt or equity
financing which it would loan to the respective tribes as necessary. In the
alternative, Lakes may be required to guarantee the tribes' debt financing or
otherwise provide support for the tribes' obligations. Any guarantees by Lakes
or similar off-balance sheet liabilities will increase Lakes' potential exposure
in the event of a default by any of these tribes.
At June 29, 2003, Lakes had approximately $75.6 million in notes receivable from
Indian tribes and other parties. Most of these amounts are advances made to the
tribes for the development of gaming properties managed by Lakes. See Note 5 to
the Consolidated Financial Statements included in Item 1.
The joint venture entities that hold the management contracts for the San Diego
and Sacramento area casino resorts were previously jointly owned with two LLC's
owned by Kevin M. Kean and Jerry A. Argovitz, (the "KAR Entities"). On January
30, 2003, subsidiaries of Lakes purchased the respective joint venture interests
of the KAR Entities for nominal consideration, at which time the joint venture
entities became indirect wholly owned subsidiaries of Lakes. At the time of the
purchase, Lakes or its subsidiaries had notes receivable from the KAR Entities
and a long-term receivable from Kevin M. Kean that, as of December 29, 2002,
were in the amounts of $1.8 million and $1.9 million, respectively. In
connection with the purchase transactions, Lakes and certain of its subsidiaries
entered into separate agreements with Kevin M. Kean and Jerry A. Argovitz, the
two individual owners of the KAR Entities. Under these agreements, Lakes and its
subsidiaries have forgiven the notes receivable from the KAR Entities, subject
to the agreements of Messrs. Kean and/or Argovitz to assume the obligations
under the notes in certain circumstances.
Under the agreements with Kevin M. Kean, Mr. Kean may elect to serve as a
consultant to Lakes' subsidiaries during the term of each subsidiary's casino
management contract if he is found suitable by relevant gaming regulatory
authorities. In such event, Mr. Kean will be entitled to receive annual
consulting fees equal to 20% of the management fees from the San Diego area
casino operations and 15% of the management fees from the Sacramento area casino
operations, less certain costs of these operations.
25
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
If Mr. Kean is found suitable by relevant gaming regulatory authorities and
elects to serve as a consultant, he will be obligated to repay 50% of the notes
receivable from the KAR Entities. If Mr. Kean is not found suitable by relevant
gaming regulatory authorities or otherwise elects not to serve as a consultant,
he will be entitled to receive annual payments of $1 million from each of the
San Diego and Sacramento area casino projects during the term of the respective
casino management contracts (but not during any renewal term of such management
contracts). Regardless of whether Mr. Kean serves as a consultant, a Lakes
subsidiary has agreed to loan up to $1.25 million to Mr. Kean, $1 million of
which must be used to fund certain obligations of Mr. Kean related to a separate
joint venture formed to acquire land in the San Diego area. Mr. Kean's personal
indebtedness to Lakes remained outstanding. Mr. Kean has agreed that 50% of the
consulting fees or other payments payable to him under the agreements with Lakes
and its subsidiaries shall be applied toward repayment of his indebtedness to
Lakes. In the event of a default under the agreements, 100% of the fees and
payments will be applied toward repayment of his indebtedness to Lakes.
Under the agreements with Jerry A. Argovitz, if Mr. Argovitz is found suitable
by relevant gaming regulatory authorities, he will be entitled to purchase for
nominal consideration a 20% equity interest in the Lakes subsidiary holding a
management contract with the San Diego area casino and a 15% equity interest in
the Lakes subsidiary holding a management contract with the Sacramento area
casino. Upon such purchase, Mr. Argovitz will become obligated to repay 50% of
the notes receivable from the KAR Entities. If he is not found suitable or does
not elect to purchase equity interests in the Lakes subsidiaries, Mr. Argovitz
may elect to receive annual payments of $1 million from each of the San Diego
and Sacramento area casino projects from the date of election through the term
of the respective casino management contracts (but not during any renewal term
of such management contracts).
