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 29,September 28, 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] 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 August 7,November 5, 2003, there were 10,638,32010,730,429 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 29,3
September 28, 2003 and December 29, 2002
3
Condensed Consolidated Statements of Earnings (Loss)Loss for the three 4
months ended September 28, 2003 and September 29, 2002
Condensed Consolidated Statements of Comprehensive 5
Loss for the three months ended June 29,September 28, 2003
and June 30,September 29, 2002 4
Condensed Consolidated Statements of Comprehensive
Earnings (Loss) for the three months ended June 29, 2003
and June 30, 2002 5
Condensed Consolidated Statement of Loss for 6
the sixnine months ended June 29,September 28, 2003 and
June 30,September 29, 2002 6
Condensed Consolidated Statements of Comprehensive 7
Loss for the sixnine months ended June 29,September 28, 2003
and June 30,September 29, 2002 7
Condensed Consolidated Statements of Cash Flows for 8
the sixnine months ended June 29,September 28, 2003 and
June 30,September 29, 2002 8
Notes to Condensed Consolidated Financial Statements 9
ITEM 2. MANAGEMENT'S DISCUSSION AND 19
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
19
ITEM 3. QUANTITATIVE AND QUALITATIVE 31
DISCLOSURES ABOUT MARKET RISK 31
ITEM 4. CONTROLS AND PROCEDURES 31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 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 29,SEPTEMBER 28, 2003 DECEMBER 29, 2002
- ----------------------------------------------------------------------------------------------------------------------------------- -----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 23,35431,292 $ 14,106
Accounts receivable, net 948610 116
Deferred tax asset 4,4812,640 6,771
Other current assets 741961 547
- ------------------------------------------------------------------------------------------------------------------------- --------
Total Current Assets 29,52435,503 21,540
- ------------------------------------------------------------------------------------------------------------------------- --------
Property and Equipment-Net 6,6976,598 6,962
- ------------------------------------------------------------------------------------------------------------------------- --------
Other Assets:
Land held under contract for sale 4,7724,967 28,832
Land held for development 29,38214,375 27,791
Notes receivable-less current installments 75,59580,360 70,955
Cash and cash equivalents-restricted --- 8,300
Investments in and notes from unconsolidated affiliates 8,4238,597 1,013
Deferred tax asset 4,7076,125 3,835
Other long-term assets 8,8238,927 6,657
- ------------------------------------------------------------------------------------------------------------------------- --------
Total Other Assets 131,702123,351 147,383
- ------------------------------------------------------------------------------------------------------------------------- --------
TOTAL ASSETS $167,923$165,452 $175,885
========================================================================================================================= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 96178 $ 226
Income taxes payable 4,3122,941 5,564
Litigation and claims accrual 180148 5,847
Accrued payroll and related 418603 252
Other accrued expenses 2,9442,895 3,486
- ------------------------------------------------------------------------------------------------------------------------- --------
Total Current Liabilities 7,9506,765 15,375
- ------------------------------------------------------------------------------------------------------------------------- --------
TOTAL LIABILITIES 7,9506,765 15,375
- ------------------------------------------------------------------------------------------------------------------------- --------
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity:
Capital stock, $.01 par value; authorized 100,000 shares;
10,640 and 10,638 common shares issued and outstanding
at June 29,September 28, 2003, and December 29, 2002, respectively 106 106
Additional paid-in-capital 131,526131,542 131,525
Retained Earnings 28,34127,039 28,879
- ------------------------------------------------------------------------------------------------------------------------- --------
Total Shareholders' Equity 159,973158,687 160,510
- ------------------------------------------------------------------------------------------------------------------------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $167,923$165,452 $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)LOSS
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------------------
SEPTEMBER 28, 2003 SEPTEMBER 29, 2002
------------------ JUNE 29, 2003 JUNE 30, 2002
------------- -------------------------------
REVENUES:
License fee income $ 2,954377 $ -
- -------------------------------------------------------------------------------------------------
-------- --------
