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, 2003April 4, 2004

                                       OR

           [ ]

               TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     -----     SECURITIES EXCHANGE ACT OF 1934

                For the transition period from ______________________ to _____________________________
                          Commission File No. 0-24993

                            LAKES ENTERTAINMENT, INC.
             -------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

                    Minnesota                             41-1913991
                    ---------                             ----------
           (State or other jurisdiction                (I.R.S. Employer
        of incorporation or organization)             Identification No.)

                 130 Cheshire Lane
              Minnetonka, Minnesota                          55305
              ---------------------                          -----
     (Address of principal executive offices)             (Zip Code)

                                 (952) 449-9092
              (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

       Yes   [X]X                      No
           [ ]-----                       -----

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

       Yes                          [ ]                                No   [X]X
           -----                       -----

As of August 7, 2003,May 12, 2004, there were 10,638,32022,207,634 shares of Common Stock, $0.01 par
value per share, outstanding.outstanding, reflecting a two-for-one stock split (the "Stock
Split") in the form of a 100% stock dividend paid on May 3, 2004 to shareholders
of record on April 26, 2004. All share and per share data has been retroactively
restated to give effect to the stock split.



                   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, 20033 April 4, 2004 and December 29, 2002 328, 2003 Condensed Consolidated Statements of Earnings (Loss)Loss for the three 4 months ended April 4, 2004 and March 30, 2003 Condensed Consolidated Statements of Comprehensive 5 Loss for the three months ended June 29,April 4, 2004 and March 30, 2003 and June 30, 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 the six months ended June 29, 2003 and June 30, 2002 6 Condensed Consolidated Statements of Comprehensive Loss for the six months ended June 29, 2003 and June 30, 2002 7 Condensed Consolidated Statements of Cash Flows for 6 the sixthree months ended June 29,April 4, 2004 and March 30, 2003 and June 30, 2002 8 Notes to Condensed Consolidated Financial Statements 97 ITEM 2. MANAGEMENT'S DISCUSSION AND 17 ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 19 ITEM 3. QUANTITATIVE AND QUALITATIVE 24 DISCLOSURES ABOUT MARKET RISK 31 ITEM 4. CONTROLS AND PROCEDURES 3124 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 3425 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 3427
2 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED)
JUNE 29,(UNAUDITED) APRIL 4, 2004 DECEMBER 28, 2003 DECEMBER 29, 2002 - ------------------------------------------------------------------------------------------------------------------------------ ----------------- ASSETS Current Assets: Cash and cash equivalents $ 23,35424,951 $ 14,10625,340 Accounts receivable, net 948 116371 1,038 Deferred tax asset 4,481 6,7715,385 5,385 Prepaids 3,220 2,119 Other current assets 741 547 - -----------------------------------------------------------------------------------------------------------------1,846 1,645 ---------- ---------- Total Current Assets 29,524 21,540 - -----------------------------------------------------------------------------------------------------------------35,773 35,527 ---------- ---------- Property and Equipment-Net 6,697 6,962 - -----------------------------------------------------------------------------------------------------------------6,435 6,492 ---------- ---------- Other Assets: Land held under contract for sale 4,772 28,8324,795 4,612 Land held for development 29,382 27,79114,590 14,536 Notes receivable-less current installments 75,595 70,955 Cash and cash equivalents-restricted - 8,300receivable 89,908 84,682 Investments in and notes from unconsolidated affiliates 8,423 1,0137,611 8,717 Deferred tax asset 4,707 3,8357,242 6,634 Other long-term assets 8,823 6,657 - -----------------------------------------------------------------------------------------------------------------8,920 8,860 ---------- ---------- Total Other Assets 131,702 147,383 - -----------------------------------------------------------------------------------------------------------------133,066 128,041 ---------- ---------- TOTAL ASSETS $167,923 $175,885 =================================================================================================================$ 175,274 $ 170,060 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 962,113 $ 2261,906 Income taxes payable 4,312 5,5647,258 7,215 Litigation and claims accrual 180 5,847126 250 Accrued payroll and related 418 252costs 304 497 Other accrued expenses 2,944 3,486 - -----------------------------------------------------------------------------------------------------------------5,055 2,768 ---------- ---------- Total Current Liabilities 7,950 15,375 - -----------------------------------------------------------------------------------------------------------------14,856 12,636 ---------- ---------- TOTAL LIABILITIES 7,950 15,375 - -----------------------------------------------------------------------------------------------------------------14,856 12,636 ---------- ---------- COMMITMENTS AND CONTINGENCIES Shareholders' Equity: Capital stock, $.01 par value; authorized 100,000200,000 shares; 10,63822,198 and 21,474 common shares issued and outstanding at June 29, 2003,April 4, 2004, and December 29, 2002 106 10628, 2003, respectively 222 215 Additional paid-in-capital 131,526 131,525136,038 132,291 Retained Earnings 28,341 28,879 - -----------------------------------------------------------------------------------------------------------------24,158 24,918 ---------- ---------- Total Shareholders' Equity 159,973 160,510 - -----------------------------------------------------------------------------------------------------------------160,418 