As part of a recently announced investment in World Poker Tour, LLC, a joint venture formed towhich will televise poker tournaments, the Company
was required to investinvested $0.1 million for an approximately 78% ownership position in the joint
venture.venture during 2002. The Company is also required to loan up to $3.2 million to
the joint venture as needed. As of June 30, 2002, $0.729, 2003, the Company had made net loans
totaling $1.8 million in advances had been made by Lakes on
this loan.
25
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
For the six months ended June 30, 2002, net cash used in operating activities
totaled $0.5 million. For the six months ended July 1, 2001, net cash provided
by operating activities totaled $6.6 million. A $15.0 million reduction in net
earnings was partially offset by changes in accounts receivable, which increased
by $4.8 million during the 2001 period and decreased by $3.6 million during the
2002 period. Also contributing to the variance were changes in income taxes
payable which increased by $3.1 million during the 2001 period and decreased by
$3.5 million during the 2002 period. For the six months ended June 30, 2002 and
July 1, 2001, net cash used in investing activities totaled $15.6 million and
$8.0 million, respectively. Included in these investing activities for the six
months ended June 30, 2002 and July 1, 2001, are proceeds primarily from
repayment of notes receivable from Indian-owned casinos, which amounted to $0.1
million and $5.9 million, respectively. Advances under notes receivable were
$9.9 million and $16.3 million for the six months ended June 30, 2002 and July
1, 2001, respectively. There was a net decrease in short-term investments of
$1.1 million and $21.9 million for the six months ended June 30, 2002 and July
1, 2001, respectively.
Also during these periods, payments for land held for development amounted to
$4.9 million and $15.4 million, respectively. Included in the payments for land
held for development of $15.4 million during the six months ended July 1, 2001
was the purchase of the Shark Club property in Las Vegas, Nevada for
approximately $10.1 million. The remaining decrease in payments made for land
held for development from the prior period to the current year period is the
result of the transfer of title and ownership obligations related to the Polo
Plaza Shopping Center to Metroflag Polo, LLC, and transfer of rights and
obligations related to the Travelodge site to Metroflag BP, LLC, on December 28,
2001.
As a part of the agreements dated as of June 30, 1998, by and among Hilton
Hotels Corporation, Park Place, Gaming Acquisition Corporation, Lakes and Grand,
the Company has agreed to indemnify Grand Casinos, Inc. against all costs,
expenses and liabilities incurred in connection with or arising out of certain
pending and threatened claims and legal proceedings to which Grand and certain
of its subsidiaries are likely to be parties. The Company's indemnification
obligations include the obligation to provide the defense of all claims made in
proceedings against Grand and to pay all related settlements and judgments. See
Part II, Item 1. Legal Proceedings.
As security to support Lakes' indemnification obligations to Grand, Lakes agreed
to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of
Park Place, an aggregate of $30 million, consisting of four annual installments
of $7.5 million during the four-year period subsequent to December 31, 1998.
Lakes' ability to satisfy this funding obligation is materially dependent upon
the continued success of its operations and the general risks inherent in its
business. In the event Lakes is unable to satisfy its funding obligation, it
would be in breach of its agreement with Grand, possibly subjecting itself to
additional liability for contract damages, which could have a material adverse
effect on Lakes' business and results of operations. The Company made the first
deposit of $7.5 million on December 31, 1999.
26
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
In 2000, Lakes deposited $18.0 million into an escrow account on behalf of the
recipients in the Stratosphere shareholders' litigation and the Grand Casinos,
Inc. shareholders' litigation. As the $18.0 million was paid out during 2001,
the remaining deposit of $7.5 million is included as restricted cash in the
accompanying consolidated balance sheets as of June 30, 2002 and December 30,
2001. In January 2001, Lakes also purchased the Shark Club property in Las Vegas
for $10.1 million in settlement of another claim that was subject to the
indemnification obligations.joint venture.
On December 28, 2001, the Company transferred title and ownership obligations of
the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction
with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and
obligations of the adjacent Travelodge property consisting of a long-term land
lease and a motel operation. This transaction was accounted for under the
deposit method of accounting under the requirements of Statement of Financial
Accounting Standards No. 66, Accounting for Sales of Real Estate rather than as
a sale. Therefore, the fair value of the property iswas included as land held
under contract for sale inon the accompanying balance sheetssheet as of June 30, 2002 and
December 30, 2001.29,
2002. The transactiontotal price for this combined transaction was approximately $30.9
million. Terms of the transaction include a $1.0 million down payment, which was
received in January 2002, a contractual commitment to pay to Lakes $23.3 million by December
29, 2002,
and a second contractual commitment to pay Lakes $7.5 million.