Total Revenues 2,954 -
- -----------------------------------------------------------------------------------------------377 --
-------- --------
COSTS AND EXPENSES:
Selling, general and administrative 4,950 9,572
Reversal of litigation and claims accrual (3,212) -2,504 2,700
Depreciation and amortization 131 120
- -----------------------------------------------------------------------------------------------135 130
-------- --------
Total Costs and Expenses 1,869 9,692
- -----------------------------------------------------------------------------------------------
EARNINGS (LOSS)2,639 2,830
-------- --------
LOSS FROM OPERATIONS 1,085 (9,692)
- -----------------------------------------------------------------------------------------------(2,262) (2,830)
-------- --------
OTHER INCOME (EXPENSE):
Interest income 314 43698 134
Interest expense - (24)-- (23)
Equity in loss of unconsolidated affiliates (60) (108)
Other (1) -
- -----------------------------------------------------------------------------------------------(50) (85)
-------- --------
Total other income, net 253 304
- -----------------------------------------------------------------------------------------------
Earnings (Loss)48 26
-------- --------
Loss before income taxes 1,338 (9,388)
Provision (Benefit)(2,214) (2,804)
Benefit for income taxes 549 (2,208)
- -----------------------------------------------------------------------------------------------(912) (1,150)
-------- --------
NET EARNINGS (LOSS) $ 789LOSS ($ 7,180)
===============================================================================================1,302) ($ 1,654)
======== ========
BASIC EARNINGS (LOSS)LOSS PER SHARE $ 0.07 ($ 0.67)
===============================================================================================0.12) ($ 0.16)
======== ========
DILUTED EARNINGS (LOSS)LOSS PER SHARE $ 0.07 ($ 0.67)
===============================================================================================0.12) ($ 0.16)
======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,63810,639 10,638
DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - -
- ------------------------------------------------------------------------------------------------- --
-------- --------
WEIGHTED AVERAGE COMMON AND DILUTED
SHARES OUTSTANDING 10,639 10,638
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 (LOSS)LOSS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
-----------------------------------
JUNE----------------------------------------
SEPTEMBER 28, 2003 SEPTEMBER 29, 2003 JUNE 30, 2002
----------------------------------------------------- ------------------
NET EARNINGS (LOSS) $ 789LOSS ($7,180)
OTHERCOMPREHENSIVE1,302) ($1,654)
OTHER COMPREHENSIVE EARNINGS (LOSS), NET OF TAX:
Unrealized lossesgains (losses) on securities:
Unrealized holding lossesgains during the period - (2)-- 21
Reclassification adjustment for losses included
in net earnings (loss) - 47
-----------------------------------loss -- 2
------- -------
COMPREHENSIVE EARNINGS (LOSS) $ 789LOSS ($7,135)
===================================1,302) ($1,631)
======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
5
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF LOSS
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
SIXNINE MONTHS ENDED
----------------
JUNE------------------------------------------
SEPTEMBER 28, 2003 SEPTEMBER 29, 2003 JUNE 30, 2002
------------- ------------------------------- ------------------
REVENUES:
Management fee income $ --- $ 1,502
License fee income 3,504 -
- -----------------------------------------------------------------------------------------------3,881 --
-------- --------
Total Revenues 3,5043,881 1,502
- ------------------------------------------------------------------------------------------------------- --------
COSTS AND EXPENSES:
Selling, general and administrative 7,929 11,671
Reversal of litigation and claims accrual (3,212) -7,221 14,371
Depreciation and amortization 259 219
- -----------------------------------------------------------------------------------------------394 349
-------- --------
Total Costs and Expenses 4,976 11,890
- -----------------------------------------------------------------------------------------------7,615 14,720
-------- --------
LOSS FROM OPERATIONS (1,472) (10,388)
- -----------------------------------------------------------------------------------------------(3,734) (13,218)
-------- --------
OTHER INCOME (EXPENSE):
Interest income 551 1,172649 1,306
Interest expense - (47)-- (70)
Equity in loss of unconsolidated affiliates (147) (231)(197) (316)
Other 158 -
- -------------------------------------------------------------------------------------------------
-------- --------
Total other income, net 562 894
- -----------------------------------------------------------------------------------------------610 920
-------- --------
Loss before income taxes (910) (9,494)(3,124) (12,298)
Benefit for income taxes (372) (2,251)