157,424 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $167,923 $175,885 =================================================================================================================$ 175,274 $ 170,060 ========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 3 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (LOSS) (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED) THREE MONTHS ENDED ------------------ JUNE 29,APRIL 4, 2004 MARCH 30, 2003 JUNE 30, 2002 ------------- --------------------------- REVENUES: License fee income $ 2,9544,140 $ - - -----------------------------------------------------------------------------------------------550 ---------- ---------- Total Revenues 2,954 - - -----------------------------------------------------------------------------------------------4,140 550 ---------- ---------- COSTS AND EXPENSES: Selling, general and administrative 4,950 9,572 Reversal of litigation and claims accrual (3,212) -3,260 2,078 Production costs 2,472 901 Depreciation and amortization 131 120 - -----------------------------------------------------------------------------------------------143 128 ---------- ---------- Total Costs and Expenses 1,869 9,692 - ----------------------------------------------------------------------------------------------- EARNINGS (LOSS)5,875 3,107 ---------- ---------- LOSS FROM OPERATIONS 1,085 (9,692) - -----------------------------------------------------------------------------------------------(1,735) (2,557) ---------- ---------- OTHER INCOME (EXPENSE): Interest income 314 436 Interest expense - (24)48 237 Equity in lossearnings (loss) of unconsolidated affiliates (60) (108)419 (87) Other (1) - - -----------------------------------------------------------------------------------------------42 159 ---------- ---------- Total other income, net 253 304 - ----------------------------------------------------------------------------------------------- Earnings (Loss)509 309 ---------- ---------- Loss before income taxes 1,338 (9,388) Provision (Benefit)(1,226) (2,248) Benefit for income taxes 549 (2,208) - -----------------------------------------------------------------------------------------------(466) (921) ---------- ---------- NET EARNINGS (LOSS)LOSS $ 789 ($ 7,180) ===============================================================================================(760) $ (1,327) ========== ========== BASIC EARNINGS (LOSS)LOSS PER SHARE $ 0.07 ($ 0.67) ===============================================================================================(0.03) $ (0.06) ========== ========== DILUTED EARNINGS (LOSS)LOSS PER SHARE $ 0.07 ($ 0.67) ===============================================================================================(0.03) $ (0.06) ========== ========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,63821,770 21,276 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - - - ------------------------------------------------------------------------------------------------- -- ---------- ---------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,638 10,638 ===============================================================================================21,770 21,276 ========== ==========
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 29,APRIL 4, 2004 MARCH 30, 2003 JUNE 30, 2002 ------------------------------------------------ -------------- NET EARNINGS (LOSS)LOSS $ 789 ($7,180) OTHERCOMPREHENSIVE(760) $ (1,327) OTHER COMPREHENSIVE EARNINGS (LOSS), NET OF TAX: Unrealized lossesgains (losses) on securities: Unrealized holding losses during the period - (2) Reclassification adjustment for losses included in net earnings (loss) - 47 -----------------------------------securities -- -- ---------- ---------- COMPREHENSIVE EARNINGS (LOSS)LOSS $ 789 ($7,135) ===================================(760) $ (1,327) ========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 5 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF LOSSCASH FLOWS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)THOUSANDS)
(UNAUDITED) SIXTHREE MONTHS ENDED ---------------- JUNE 29,APRIL 4, 2004 MARCH 30, 2003 JUNE 30, 2002 ------------- --------------------------- REVENUES: Management fee incomeOPERATING ACTIVITIES: Net loss $ -(760) $ 1,502 License fee income 3,504 - - ----------------------------------------------------------------------------------------------- Total Revenues 3,504 1,502 - ----------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Selling, general and administrative 7,929 11,671 Reversal of litigation and claims accrual (3,212) -(1,327) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 259 219 - ----------------------------------------------------------------------------------------------- Total Costs and Expenses 4,976 11,890 - ----------------------------------------------------------------------------------------------- LOSS FROM OPERATIONS (1,472) (10,388) - ----------------------------------------------------------------------------------------------- OTHER INCOME (EXPENSE): Interest income 551 1,172 Interest143 128 Unit-based compensation expense - (47)94 -- Equity in (earnings) loss of unconsolidated affiliates (147) (231) Other 158 - - ----------------------------------------------------------------------------------------------- Total other income, net 562 894 - ----------------------------------------------------------------------------------------------- Loss before(419) 87 Deferred income taxes (910) (9,494) Benefit(608) (330) Changes in operating assets and liabilities: Accounts receivable 667 (648) Income taxes 43 283 Accounts payable 207 (118) Accrued expenses 1,970 (191) Other (1,295) (899) ---------- ---------- Net Cash Provided by (Used in) Operating Activities 42 (3,015) ---------- ---------- INVESTING ACTIVITIES: Payments for incomeland held under contract for sale (183) (221) Payments made for land held for development (54) (1,433) Advances on notes receivable (5,238) (3,492) Investment in and notes receivable from unconsolidated affiliates 1,537 (285) Increase in restricted cash, net -- (13) Increase in other long-term assets (60) (156) Reduction of (payments for) property and equipment, net (86) 9 ---------- ---------- Net Cash Used in Investing Activities (4,084) (5,591) ---------- ---------- FINANCING ACTIVITIES: Proceeds from issuance of common stock 3,653 -- ---------- ---------- Net Cash Provided by Financing Activities 3,653 -- ---------- ---------- Net decrease in cash and cash equivalents (389) (8,606) Cash and cash equivalents - beginning of period 25,340 14,106 ---------- ---------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 24,951 $ 5,500 ========== ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ -- $ -- Income taxes (372) (2,251) - ----------------------------------------------------------------------------------------------- NET LOSS ($ 538) ($ 7,243) =============================================================================================== BASIC LOSS PER SHARE ($ 0.05) ($ 0.68) =============================================================================================== DILUTED LOSS PER SHARE ($ 0.05) ($ 0.68) =============================================================================================== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - - - ----------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,638 10,638 ===============================================================================================12 5 Noncash operating activities: Capitalized television costs related to unit options issued to consultants 213 --
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) SIX MONTHS ENDED ------------------------------------ JUNE 29, 2003 JUNE 30, 2002 ------------------------------------ NET LOSS ($ 538) ($7,243) OTHER COMPREHENSIVE LOSS, NET OF TAX: Unrealized losses on securities: Unrealized holding losses during the period - (10) Reclassification adjustment for losses included in net loss - 47 ------------------------------------ COMPREHENSIVE LOSS ($ 538) ($7,206) ====================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 7 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
(UNAUDITED) SIX MONTHS ENDED ---------------- JUNE 29, 2003 JUNE 30, 2002 ------------- ------------- OPERATING ACTIVITIES: Net loss ($ 538) ($ 7,243) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 259 218 Equity in loss of unconsolidated affiliates 147 231 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 Income taxes 167 (3,547) Accounts payable (130) (105) Accrued expenses (2,922) 915 Other (194) (1,565) - ----------------------------------------------------------------------------------------------------------- Net Cash Used in Operating Activities (4,043) (495) - ----------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Short-term investments, sales/maturities - 1,101 Payments for land held under contract for sale (433) (666) Payments received on land held under contract for sale 16,765 - Payments for land held for development (1,591) (4,910) Advances on notes receivable (6,642) (9,947) Proceeds from repayment of notes receivable - 67 Investment in and notes receivable from unconsolidated affiliates (495) (139) Decrease (increase) in restricted cash, net 5,906 (55) Increase in other long-term assets (225) (333) Reduction of (payments for) property and equipment, net 6 (716) - ----------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities 13,291 (15,598) - ----------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Payments on capital lease obligations - (5,714) Payments on long-term debt - (350) - ----------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities - (6,064) - ----------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 9,248 (22,157) Cash and cash equivalents - beginning of period 14,106 42,638 - ----------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 23,354 $ 20,481 =========================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ - $ 49 Income taxes 4 5
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' primary business is to develop and manage Indian-owned casino properties that offer the opportunity for long-term development of related entertainment facilities, including hotels, theaters, recreational vehicle parks and other complementary amenities designed to enhance the customers' total entertainment experience and to differentiate facilities managed by Lakes currentlyfrom its competitors. Lakes provides experienced corporate and casino management and develops and implements a wide scale of marketing programs. In conjunction with this part of Lakes' business strategy, Lakes has entered into development and management agreements with four separate tribes for four newrelating to one casino operations, oneproject in Michigan, two casino projects in California, and one with the Nipmuc Nationcasino project on the east coast. The Company also has agreements for thecoast, with 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 Companyeach subject to regulatory approvals. Lakes has also formedexplored, and will continue to explore, numerous other possible development projects. World Poker Tour, LLC ("WPT"), a joint venture with78% owned subsidiary of Lakes, has created a producer to launchcircuit of previously-established poker tournaments affiliated under the "World Poker Tour" name, and has produced the World Poker Tour ("WPT") and establish poker as the next significant televised mainstream sport. During March of 2003, thetelevision series. WPT signed an agreement for a second season with the Travel Channel, LLC (TRV)("TRV"), granting TRV the right tofor broadcast the first season of the WPTWorld Poker Tour series which has now been completed. During July of 2003, WPT reached an agreement withon cable television. TRV for a second season withwas also granted options for five additional seasons. WPT receives a series of fixed license payments from TRV, subjectTRV. During January of 2004, World Poker Tour announced that it will seek to raise approximately $20 million pursuant to an underwritten initial public offering of common stock at a price to be determined. World Poker Tour will be converted into a Delaware corporation immediately before the offering. It is expected that proceeds from the offering will be used to expand World Poker Tour's entertainment production business and for its working capital. There will be no selling shareholders participating in each casethe offering. Lakes does not expect to satisfactionrecognize a gain on this transaction and the proceeds will be reflected as a minority interest. Lakes has included $0.4 million of production milestonesdirect costs related to this offering in other current assets as of April 4, 2004. These costs will be reflected as a reduction of proceeds when the offering is completed or as an expense if the offering is unsuccessful. Lakes has recently created a new division to buy, license and/or market new table game concepts for licensing to casinos. The Company is currently testing a number of new games and other conditions. Revenue is recognized ratably as production milestones and other conditions are met.there may be revenue from this effort beginning during 2004. See also Note 7. 