26
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
During 2002, Lakes and Metroflag restructured the terms of the Polo Plaza and
Travelodge property transactions due to deteriorating economic conditions. The
parties reduced the purchase price for the Polo Plaza property from $23.8
million to $21.8 million. On the payment date, which was scheduled to be no
later than January 31, 2003, $16.8 million of the purchase price was to be
payable to Lakes in cash and $4.0 million was to be payable through the issuance
to Lakes of a preferred membership interest in Metroflag. During 2002, Lakes
recorded a $3.0 million impairment charge for these properties relating to the
adjustment in the purchase price and a negotiated potential discount on June
30, 2004.the
return of Lakes' preferred interest. Lakes' collateral for the two contractual
commitments is the property and lease rights described above which would revert
back to Lakes in the event of default by Metroflag.
The transaction was closed subject to certain administrative
post-closing conditions that must be satisfied within six months after the
closing. This post-closing period has been extended through September 27, 2002.
CertainDuring March of these conditions have not yet been satisfied as of September 15,
2002. If the conditions are not satisfied or waived by Metroflag within the
prescribed period, Metroflag has the right to require Lakes to repurchase the
properties.2003, Lakes and Metroflag have agreed in principle, subject to proper documentation,additional revisions to restructure the
terms of the Polo Plaza and Travelodge property transactions
due to deteriorating economic conditions.transactions. The parties have
agreed in principle
to reduceincreased the purchase price of the Polo Plaza property from $23.3$21.8 million to $21.3$25.8
million. On the payment date, which is scheduledwas extended to be no later than January 31,May 15, 2003, $17.3$16.8 million
of the purchase price will bewas paid to Lakes in cash, and $4.0 million will bewas paid through
the issuance to Lakes of a preferred membership interest in Metroflag and $4.0
million was paid through the issuance to Lakes of a subordinated membership
interest in Metroflag. On or before the first anniversary of the payment date,April 30, 2004, Metroflag Polo may elect to
distribute to Lakes $3.0 million plus interest in cash as full return of Lakes'
preferred interest. If Lakes' preferredpaid after April 30, 2004 and in no event later than
December 24, 2006, the entire $4.0 million plus interest remainswill be payable. The
subordinated interest must be repurchased for $4.0 million at the time of
repayment of an outstanding $3.5 million contractual commitment in connection
with the Travelodge property, which is scheduled on or before December 28, 2004.
If the Travelodge commitment is not repaid by December 28, 2004, ownership of
the Travelodge lease rights would revert back to Lakes. If at any time on or
after the fourth anniversary ofPolo
Plaza property is sold and the payment date, Lakes can requireTravelodge commitment has not been repaid,
Metroflag is required to repurchase the preferredsubordinated interest for the lesser of
$4.0 million plus a priority returnor any portion of eight percent (8%) per annum. Effective June 30, 2002,the net cash proceeds from such sale or
refinancing that exceeds $60.0 million.
In March of 2003, the parties decreased the sale price of the Travelodge
property from $7.5 million to $3.5 million. The contractual commitment to pay
Lakes recorded a $3.0was also decreased from $7.5 million impairment charge for these properties relating to $3.5 million and is now payable no
later than December 28, 2004.
On July 1, 2003, Lakes completed the adjustment in the
purchase price and the potential discount on the returnsale of Lakes' preferred
interest.
Lakes continues to own theits Shark Club property which isin Las
Vegas, Nevada to an approximate 3.5 acre
undeveloped site adjacententity to the Polo Plaza shopping centerbe managed and Travelodge
sites.operated by Marriott Ownership
Resorts, Inc. As consideration for this sale, Lakes received $15.0 million in
cash, plus $1.0 million as repayment of a loan previously made to Chateaux by
Lakes.