- -----------------------------------------------------------------------------------------------(1,284) (3,401)
-------- --------
NET LOSS ($ 538)1,840) ($ 7,243)
===============================================================================================8,897)
======== ========
BASIC LOSS PER SHARE ($ 0.05)0.17) ($ 0.68)
===============================================================================================0.84)
======== ========
DILUTED LOSS PER SHARE ($ 0.05)0.17) ($ 0.68)
===============================================================================================0.84)
======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,63810,639 10,638
DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - -
- ------------------------------------------------------------------------------------------------- --
-------- --------
WEIGHTED AVERAGE COMMON AND DILUTED
SHARES OUTSTANDING 10,639 10,638
10,638
======================================================================================================= ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
6
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
(UNAUDITED)
SIXNINE MONTHS ENDED
------------------------------------
JUNESEPTEMBER 28, 2003 SEPTEMBER 29, 2003 JUNE 30, 2002
------------------------------------------------------ ------------------
NET LOSS ($ 538)1,840) ($7,243)8,897)
OTHER COMPREHENSIVE LOSS, NET OF TAX:
Unrealized lossesgains (losses) on securities:
Unrealized holding lossesgains during the period - (10)-- 10
Reclassification adjustment for losses included
in net loss - 47
-------------------------------------- 50
------- -------
COMPREHENSIVE LOSS ($ 538)1,840) ($7,206)
====================================8,837)
======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
7
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIXNINE MONTHS ENDED
----------------
JUNESEPTEMBER 28, 2003 SEPTEMBER 29, 2003 JUNE 30, 2002
------------- ------------------------------- ------------------
OPERATING ACTIVITIES:
Net loss ($ 538)1,840) ($ 7,243)8,897)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 259 218394 349
Equity in loss of unconsolidated affiliates 147 231197 316
Impairment of land held under contract for sale --- 3,000
Write down of related party receivables --- 4,000
Changes in operating assets and liabilities:
Accounts receivable (832) 3,601(494) 3,510
Income taxes 167 (3,547)(782) (4,719)
Accounts payable (130) (105)(48) 185
Accrued expenses (2,922) 915(2,818) 570
Other (194) (1,565)
- -----------------------------------------------------------------------------------------------------------(414) 280
-------- --------
Net Cash Used in Operating Activities (4,043) (495)
- -----------------------------------------------------------------------------------------------------------(5,805) (1,406)
-------- --------
INVESTING ACTIVITIES:
Short-term investments, sales/maturities - 1,101-- 2,130
Payments for land held under contract for sale (433) (666)(629) (783)
Payments received on land held under contract for sale 16,765 -16,766 --
Payments received (made) for land held for development (1,591) (4,910)13,416 (3,748)
Advances on notes receivable (6,642) (9,947)(12,382) (15,257)
Proceeds from repayment of notes receivable -1,000 67
Investment in and notes receivable from unconsolidated affiliates (495) (139)(704) (165)
Decrease (increase) in restricted cash, net 5,906 (55)5,907 (579)
Increase in other long-term assets (225) (333)
Reduction of (payments for)(370) (1,420)
Payments for property and equipment, net 6 (716)
- -----------------------------------------------------------------------------------------------------------(30) (1,127)
-------- --------
Net Cash Provided by (Used in) Investing Activities 13,291 (15,598)
- -----------------------------------------------------------------------------------------------------------22,974 (20,882)
-------- --------
FINANCING ACTIVITIES:
Payments on capital lease obligations --- (5,714)
Proceeds from issuance of common stock 17 --
Payments on long-term debt --- (350)
- ------------------------------------------------------------------------------------------------------------------- --------
Net Cash Used in Financing Activities -17 (6,064)
- ------------------------------------------------------------------------------------------------------------------- --------
Net increase (decrease) in cash and cash equivalents 9,248 (22,157)17,186 (28,352)
Cash and cash equivalents - beginning of period 14,106 42,638
- ------------------------------------------------------------------------------------------------------------------- --------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 23,35431,292 $ 20,481
===========================================================================================================14,286
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ --- $ 4974
Income taxes 4 56 9
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 which is currently being disputed by the tribe. Each of
these projects is currently in the development phase.