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. 97 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,Previously, Metroflag Polo may elect to distribute to Lakes $3.0paid $1.0 million plus interest in cash as full return of Lakes'a down payment. Lakes can require Metroflag to repurchase the $4.0 million preferred interest. If paidinterest any time on or after April 30, 2004, and in no event later than December 24, 2006, the entire $4.0 million plus interest will be payable.2006. The subordinated interest must be repurchased for $4.0 million at the time of repayment by Metroflag 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.million, as a result of the increase in the purchase price of the Polo Plaza property discussed above. During 2003, Lakes took a $1.0 million impairment charge on the Travelodge property. If the Travelodge commitment is not repaid by December 28, 2004, ownership of the Travelodge lease rights would revert back to Lakes. Lakes has also agreed to loan to Metroflag BP up to $3.0 million related to Travelodge operating shortfalls through December 28, 2004. As of April 4, 2004 and December 28, 2003, the outstanding loan balance was $2.3 million and $2.1 million, respectively. This loan is scheduled to be repaid on December 28, 2004. 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 has 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 includedIncluded 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, 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 8 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 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.projects. 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 voting50% ownership interest in the Chateaux,2022 Ranch, LLC, a joint venture formed to develop and/or sell approximately 2000 acres owned by the Shark Club Parceljoint venture in Las Vegas, Nevada, into an upscale timeshare project. See Note 8 for current statusEastern San Diego County. This land was sold during the first quarter of 2004. The sale of the Shark Club Parcel. 11land reduced Lakes' investment in 2022 Ranch to less than $0.1 million. 8 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 sixthree months ended June 29, 2003April 4, 2004 are not necessarily indicative of the results that may be expected for the year ending December 28, 2003.January 2, 2005. 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, 2002.28, 2003. 3. STOCK-BASED COMPENSATION At June 29, 2003,April 4, 2004, the Company has two stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB OptionOpinion 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. WPT also has a unit-based compensation plan for both employees and consultants. WPT has a 2002 Unit Option Plan (the "2002 Plan") which is approved to issue up to an aggregate of 7,000 Class B non-voting units of WPT in connection with unit option grants to employees and consultants. The options become exercisable in quarterly installments on each of the first four anniversaries of the date of the grant and each installment expires six years after being exercisable. The employee must be employed by the Company on the anniversary date in order to vest in any units that year. If the employee is terminated (voluntarily or involuntarily) prior to the vesting of any portion of a unit option, the unvested portion will be forfeited. For WPT unit options issued to employees, deferred stock compensation for the unit options is measured at the units' fair value in excess of the exercise price on the date of grant and is being amortized over the vesting period of four years. For WPT unit options issued to consultants, compensation expense is measured at the option's fair value. Fair value is measured when the unit options vest in quarterly installments on each of the first four anniversaries of the date of the grant. Compensation expense is estimated in periods prior to vesting based on the then current fair value. Changes in the estimated fair value of unvested options are recorded in the periods the change occurs. Additionally, on March 4, 2002, WPT granted 15,000 Class A voting units to its President under a management agreement. The restricted units vest in four equal installments annually beginning February 25, 2003. If there is a change of control, all non-vested restricted units vest immediately. 9 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The Company accounts for the WPT unit-based employee compensation under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Compensation expense for unit option grants issued to employees is recorded to the extent the fair market value of the units on the date of grant exceeds the option price. Compensation expense for restricted unit grants is measured based on the fair market value of the units on the date of grant. The compensation expense is amortized ratably over the vesting period of the awards. The Company accounts for WPT unit-based consultant compensation according to the recognition and measurement principles of EITF 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Compensation expense for unit option grants issued to consultants is recorded at the fair market value of the options at the measurement date, defined as the date the options vest and services have been provided. The following table illustratesillustrated 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.compensation under the Lakes' plans and unit-based employee and consultant compensation under the WPT Plans (in thousands except per share data).