27
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
During August 2002, Lakes formed a joint venture with Diamond Resorts, LLC, a
Nevada limited liability company and experienced time-share developer for the
purpose of developing the Shark Club parcel as an upscale time-share project.
The terms of this joint venture agreement require that Diamond and Lakes each
make an initial working capital contribution of $250,000. Subject to Diamond
obtaining a financing commitment for a construction loan sufficient to fund at
least the first phase of the building improvements contemplated by the
time-share project, the joint venture agreement will require Lakes to contribute
the relevant portion of the Shark Club parcel, valued at $16 million. Diamond
has agreed to perform sales, marketing, administrative and managerial services
for the project. The terms of the agreement provide for the repayment to Lakes
of its contribution of property in cash based on the joint venture's cash flow
and time-share unit sales. It is contemplated that Lakes will be required to
make no other material contributions of cash or property to the project.
Lakes has approximately $63.0 million in notes receivable from Indian tribes and
other parties. Most of these amounts are advances made to the tribes for the
development of gaming properties managed by Lakes. See Note 4 to the
Consolidated Financial Statements.
Notes receivable from the Coushatta Tribe of Louisiana were $0.1 million at
December 30, 2001. The outstanding balance was repaid at the conclusion of the
management agreement on January 16, 2002. In addition, Lakes was previously the
guarantor of a loan agreement entered into by the Coushatta Tribe in the amount
of $25.0 million, with a balance of $6.8 million outstanding at December 30,
2001. Lakes was released from the guaranty agreement on January 16, 2002.
On January 2, 2002, the Company completed the purchase of its corporate office
building in Minnetonka, Minnesota for $6.4 million, including transaction
expenses. This transaction resulted in the extinguishment of the Company's
capital lease obligation related to the building.
OBLIGATIONS
The Company currently has one note payable with a third party. This note is
collateralized by certificates of deposit, with $1.0 million outstanding at June
30, 2002 and December 30, 2001. Interest is compounded and paid on a quarterly
basis at 10%. The principal and any unpaid interest are due December 22, 2002. A
second note which was collateralized by property with $0.4 million outstanding
at June 20, 2002 and December 30, 2001 was paid off on June 20, 2002.
Pursuant to the terms of the Distribution Agreement, Grand Casinos assigned to
Lakes, and Lakes assumed, a lease agreement dated February 1, 1996 covering
Lakes' current corporate office space of approximately 65,000 square feet with a
lease term of fifteen years. The lease commenced on October 14, 1996. During
2001, also pursuant to the terms of the Distribution Agreement, Lakes entered
into a capital lease arrangement for the corporate office space at which time
the operating lease was cancelled. Accordingly, Lakes recorded a capital leased
asset and liability in the amount of approximately $5.8 million. These amounts
are included in the accompanying consolidated balance sheet as of December 30,
2001. On January 2,
2002, as per the agreement with Grand Casinos, Lakes purchased the building for
$6.4 million, including transaction expenses. This transaction resulted in the
extinguishment of the Company's capital lease obligation related to the
building.
The Company had two notes payable with third parties, which were repaid during
2002. The first was collateralized by certificates of deposit, in the amount of
$1.0 million. The second was collateralized by property in the amount of $0.4
million.
As a part of the agreements resulting from Lakes' spin-off from Grand Casinos
and related transactions, Lakes has agreed to indemnify Grand Casinos against
all costs, expenses and liabilities incurred in connection with or arising out
of certain pending and threatened claims and legal proceedings to which Grand
Casinos and certain of its subsidiaries are likely to be parties. The Company's
indemnification obligations include the obligation to provide the defense of all
claims made in proceedings against Grand Casinos and to pay all related
settlements and judgments. See Part II Item 1. Legal Proceedings. As of December
29, 2002, Lakes had $7.5 million deposited in trust as discussed above.
28
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)security to support
Lakes' indemnification obligations to Grand Casinos. In May 2003, $2.3 million
was paid out of the trust to Stratosphere. Following such payment, the trust
account was terminated and the remaining restricted funds of approximately $5.9
million, including interest, were released to Lakes and reclassified as
unrestricted cash on Lakes' condensed consolidated balance sheet as of June 29,
2003. Notwithstanding termination of the trust account, Lakes' indemnification
obligations to Grand remain in effect. Subsequent indemnification obligations to
Grand Casinos, if any, would be paid directly by Lakes.