The Company 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. During March of 2003, the WPT signed an agreement with the
Travel Channel, LLC (TRV), granting TRV the right to broadcast the first 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 TRV being granted options for
five additional seasons. WPT receives a series of fixed license payments from
TRV, subject in each case to 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 property was included as land held under contract for
sale on the accompanying condensed consolidated balance sheet as of December 29,
2002. The total price for this combined transaction was approximately $30.9
million. Terms of the transaction included 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. A $0.5 million payment on the notes receivable
was received during 2002.
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 revised 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. 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 announced that it hashad signed a Letter of Intent to sell
the approximate 3.5 acre undeveloped site, known 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 $15.0 million payment, Lakes received $1.0 million as
repayment of a loan previously made by Lakes to Chateaux, LLC, a joint venture
entity originally formed by Lakes and a time-share developer for the purpose of
developing the Shark Club Parcel as an upscale time-share 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 $14.4
million and $12.8 million as of June 29,September 28, 2003 and December 29, 2002,
respectively.
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.
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 86 Commitments and Contingencies.
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
JuneDecember 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.
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 and a 49 percent voting interest in the
Chateaux, LLC, a joint venture formed to develop the Shark Club Parcel in Las
Vegas, Nevada, into an upscale timeshare project. See Note 8 for current status
of the Shark Club Parcel.California.
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.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for fair presentation have been included.
Operating results for the sixnine months ended June 29,September 28, 2003 are not
necessarily indicative of the results that may be expected for the year ending
December 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 for the year
ended December 29, 2002.
3. STOCK-BASED COMPENSATION
At June 29,September 28, 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.
SIXNINE MONTHS ENDED THREE MONTHS ENDED
---------------- ------------------
JUNE----------------------------------- ----------------------------------
SEPT. 28, 2003 SEPT. 29, 2002 SEPT. 28, 2003 JUNE 30,SEPT. 29, 2002
JUNE 29, 2003 JUNE 30, 2002
------------- ------------- ------------- --------------------------- -------------- -------------- --------------
Net earnings (loss):loss:
As reported $ (538)(1,840) $ (7,243)(8,897) $ 789(1,302) $ (7,180)
As reported(1,654)
Less: Total stock-based compensation
expense determined under the fair
value method, net of related
tax effects (767) (849)(1,150) (1,276) (383) (426)
Pro forma (1,305) (8,092) 406 (7,606)(2,990) (10,173) (1,685) (2,080)
Net earnings (loss)loss per share:
As reported -- Basic $ (0.05)(0.17) $ (0.68)(0.84) $ 0.07(0.12) $ (0.67)(0.16)
Pro forma -- Basic (0.12) (0.76) 0.04 (0.71)(0.28) (0.96) (0.16) (0.20)
As reported -- Diluted (0.05) (0.68) 0.07 (0.67)(0.17) (0.84) (0.12) (0.16)
Pro forma -- Diluted (0.12) (0.76) 0.04 (0.71)(0.28) (0.96) (0.16) (0.20)
12
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. MANAGEMENT CONTRACTS FOR 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 the Cloverdale Rancheria
of Pomo Indians. The Rancheria is currently 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 Bureau of Indian Affairs (BIA).
The tribe has 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 are
subordinated to certain other financial obligations of the respective tribes.
Through June 29,September 28, 2003, no amounts have been withheld under these
provisions.
13
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Notes receivable consist of the following (in thousands):
June 29,September 28, 2003 December 29, 2002
------------------------------- -----------------
Properties under development:
Notes from the Pokagon Band of Potawatomi Indians with variable interest rates
(not to exceed 10%) (5.00% at June 29,September 28, 2003), receivable in 60 monthly
installments subsequent to commencement date $ 40,624 $ 39,470$41,450 $39,470
Notes from the Shingle Springs Band of Miwok Indians with variable interest
rates (6.00% at June 29,September 28, 2003), receivable in varying monthly installments
based on contract terms subsequent to commencement date 17,53921,304 14,035
Notes from Jamul Indian Village with variable interest rates (6.00% at June 29,September
28, 2003), receivable in 12 monthly installments subsequent to commencement date 10,79511,744 9,492
Notes from the Nipmuc Nation with variable interest rates (6.00% at June 29,September
28, 2003) receivable in varying installments based on contract
terms subsequent to commencement date 4,1504,323 3,814
Other 2,4871,539 4,144
--------- --------------- -------
Total notes receivable 75,595 70,955
======== ========$80,360 $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 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 29,September
28, 2003 and December 29, 2002, $12.2$13.7 million and $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 29,September 28, 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.