SIX MONTHS ENDED THREE MONTHS ENDED ---------------- ------------------ JUNE 29,APRIL 4, 2004 MARCH 30, 2003 JUNE 30, 2002 JUNE 29, 2003 JUNE 30, 2002 ------------- ------------- ------------- --------------------------- Net earnings (loss):loss: $ (538)(760) $ (7,243) $ 789 $ (7,180)(1,327) As reported Add: Unit-based compensation expense 94 -- included in reported net loss Less: Total stock-based compensation (451) (374) expense determined under the fair value method, net of related tax effects (767) (849) (383) (426) Pro forma (1,305) (8,092) 406 (7,606)(1,117) (1,701) Net earnings (loss)loss per share: As reported -- Basic $ (0.05)(0.03) $ (0.68) $ 0.07 $ (0.67)(0.06) Pro forma -- Basic (0.12) (0.76) 0.04 (0.71)(0.05) (0.08) As reported -- Diluted (0.05) (0.68) 0.07 (0.67)(0.03) (0.06) Pro forma -- Diluted (0.12) (0.76) 0.04 (0.71)(0.05) (0.08)
1210 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 remodelingdevelopment portion of the agreements commencedcommences with the signing of the respective contracts and continuedcontinues until the casinos openedopen 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.reconsideration (see Note 9). 5. NOTES RECEIVABLE The notes receivable from Indian Tribes are generallyresult from costs incurred by the Company for the development of gaming properties to be managed byunder which the Company.Company has signed management contracts. 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, 2003, no amounts have been withheld under these provisions. 1311 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Notes receivable consist of the following (in thousands):
June 29,April 4, 2004 December 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, 2003)April 4, 2004), receivable in 60 monthly installments subsequent to commencement date $ 40,62442,846 $ 39,47041,729 Notes from the Shingle Springs Band of Miwok Indians with variable interest rates (6.00% at June 29, 2003)April 4, 2004), receivable in varying monthly installments based on contract terms subsequent to commencement date 17,539 14,03527,370 24,428 Notes from Jamul Indian Village with variable interest rates (6.00% at June 29, 2003)April 4, 2004), receivable in 1260 monthly installments subsequent to commencement date 10,795 9,49213,011 12,336 Notes from the Nipmuc Nation with variable interest rates (6.00% at June 29, 2003)April 4, 2004) receivable in varying installments based on contract terms subsequent to commencement date 4,150 3,8145,105 4,634 Other 2,487 4,144 --------- --------1,576 1,555 ---------- ---------- Total notes receivable 75,595 70,955 ======== ========$ 89,908 $ 84,682 ========== ==========
Interest income on notes receivable from Indian Tribes related to casinoproperties under 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, 2003April 4, 2004 and December 29, 2002, $12.228, 2003, $16.8 million and $10.1$15.2 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, 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. 1412 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.term, which began May 1, 2004. Approximate future minimum lease payments, due under this lease as of June 29, 2003, assuming the second one-year renewal is exercised,April 4, 2004, are as follows (in thousands):
Operating Leases ---------------- 20032004 $ 300 2004 600450 2005 200 --------------- $ 1,100 ========650 =======
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 through December 28, 2004 against all costs, expenses and liabilities incurred in connection with or arising out of certain pending and threatened claims and legal proceedings to whichagainst Grand and certain of its subsidiaries are likely to be parties.pay all related settlements and judgments. 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.Caesars Entertainment, Inc, the parent Company of Grand. LEGAL PROCEEDINGS The following summaries describe certain known legal proceedings to which Grand isSLOT MACHINE LITIGATION In 1994, William H. Poulos filed a party which Lakes has assumed, or with respect to which Lakes may have agreed to indemnify Grand,class-action lawsuit in connection with the Distribution. STRATOSPHERE PREFERENCE ACTION In April 1998, Stratosphere served onUnited States District Court for the Middle District of Florida against various parties, including Grand and Grand Media & Electronics Distributing, Inc.,numerous other parties alleged to be casino operators or slot machine manufacturers. This lawsuit was followed by several additional lawsuits of the same nature against the same, as well as additional defendants, all of which were subsequently consolidated into a wholly owned subsidiary of Grand ("Grand Media"), a complaintsingle class-action pending in the Stratosphere bankruptcy case seeking recoveryUnited States District Court for the District 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. 16Nevada. 13 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Stratosphere claimedFollowing a court order dismissing all pending pleadings and allowing the plaintiffs to re-file a single complaint, a complaint has been filed containing substantially identical claims, alleging that the defendants fraudulently marketed and operated casino video poker machines and electronic slot machines, and asserting common law fraud and deceit, unjust enrichment and negligent misrepresentation and claims under the federal Racketeering-Influenced and Corrupt Organizations Act. Various motions were filed by the defendants seeking to have this new complaint dismissed or otherwise limited. In December 1997, the Court, in its complaintgeneral, ruled on all motions in favor of the plaintiffs. The plaintiffs then filed a motion seeking class certification and the defendants opposed it. In June 2002, the Court entered