SEASONALITY
The Company believes that the operations of all casinos to be managed by the
Company will be affected by seasonal factors, including holidays, weather and
travel conditions.
REGULATION AND TAXES
The Company is subject to extensive regulation by state gaming authorities. The
Company will also be subject to regulation, which may or may not be similar to
current state regulations, by the appropriate authorities in any other
jurisdiction
where it may conduct gaming activities in the future. Changes in applicable laws
or regulations could have an adverse effect on the Company.
28
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
The gaming industry represents a significant source of tax revenues. From time
to time, various federal legislators and officials have proposed changes in tax
law, or in the administration of such law, affecting the gaming industry. It is
not possible to determine the likelihood of possible changes in tax law or in
the administration of such law. Such changes, if adopted, could have a material
adverse effect on the Company's results of operations and financial results.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" in November 2002. This interpretation elaborates on the disclosures to
be made by a guarantor in its financial statements about its obligations under
certain guarantees that it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee.
The initial recognition and initial measurement provisions of this
interpretation are applicable to all guarantees and modification to guarantees
made after December 31, 2002. The Company's disclosure of the indemnification
and guarantee agreements of the Company is in compliance with the
interpretation. The disclosure requirements in this interpretation are effective
for financial statements of interim or annual periods ended after December 15,
2002. The adoption of the interpretation did not have a material impact on the
Company's results of operations, financial position and cash flows. The Company
does have an indemnification agreement with Grand Casinos which is fully
described in the Financial Condition section of this Management's Discussion and
Analysis.
In January 2003, the FASB issued Interpretation No. 46 (FIN46), "Consolidation
of Variable Interest Entities", which addresses the consolidation of variable
interest entities. The interpretation applicable immediately to variable
interest entities created after January 31, 2003, and to variable interest
entities in which a Company obtains an interest after that date. For variable
interests in variable interest entities acquired before February 1, 2003, the
interpretation applicable applies in the first interim period beginning after
June 15, 2003. The Company has determined that it has no investments or other
interests in entities that may be deemed variable interest entities under the
provisions of FIN 46, as the development projects subject to the management
agreements with the Indian Tribes are not separate entities or legal structures.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123". SFAS No. 148 provides alternative transition methods for companies that
make a voluntary change to the fair-value-based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company has adopted the disclosure provisions of SFAS No. 148 and
its adoption had no impact on the Company's consolidated financial position or
results of operations.
29
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
PRIVATE SECURITIES LITIGATION REFORM ACT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information included in this integrated
Quarterly Report on Form 10-Q10-K
and other materials filed or to be filed by the Company with the Securities and
Exchange Commission (as well as information included in oral statements or other
written statements made or to be made by the Company) contain statements that
are forward-looking, such as plans for future expansion and other business
development activities as well as other statements regarding capital spending,
financing sources and the effects of regulation (including gaming and tax
regulation) and competition.
Such forward-lookingforward looking information involves important risks and uncertainties that
could significantly affect the anticipated results in the future and,
accordingly, actual results may differ materially from those expressed in any
forward-looking statements made by or on behalf of the Company.
These risks and uncertainties include, but are not limited to, those relating to
possible delays in completion of Lakes' casino projects, including various
regulatory approvals and numerous other conditions which must be satisfied
before completion of these projects; possible termination or adverse
modification of management contracts; continued indemnification obligations to
Grand;Grand Casinos; highly competitive industry; possible changes in regulations;
reliance on continued positive relationships with Indian tribes; possible impairmenttribes and repayment of
notes receivable ofamounts owed to Lakes by Indian tribes held by Lakes, which represent a large portion
of Lakes' assets;tribes; possible need for future financing to
meet Lakes' expansion goals; risks of entry into new businesses; and reliance on
Lakes' management. For further information regarding the risks and
uncertainties, see the "Business - -- Risk Factors" section of the Company's
Annual Report on Form 10-K/A10-K for the fiscal year ended December 29, 2002.
30 2001.