14
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
6. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company leases certain property and equipment, including an airplane, under
a non-cancelable operating lease. The airplane lease expired May 1, 2003 and was
renewed for a one-year period. The lease provides for one additional one-year
renewal term. Approximate future minimum lease payments, due under this lease as
of June 29,September 28, 2003, assuming the second one-year renewal is exercised, are as
follows (in thousands):
Operating Leases
----------------
2003 $ 300$150
2004 600
2005 200
--------
$ 1,100
========----
$950
====
PURCHASE OPTIONS
The Company has the right to purchase the airplane it leases during the base
lease term and any renewal
termterms for approximately $8 million.
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 agreed
to deposit an aggregate of $30 million, in trust for the benefit of Grand, as a
wholly owned subsidiary of Park Place, 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). The deposits were to be made in four
annual installments of $7.5 million, over the four-year period subsequent to
December 31, 1998. Any proceeds remaining in this trust after all the secured
obligations were indefeasibly paid in full and discharged were to be returned 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 deposited
an additional $18 million in an escrow account in July 2000. The $18 million
deposit represented partial satisfaction of Lakes indemnification obligation
pursuant to a settlement agreement related to certain litigation claims brought
against Grand by its shareholders. Upon receipt of a court order on August 14,
2001 giving final approval to the settlement, the $18 million in restricted cash
was removed from the Company's condensed consolidated balance sheet. In January
2001, Lakes purchased the Shark Club property in Las Vegas for $10.1 million in
settlement of another Grand obligation that was subject to the indemnification
by Lakes. As of December 29, 2002, $7.5 million related to security to support
Lakes' indemnification obligations to Grand was 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.
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.
16
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Stratosphere claimedLEGAL PROCEEDINGS
WILLARD EUGENE SMITH LITIGATION
On October 24, 2003, Lakes announced that it had been named as one of a number
of defendants in its complainta counterclaim filed in state court in Harris County, Texas by
Willard Eugene Smith involving Kean Argovitz Resorts, LLC (KAR), related persons
and entities. In the counterclaim, Smith asserts that, such amounts are recoverable by
Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand
responded to Stratosphere's complaint denying that Stratospherean alleged oral
agreement with Kevin Kean, he is entitled to recovera percentage of fees to be received
by the amounts describedKAR entities or their principals relating to the Shingle Springs and
Jamul casinos that Lakes' subsidiaries are developing in California. Smith also
seeks recovery of damages and other relief from the KAR entities, Lakes and
certain affiliates based on their conduct with respect to the alleged agreement.
Lakes believes the counterclaim against it is without merit. Lakes understands
that the alleged oral agreement upon which Smith bases his claim was rendered
null and void in a prior judgment issued against Smith by the Harris County,
Texas state court in October 2000. However, in September 2003, the court vacated
the prior judgment against Smith. Lakes acquired KAR's interests in the complaint. Discovery was completedShingle
Springs and Jamul projects on December 31, 2001January 30, 2003. In the buyout agreements between
Lakes and certain KAR entities and related principals, the case proceededKAR entities
represented to trial beforeLakes that the United States
Bankruptcy Court forKAR entities and their affiliates had no
continuing agreements with any third party relating to the DistrictShingle Springs and
Jamul projects and agreed to indemnify Lakes and its affiliates from damages
resulting from prior dealings of Nevada on June 20, 2002.