an order denying class certification, and the plaintiffs have appealed this order to the 9th Circuit Court of Appeals. Briefing is complete, an oral hearing took place in January 2004, and no ruling has yet been issued. WILLARD EUGENE SMITH LITIGATION On October 24, 2003, Lakes announced that such amounts are recoverableit had been named as one of a number of defendants in a counterclaim filed in state court in Harris County, Texas by Stratosphere as preferential paymentsWillard Eugene Smith involving Kean Argovitz Resorts, LLC (KAR), related persons and entities. In the counterclaim, Smith asserts that, 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. DiscoveryShingle 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 Lakes and its affiliates from damages resulting from prior dealings of the KAR entities and related principals concerning the projects. Lakes will vigorously defend against the allegations made against it and will pursue its indemnification rights against the KAR entities and their principals under the buyout agreements if necessary. EL DORADO COUNTY, CALIFORNIA LITIGATION On January 3, 2003, El Dorado County filed an action in the Superior Court of the State of California, seeking to prevent the construction of a highway interchange that was completedapproved by a California state agency. The action does not seek relief directly against Lakes. However, the interchange is necessary to permit the construction of a casino to be developed and managed by Lakes through a joint venture. 14 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The casino will be owned by the Shingle Springs Band of Miwok Indians. The matter was tried to the court on December 31, 2001 andAugust 22, 2003. On January 2, 2004, Judge Lloyd G. Connelly, Judge of the case proceeded to trial before the United States BankruptcySuperior Court for the DistrictState of NevadaCalifornia, issued his ruling on June 20, 2002. On December 31, 2002, the Bankruptcymatter. The Court issued its final judgment holding that: (i) paymentsdenied the petition in all respects except one. As to Grand Mediathe one exception, the Court sought clarification as to whether the transportation conformity determination used to determine the significance of the air quality impact of the interchange operations considered the impact on attainment of the state ambient air quality standard for electronic equipment totaling approximately $3.3 million are not recoverableozone. The California Department of Transportation prepared and filed the clarification sought by Stratosphere as avoidable preferences,the Court. Prior to the Court's determination of the adequacy of the clarification, El Dorado County appealed Judge Connelly's ruling to the California Court of Appeals. Judge Connelly ruled on April 9, 2004, that he has jurisdiction to determine the adequacy of the clarification and (ii) paymenthas scheduled another hearing for May 21, 2004 to Grand for management services inhear argument on whether 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.last issue has been satisfactorily resolved. 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, including the matters discussed above, 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 2001Lakes is currently in the process of negotiating a license agreement with Sklansky Games, LLC ("Sklansky") and 2000,World Poker Tour, LLC pursuant to which Lakes madewill develop a totalcasino table game jointly with Sklansky utilizing the World Poker Tour brand name. Sklansky, through a joint venture with an unrelated third party, is also in negotiations to license the World Poker Tour brand in connection with the joint venture's development of $4.0 millionan electronic poker-related gaming machine. In addition to our indirect majority ownership in unsecured loans, which were receivableWorld Poker Tour, LLC through one of our wholly owned subsidiaries, Mr. Berman and his son, Brad Berman, each own an equity interest in full on December 31, 2002, to ViatiCare Financial Services,Sklansky. Mr. Berman owns 28% and Brad Berman owns 44% of Sklansky. Effective as of February 24, 2004, Lakes' majority-owned subsidiary, World Poker Tour, LLC which has since been acquired by Living Benefits Financial Servicesentered into a non-exclusive license agreement with G-III Apparel Group, Ltd. ("Living Benefits"G-III"). In March 2001,Morris Goldfarb, a Lakes director, is a director, Co-Chairman of 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 of G-III. Under the agreement, G-III licenses the World Poker Tour name, logo and a Directortrademark from World Poker Tour, LLC in connection with G-III's production of Lakes, made loanscertain types of apparel for distribution in authorized channels within the United States, its territories and possessions and in certain circumstances, Canada. As consideration for this non-exclusive license, G-III pays royalties and certain other fees 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. 17World Poker Tour, LLC. 15 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Previously, Lakes formed two joint venture partnerships with Kean Argovitz Resorts, LLC ("KAR"),8. SEGMENT INFORMATION Lakes' principal business is the development and management of gaming related properties. Additionally, the Company is the majority owner of the World Poker Tour, LLC. (See Note 1). Substantially, all of our operations are conducted in the United States. Lakes' reportable segments are as follows (in millions): Industry Segments
Real Estate World Poker Corporate & Total Development Tour Eliminations Consolidated ----------- ----------- ------------ ------------ For the Three Months Ended/as of April 4, 2004 Revenue $ -- $ 4.1 $ -- $ 4.1 Operating income (loss) (0.1) 0.8 (1.5) (0.8) Total assets 133.2 2.5 39.6 175.3 Depreciation expense -- -- 0.1 0.1 For the Three Months Ended/as of March 30, 2003 Revenue $ -- $ 0.6 $ -- $ 0.6 Operating loss (0.1) (0.4) (0.8) (1.3) Total assets 150.7 0.8 22.7 174.2 Depreciation expense -- -- 0.1 0.1