29
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSIONQUANTITATIVE AND ANALYSIS OF FINANCIAL CONDITIONQUALITATIVE DISCLOSURES ABOUT MARKET RISK; CONTROLS AND
RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)PROCEDURES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and cash equivalents,
marketable securities and long-term debt. The Company's main investment
objectives are the preservation of investment capital and the maximization of
after-tax returns on its investment portfolio. Consequently, the Company invests
with only high-credit-quality issuers and limits the amount of credit exposure
to any one issuer. The Company does not use derivative instruments for
speculative or investment purposes.
The Company's cash and cash equivalents are not subject to significant interest
rate risk due to the short maturities of these instruments. As of June 30, 2002,29, 2003,
the carrying value of the Company's cash and cash equivalents approximates fair
value. The Company'sCompany has in the past and may in the future obtain marketable debt
securities (principally consisting of commercial paper, corporate bonds, and
government securities) havehaving a weighted average duration of one year or less.
Consequently, such securities arewould not be subject to significant interest rate
risk.
The Company's primary exposure to market risk associated with changes in
interest rates involves the Company's notes receivable related to loans for the
development and construction of Native American owned casinos. The loans and
related note balances earn various interest rates based upon a defined reference
rate. The floating rate receivables will generate more or less interest income
if interest rates rise or fall. Interest income is deferred during development
of the casinos because realizability of the interest is contingent upon the
completion and positive cash flow from operation of the casino. As of June 30, 2002,29
2003, Lakes had $63.0$75.5 million of floating rate notes receivable.receivables. Based on the
applicable current reference rates and assuming all other factors remain
constant, deferred interest income for a twelve month period would be $3.9$4.1
million. A reference rate increase of 100 basis points would result in an
increase in deferred interest income of $0.6$0.8 million. A 100 basis point decrease
in the reference rate would result in a decrease of $0.6$0.8 million in deferred
interest income over the same twelve month period.
30ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our chief executive officer and chief financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) or Rule 15d - 15(e) promulgated under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the
period covered by this quarterly report. Based on their evaluation, our chief
executive officer and chief financial officer concluded that Lakes
Entertainment, Inc.'s disclosure controls and procedures are effective.
There have been no significant changes (including corrective actions with regard
to significant deficiencies or material weaknesses) in our internal controls or
in other factors that could significantly affect these controls subsequent to
the date of the evaluation referenced above.
31
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following summaries describe certain known legal proceedings to which Grand
is a party which Lakes has assumed, or with respect to which Lakes may have
agreed to indemnify Grand, in connection with the Distribution.
SLOT MACHINE LITIGATION
In April 1994, William H. Poulos brought an action in the U.S. District Court
for the Middle District of Florida, Orlando Division -- William H. Poulos, et al
v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various
parties (including Grand) alleged to operate casinos or be slot machine
manufacturers were named as defendants. The plaintiff sought to have the action
certified as a class action.
A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et
al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was
consolidated with the Poulos action.
Both actions included claims under the federal Racketeering-Influenced and
Corrupt Organizations Act and under state law, and sought compensatory and
punitive damages. The plaintiffs claimed that the defendants are involved in a
scheme to induce people to play electronic video poker and slot machines based
on false beliefs regarding how such machines operate and the extent to which a
player is likely to win on any given play.
In December 1994, the consolidated actions were transferred to the U.S. District
Court for the District of Nevada.
In September 1995, Larry Schreier brought an action in the U.S. District Court
for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al
- -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier
action were similar to those made by the plaintiffs in the Poulos and Ahearn
actions, except that Schreier claimed to represent a more precisely defined
class of plaintiffs than Poulos or Ahearn.
In December 1996, the court ordered the Poulos, Ahearn and Schreier actions
consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et
al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the
plaintiffs to file a consolidated and amended complaint. In February 1997, the
plaintiffs filed a consolidated and amended complaint.
In March 1997, various defendants (including Grand) filed motions to dismiss or
stay the consolidated action until the plaintiffs submitted their claims to
gaming authorities and those authorities considered the claims submitted by the
plaintiffs.
31
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
In December 1997, the court denied all of the motions submitted by the
defendants, and ordered the plaintiffs to file a new consolidated and amended
complaint. That complaint has been filed. Grand has filed its answer to the new
complaint.