On December 31, 2002, the Bankruptcy Court issuedKAR entities and related principals
concerning the projects. Lakes will vigorously defend against the allegations
made against it and will pursue its final judgment holding
that: (i) payments to Grand Media for electronic equipment totaling
approximately $3.3 million are not recoverable by Stratosphere as avoidable
preferences,indemnification rights against the KAR
entities and (ii) payment to Grand for management services intheir principals under 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 had recorded a reserve assessment related to this litigation
which exceeded the final judgment amount by $3.2 million. This amount was
reversed during the second quarter of 2003 resulting in a $3.2 million pre-tax
decrease in costs and expenses in the accompanying consolidated statement of
loss for the six months ended June 29, 2003 and the accompanying consolidated
statement of earnings for the three months ended June 29, 2003.buyout agreements if necessary.
OTHER LITIGATION
Lakes is 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 the Company's consolidated
financial position or results of operations.
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 ("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, made loans to Living Benefits. 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.
17
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
7. RELATED PARTY TRANSACTIONS
Previously, Lakes formed two joint venture partnerships with Kean Argovitz
Resorts, LLC ("KAR"),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 joint 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$0.6 million, and $0.2
million, as of June 29,September 28, 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 associated 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 repayment 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
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 for the Pokagon Band of
Potawatomi Indians. (2) Lakes has 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 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 60 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 submitted additional information
to the BIA for reconsideration.
In addition, Lakes owns options to purchase various new casino games and is
actively marketing these new games to the casino industry in an attempt to have
a casino accept the games for use in their operations. Lakes has also formed a
joint venture with another company to develop approximately 2,000 acres owned by
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 with the Travel Channel ("TRV") in March 2003,
for broadcast of the first 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 TRV being granted options for five additional seasons. Revenue is
recognized ratably as production milestones and other conditions are met. During
the first twothree quarters of 2003, Lakes recognized approximately $3.5$3.9 million in
revenue related to the World Poker Tour. Revenues related to the second season
will be recognized during 2004.
19
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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.
SIGNIFICANT 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 will not recognize revenue related to
Indian casino management. Interest 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 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 tribes. Through June 29,September 28, 2003, no impairments
have been recorded 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.
The 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)
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 for
the year ended December 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 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
JuneDecember 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.
21
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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.
SIXNINE MONTHS ENDED JUNE 29,SEPTEMBER 28, 2003 COMPARED TO THE SIXNINE MONTHS ENDED JUNE 30,SEPTEMBER
29, 2002
Revenues
Total revenues were $3.5$3.9 million for the sixnine months ended June 29,September 28, 2003
compared to $1.5 million for 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 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. The management contract with the Coushatta
Tribe of Louisiana for Grand Casino Coushatta expired on January 16, 2002. The
Company currently has no other management contracts from which it will derive
revenues in 2003.
Costs and Expenses
Total costs and expenses were $5.0$7.6 million for the sixnine months ended June 29,September
28, 2003, compared to $11.9$14.7 million for the same period in the prior year.
Selling, general and administrative expenses decreased from $11.7$14.4 million for
the sixnine months ended June 30,September 29, 2002 to $7.9$7.2 million for the sixnine months
ended June 29,September 28, 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$2.5 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 sixnine months ended June 29,September 28, 2003
compared to $1.2$1.3 million for the same period in the prior year. This decrease is
primarily due to lower cash balancesmarket rates during the period.period as well as a decrease in
interest earned on amounts owed to Lakes by Metroflag related to the properties
sold to Metroflag by Lakes in Las Vegas, Nevada.
Losses Per Common Share and Net Losses
For the sixnine months ended June 29,September 28, 2003, basic and diluted losses per
common share were $0.05,$0.17, compared to basic and diluted losses of $0.68,$0.84 per
common share, for the same period in the prior year. Losses for the period ended
June 29,September 28, 2003 were $0.5$1.8 million compared to $7.2$8.9 million for the sixnine
months ended June 30,September 29, 2002. This decrease in losses is primarily due to the
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,SEPTEMBER 28, 2003 COMPARED TO THE THREE MONTHS ENDED
JUNE 30,SEPTEMBER 29, 2002
Revenues
Total revenues were $3.0$0.4 million for the three months ended June 29,September 28, 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$2.6 million for the three months ended June 29,September
28, 2003, compared to $9.7$2.8 million for the same period in the prior year.