9. SUBSEQUENT EVENTS During April of 2004, the Company's Board of Directors declared a limited liability company basedtwo-for-one stock split, payable in Houston, Texasthe form of a 100% stock dividend on Lakes' outstanding common stock. The stock dividend was paid on May 3, 2004 to shareholders of record as of April 26, 2004. As a result of the stock split, shareholders received one additional share of common stock for every share they held on the purposerecord date. Upon completion of developing and managing casino resort projectsthe split, the number of common shares outstanding was approximately 22.2 million. In connection with the Shingle Springs Band of Miwok Indiansstock split, the Company introduced a direct registration program to provide for uncertified shares through Wells Fargo Shareowner Services, the Company's transfer agent and registrar. As a result, the Jamul Indian Village, bothadditional shares were issued in California. On January 30, 2003, Lakes restructured a series of arrangements with KAR"book-entry" form without stock certificates and its individual members such that Lakes has effectively acquired 100% ownershipare registered on the books of the joint venturesCompany maintained by Wells Fargo Shareowner Services. All share and per share data reflected in exchange for restructuring indebtedness of $1.8 million from the joint venture partnershipsthis quarterly report has been retroactively restated to Lakes and an agreement to make certain conditional paymentsgive effect to the individual KAR members from profits received understock split. During April of 2004, 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 purchasedNipmuc Nation was notified by the joint venture near San Diego, California. Land Baron West, LLC owedDirector, Office of Federal Acknowledgement (OFA) within the joint venture $0.5 million, and $0.2 million, asBureau of June 29, 2003 and December 29, 2002, respectively. These amounts are included in accounts receivable onIndian Affairs (BIA), that 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 valueprojected date of the associated use and all payments totaling $0.02 million for such use have been received. 8. SUBSEQUENT EVENT SHARK CLUB On JulyBIA's final determination on federal recognition (Petition 69A) was extended by forty-five days. In a letter to the Nipmuc Nation Chief Walter Vickers, the BIA projects issuing the Nipmuc final determination by June 15, 2004, rather than the previously projected date of May 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. 182004. 16 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)begin. 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 withIndian-owned gaming resorts for the Jamul Indian Village and the other near Sacramento with thefollowing: o Shingle Springs Band of Miwok Indians. (3) Lakes and another company have formed a partnership with a contract to finance the constructionIndians near Sacramento, California o Pokagon Band of an Indian-owned casino 60 miles north ofPotawatomi Indians near New Buffalo, Michigan o Jamul Indian Village near 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 theDiego, California o Nipmuc Nation a Massachusetts Indian tribe, for development and managementon the East Coast 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.States In addition, Lakes owns options to purchase the patent rights for various new casino games and is actively marketing these new games to the casino industry in an attempt to have a casino acceptlicense the games for use in their operations. World Poker Tour, a majority-owned subsidiary of Lakes, has also formedcreated a joint venture with another company to develop approximately 2,000 acres owned bycircuit of previously-established poker tournaments affiliated under 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"World Poker Tour" name, and has also formed a joint venture with a producer to launchproduced the World Poker Tour ("WPT") and establish poker as the next significant televised mainstream sport. The joint venturetelevision series. World Poker Tour 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 the Travel Channel, LLC ("TRV") for broadcast of the World Poker Tour series on cable television which is currently airing. TRV was also granted options for five additional seasons. Revenue is recognized ratably as production milestones and other conditions are met.WPT receives a series of fixed license payments from TRV. During the first two quartersJanuary of 2003, Lakes recognized approximately $3.5 million in revenue related to the2004, World Poker Tour. Revenues relatedTour announced that it will seek to raise approximately $20 million through a newly formed corporation pursuant to an underwritten initial public offering of common stock at a price to be determined. It is expected that proceeds from the second seasonoffering will be recognized during 2004. 19used to expand World Poker Tour's entertainment production business and for its working capital. There will be no selling shareholders participating in the offering. Lakes does not expect to recognize a gain or loss on this transaction and the proceeds will be reflected as a minority interest. Additionally, Lakes continually evaluates other opportunities to diversify the Company's activities and bring in new revenue streams. 