The plaintiffs have filed a motion seeking an order certifying the action as a
class action. Grand and certain of the defendants have opposed the motion. The
Court has not ruled on the motion.
STANDBY EQUITY COMMITMENT LITIGATION
In September 1997, the Stratosphere Trustee under the indenture pursuant to
which Stratosphere issued its first mortgage notes filed a complaint in the U.S.
District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company,
Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand
as defendant.
The complaint alleges that Grand failed to perform under the Standby Equity
Commitment entered into between Stratosphere and Grand in connection with
Stratosphere's issuance of such first mortgage notes in March 1995. The
complaint seeks an order compelling specific performance of what the Trustee
claims are Grand's obligations under the Standby Equity Commitment.
The Stratosphere Trustee filed the complaint in its alleged capacity as a third
party beneficiary under the Standby Equity Commitment. Pursuant to the Second
Amended Plan, a new limited liability company (the "Stratosphere LLC") was
formed to pursue certain alleged claims and causes of action that Stratosphere
and other parties may have against numerous third parties, including Grand
and/or officers and/or directors of Grand. The Stratosphere LLC has been
substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding.
In August 2000, the Court and the parties agreed to try the action upon an
amended joint pre-trial order and a series of post-trial briefs. Post-trial
briefing concluded on December 12, 2000 and oral argument was held on January
22, 2001. On April 4, 2001, the Court entered judgment in favor of Grand and
issued its findings of fact and conclusions of law.
The plaintiff filed an appeal with the Ninth Circuit Court of Appeals on May 4,
2001, Case No. 01-15947. On August 13, 2002, the Ninth Circuit affirmed the
prior ruling in favor of Grand.
STRATOSPHERE PREFERENCE ACTION
In April 1998, Stratosphere served on Grand and Grand Media & Electronics
Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a
complaint in the Stratosphere bankruptcy case seeking recovery of certain
amounts paid by Stratosphere to (i) Grand Media for electronic equipment
purchased by Stratosphere from Grand Media, and (ii) Grand as management fees
and for costs and expenses under a management agreement between Stratosphere and
Grand, and (ii)
Grand Media for electronic equipment purchased byGrand.
Stratosphere from Grand Media.
32
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
Stratosphere claimsclaimed in its complaint that such amounts are recoverable by
Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand
responded to Stratosphere's complaint denying that Stratosphere is entitled to
recover the amounts described in the complaint. Discovery was completed on
December 31, 2001 and the case proceeded to trial before the United States
Bankruptcy Court for the District of Nevada on June 20, 2002.
A decision hasOn December 31, 2002, the Bankruptcy Court issued its final judgment holding
that: (i) payments to Grand Media for electronic equipment totaling
approximately $3.3 million are not yet been issued.recoverable by Stratosphere as avoidable
preferences, and (ii) payment to Grand for management services in the
approximate amount of $2.3 million is recoverable by Stratosphere and an
avoidable preference. On May 8, 2003, this judgment was satisfied out of amounts
held in trust as security to support Lakes' indemnification obligations to
Grand.
OTHER LITIGATION
The Company has recorded a reserve assessment related to various of the above
items based on management's best estimate. The reserveLakes is reflected as a
litigation and claims accrual on the accompanying consolidated balance sheet as
of June 30, 2002.
Grand and Lakes are involved in various other inquiries, administrative proceedings, and
litigation relating to contracts and other matters arising in the normal course
of business. While any proceeding or litigation has an element of uncertainty,
management currently believes that the final outcome of these matters is not
likely to have a material adverse effect upon Grand's or the Company's consolidated
financial position or results of operations.
32
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders was held on June 5, 2002.2, 2003.