Selling, general and administrative expenses decreased from $9.6remained nearly constant at $2.5
million for the three months ended June 30, 2002September 28, 2003 compared to $5.0$2.7 million
for the three months ended JuneSeptember 29, 2003. This decrease is primarily due to a second quarter 2002 impairment of $4.02002.
Other
Interest income was $0.1 million relating to a note receivable from Living Benefits Financial Services,
LLC, as well as a $3.0 million impairment charge taken onfor the Polo Plazathree months ended September 28, 2003
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 $1.2 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.September 29, 2002.
23
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Other
Interest income was $0.3 million for the three months ended June 29, 2003
compared to $0.4 million for the same period in the prior year. This decrease is
primarily due to lower cash balances during the period.
Earnings Per Common Share and Net Earnings
For the three months ended June 29,September 28, 2003, basic and diluted earningslosses per
common share were $0.07,$0.12, compared to basic and diluted losses of $0.67,$0.16 per
share, for the same period in the prior year. EarningsLosses for the three months ended
June 29,September 28, 2003 were $0.8$1.3 million compared to losses of $7.2$1.7 million for the
three months ended June
30,September 29, 2002. This increasedecrease in earningslosses relates primarily
to revenue recognized during the impairment chargescurrent year period of $7.0$0.4 million taken inrelated to
the WPT. No revenue was recognized during the prior year period discussed above. Also
contributing to the increase was the WPT revenue recognized in the current year
quarter.period.
Outlook
It is currently contemplated that there will be no operating revenues for the
remainder 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,September 28, 2003, Lakes had $23.4$31.3 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 sixnine months ended June 29,September 28, 2003,
net cash used in operating activities totaled $4.0$5.8 million. For the sixnine months
ended June 30,September 29, 2002, net cash used in operating activities totaled $0.5$1.4
million. For the current year period, net cash provided by investing activities
totaled $13.3$23.0 million. For the sixnine months ended June 30,September 29, 2002, net cash
used in investing activities totaled $15.6$20.9 million. Included in these investing
activities for the periods ended June 29,September 28, 2003 and June 30,September 29, 2002 are
advances on notes receivable of $6.6$12.4 million and $9.9$15.3 million, respectively.
Net receipts from land held under contract for sale were $16.3$16.1 million during
the sixnine months ended June 29,September 28, 2003. Payments for land held under contract
for sale were $0.7$0.8 million for the sixnine months ended June 30,September 29, 2002.
24
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Unrestricted cash increased by $5.9 million during the 2003 period as a result
of the reclassification of restricted cash as unrestricted. During the periodsnine
months ended June 29,September 28, 2003, and June 30, 2002,net payments received for land held for
development were $13.4 million. During the prior year period, payments for land
held for development amounted to $1.6 million and $4.9 million, respectively.$3.7 million.
24
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Lakes plans to use its cash for continuing operations, loans to current joint
ventures 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,September 28, 2003, Lakes had approximately $75.6$80.4 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 joint venture which will televise poker tournaments,the formation of WPT, the Company invested $0.1 million for an
approximately 78%80% ownership position in the joint venture during 2002. The
Company is also required to loan up to $3.2 million to the joint ventureWPT as needed. As of
June 29,September 28, 2003, the Company had made net loans totaling $1.8$2.0 million to the 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 was included as land held
under contract for sale on the accompanying balance sheet as of December 29,
2002. The total 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
and a second contractual commitment to pay Lakes $7.5 million.WPT.
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 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.
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. On the payment date, which was extended to May 15, 2003, $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.
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.
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 was also decreased from $7.5 million to $3.5 million and is now payable no
later than December 28, 2004.
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 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)
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. 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 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, wouldwill 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 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 Form 10-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 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 Casinos; highly competitive industry; possible changes in regulations;
reliance on continued positive relationships with Indian tribes and repayment of
amounts owed to Lakes by Indian 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 for the fiscal year ended December 29, 2002.
30
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK; CONTROLS AND 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 29,September 28,
2003, the carrying value of the Company's cash and cash equivalents approximates
fair value. The Company has in the past and may in the future obtain marketable
debt securities (principally consisting of commercial paper, corporate bonds,
and government securities) having a weighted average duration of one year or
less. Consequently, such securities would 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 29September
28, 2003, Lakes had $75.5$80.4 million of floating rate notes 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 $4.1$4.4
million. A reference rate increase of 100 basis points would result in an
increase in deferred interest income of $0.8 million. A 100 basis point decrease
in the reference rate would result in a decrease of $0.8 million in deferred
interest income over the same twelve month period.
ITEM 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 describePROCEEDING
WILLARD EUGENE SMITH LITIGATION
On October 24, 2003, Lakes announced that it had been named as one of a number
of defendants in a counterclaim filed in state court in Harris County, Texas by
Willard Eugene Smith involving Kean Argovitz Resorts, LLC (KAR), related persons
and entities. In the counterclaim, Smith asserts that, under an alleged oral
agreement with Kevin Kean, he is entitled to a percentage of fees to be received
by the KAR entities or their principals relating to the Shingle Springs and
Jamul casinos that Lakes' subsidiaries are developing in California. Smith also
seeks recovery of damages and other relief from the KAR entities, Lakes and
certain known legal proceedings to which Grand
is a party which Lakes has assumed, oraffiliates based on their conduct with respect to the alleged agreement.
32
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
Lakes believes the counterclaim against it is without merit. Lakes understands
that the alleged oral agreement upon which Smith bases his claim was rendered
null and void in a prior judgment issued against Smith by the Harris County,
Texas state court in October 2000. However, in September 2003, the court vacated
the prior judgment against Smith. Lakes may haveacquired KAR's interests in the Shingle
Springs and Jamul projects on January 30, 2003. In the buyout agreements between
Lakes and certain KAR entities and related principals, the KAR entities
represented to Lakes that the KAR entities and their affiliates had no
continuing agreements with any third party relating to the Shingle Springs and
Jamul projects and agreed to indemnify Grand, in connection withLakes and its affiliates from damages of
the Distribution.
STRATOSPHERE PREFERENCE ACTION
In April 1998, Stratosphere served on GrandKAR entities and Grand Media & Electronics
Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a
complaint inrelated principals concerning 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,projects. Lakes will
vigorously defend against the allegations made against it and (ii) Grand as management feeswill pursue its
indemnification rights against the KAR entities and for costs and expensestheir principals under a management agreement between Stratosphere and
Grand.
Stratosphere claimed 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.
On 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 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.buyout agreements if necessary.
OTHER LITIGATION
Lakes is 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 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 2, 2003.
(b) At the Annual 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 10,235,925 166,670
Timothy J. Cope 10,239,260 163,335
Morris Goldfarb 10,070,022 332,573
Ronald Kramer 10,348,604 53,991
Neil I. Sell 10,103,334 299,261
(2) The appointment of Deloitte & Touche, LLP as independent auditors of the
Company was ratified with the following vote:
Affirmative Votes Negative Votes Abstentions
- ----------------- -------------- -----------
10,378,640 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
10.1 PurchaseAmendment dated July 25, 2003 to Acquisition Master Agreement
dated as of June 26,January 22, 2003, by and between Grand Casinos Nevada I, Inc.The Travel Channel, LLC
and Diamond Resorts,World Poker Tour, LLC (portions of this exhibit have been
omitted pursuant to a request for confidential treatment and
have been filed separately with the Commission pursuant to
Rule 24b-2 of the Securities Exchange Act of 1934)
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 Sarbanes-Oxley Act of 2002
31.2 Certification of CFO pursuant to Securities Exchange Act Rules
13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant 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 April 7,July 2, 2003
(ii) A Form 8-K, Item 5. Other Events, and Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, was
filed on April 14,July 24, 2003
(iii) A Form 8-K, Item 7. Financial Statements, Pro Forma Financial
Information and Exhibits, and Item 12. Results of Operations and
Financial Condition, was filed on 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 May 16,August 7, 2003
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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: August 13,November 12, 2003 LAKES ENTERTAINMENT, INC.
-------------------------
Registrant
/s// s/ Lyle Berman
-------------------------------------------------------------
Lyle Berman
Chairman of the Board and
Chief Executive Officer
/s/ Timothy J. Cope
-------------------------------------------------------------
Timothy J. Cope
President and
Chief Financial Officer
3635