(b) At the Annual Meeting, all of management's nominees for directors as
listed in the proxy statement were elected with the following vote:Meeting:
(1) Management's nominees for directors as listed in the proxy statement
were elected with the following vote:
Affirmative Votes Authority Withheld
----------------- ------------------
Lyle Berman 10,087,176 135,10210,235,925 166,670
Timothy J. Cope 10,087,956 134,32210,239,260 163,335
Morris Goldfarb 10,087,618 134,66010,070,022 332,573
Ronald Kramer 10,159,111 63,16710,348,604 53,991
Neil I. Sell 10,158,987 63,29110,103,334 299,261
(2) The shareholders approved an amendment to the Company's
articlesappointment of incorporation to change the corporate nameDeloitte & Touche, LLP as independent auditors of the
Company from "Lakes Gaming, Inc." to "Lakes Entertainment,
Inc."was ratified with the following vote:
Affirmative Votes Negative Votes Abstentions
- ----------------- -------------- -----------
10,208,257 7,170 6,85110,378,640 20,847 3,108
(3) The proposal to grant full voting rights to shares of the Company's
common stock held by Mr. Lyle Berman, pursuant to the Minnesota Control
Share Acquisition Act, was not approved, with the following vote:
Affirmative Votes Negative Votes Abstentions Broker Non-Votes
- ----------------- -------------- ----------- ----------------
4,766,478 1,282,130 9,618 4,344,369
33
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
ITEM 5. OTHER INFORMATION
The Lakes Board of Directors previously has determined that each of the three
Audit Committee members is an "independent director" under Nasdaq listing
standards. The Board has been advised of an informal interpretation of the
Nasdaq rules that might cause Neil I. Sell, a member of the Audit Committee, not
to be considered independent. Mr. Sell is a partner in the law firm of Maslon
Edelman Borman & Brand, LLP, which performs legal services for Lakes, and the
fees paid by Lakes to the Maslon law firm have exceeded $60,000 per year. Under
the informal interpretation, all of these fees are imputed to Mr. Sell
personally, and he is not considered independent. However, under Nasdaq
guidelines, he can still serve as a member of the Audit Committee if the Board
of Directors determines that membership on the Audit Committee by Mr. Sell is
required by the best interests of Lakes and its shareholders. The Board has made
this determination considering all relevant factors, principally Mr. Sell's
membership on the Audit Committee since Lakes commenced its business, resulting
in his understanding of Lakes' financial statements and accounting issues; his
dedication and thoroughness as a member of the Audit Committee; his previous
background as a member of the Board of Directors and Audit Committee of Grand
Casinos, Inc.; and his background as a certified public accountant.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3 Articles10.1 Purchase Agreement dated as of Amendment filed withJune 26, 2003, by and between
Grand Casinos Nevada I, Inc. and Diamond Resorts, LLC
31.1 Certification of CEO pursuant to Securities Exchange Act Rules
13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the
Minnesota SecretarySarbanes-Oxley Act of State on June 28, 2002
(incorporated by reference31.2 Certification of CFO pursuant to Exhibit ASecurities Exchange Act Rules
13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the
definitive Proxy Statement dated May 3,Sarbanes-Oxley Act of 2002
for the
2002 Annual Meeting)
99.132.1 Certification of Chief Executive Officer 99.2pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
34
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
(b) Reports on Form 8-K
(i) A Form 8-K, Item 5. Other Events, and Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, was
filed on May 31, 2002.April 7, 2003
(ii) A Form 8-K, Item 5. Other Events, and Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, was
filed on August 7, 2002.April 14, 2003
(iii) A Form 8-K, Item 5. Other Events,7. Financial Statements, Pro Forma Financial
Information and Exhibits, and Item 12. Results of Operations and
Financial Condition, was filed on August 23,
2002.April 28, 2003
(iv) A Form 8-K, Item 5. Other Events, and Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, was
filed on September 10,
2002.
34May 16, 2003
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: September 18, 2002August 13, 2003 LAKES ENTERTAINMENT, INC.
-------------------------
Registrant
/s/ LYLE BERMAN
-----------------------------------Lyle Berman
--------------------------
Lyle Berman
Chairman of the Board and
Chief Executive Officer and
President
35
CERTIFICATIONS
I, Lyle Berman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lakes
Entertainment, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statement made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
/s/ Lyle Berman
--------------------------
Lyle Berman
Chief Executive Officer
I, Timothy J. Cope, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lakes
Entertainment, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statement made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
/s/ Timothy J. Cope
--------------------------
Timothy J. Cope
President and
Chief Financial Officer
36