17 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. RevenueLicense revenue from the World Poker Tour series airing on TRV is recognized ratably as production milestonesupon delivery of completed episodes. WPT sponsorship and other conditionshost casino revenue is recognized upon airing of episodes. Any payments received in excess of WPT revenue earned are met.deferred and recoginized upon delivery or airing of episodes. IMPAIRMENT OF LONG-TERM ASSETS: TheCurrently, the Company's notes receivable from Indian Tribes are generally for the pre-construction 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 ofto certain distribution priorities specified in the management contracts. In addition, repayment of the notes receivable and the manager's fees under the management contracts may beare subordinated to certain other financial obligations of the respective tribes. Through June 29, 2003,April 4, 2004, 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.an assessment of the underlying facility and an assessment as to the liklihood of project completion. If the Company determines an impairment has occurred, the notes receivable would be written down to their estimated fair value. 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 June 15,28, 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. 2118 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. SIXTHREE MONTHS ENDED JUNE 29, 2003APRIL 4, 2004 COMPARED TO THE SIXTHREE MONTHS ENDED JUNEMARCH 30, 20022003 Revenues Total revenues were $3.5$4.1 million for the sixthree months ended June 29, 2003April 4, 2004, compared to $1.5$0.6 million for the same period in the prior year.year period. Revenues for the current and prior year periodperiods were primarily derived entirely from license fees related to the WPT series, which has now completed its first full season. An agreement forseries. The increase in revenue is the result of a WPT second season was reached during Julygreater number of 2003. Underepisodes delivered to the new agreement, WPT will receive a series of fixed license payments forTravel Channel in the second season. These payments will commence in 2004 and are subjectcurrent year period compared 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.period. Costs and Expenses Total costs and expenses were $5.0$5.9 million for the sixthree months ended June 29, 2003,April 4, 2004, compared to $11.9$3.1 million for the same period in the prior year. Selling, general and administrative expenses decreasedincreased from $11.7$2.1 million for the sixthree months ended JuneMarch 30, 20022003 to $7.9$3.3 million for the sixthree months ended June 29, 2003.April 4, 2004. This decreaseincrease is the result of impairment charges takendue to an increase in the prior year period of $4.0 million relating to a note receivable from Living Benefits, LLC,costs associated with World Poker Tour and $3.0 million relating to the Polo Plaza and Travelodge properties, which was partially offset by an increase in professional fees incurred by Lakes, related to development projects. World Poker Tour production costs increased from $0.9 million for the three months ended March 30, 2003 to $2.5 million for the three months ended April 4, 2004. Production costs consist of capitalizable direct costs, production overhead and development costs for each episode and are generally expensed as revenues are recognized upon delivery and acceptance of the completed episode. However, the $0.9 million in production costs recognized in the 2003 period does not include an additional $1.0 million in production costs that were previously expensed in 2002 even though the episodes were not delivered until 2003. These previous costs were not capitalized as of December 29, 2002, because World Poker Tour did not have a contract for the sale of episodes at that time. Other 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. During the first quarter of 2004, the joint venture sold this land. Lakes' share of the proceeds related to this sale was approximately $1.7 million in cash after payment of closing costs. The sale resulted in a gain to Lakes of approximately $1.4$0.4 million related to the property sales in Las Vegas, Nevada, as well as an increase in costs incurred associated with WPTwhich is included in the amountaccompanying consolidated statement of $2.2 million duringearnings for 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. 22three months ended April 4, 2004. 19 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Other Interest income was $0.6 million for the six months ended June 29, 2003 compared to $1.2 million for the same period in the prior year. This decrease is primarily due to lower cash balances during the period. LossesEarnings Per Common Share and Net LossesEarnings For the sixthree months ended June 29, 2003,April 4, 2004, basic and diluted losses per common share were $0.05,$0.03, compared to basic and diluted losses of $0.68,$0.06 per share, for the same period in the prior year. Losses for the periodthree months ended June 29, 2003April 4, 2004 were $0.5$0.8 million compared to $7.2 million for the six months ended June 30, 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, 2003 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2002 Revenues Total revenues were $3.0$1.3 million for the three months ended June 29,March 30, 2003. There were no revenuesThis decrease in the same periodlosses relates primarily to an increase in the prior year. Revenues fornet World Poker Tour income during the current year period were derived entirelyperiod. Outlook It is currently contemplated that there will be no operating revenues for 2004 from license fees related toexisting casino development projects. Revenue from the WPT series, which has now completed its first full season. An agreement for a WPT second season was reachedof the World Poker Tour series will be recognized along with associated production costs during July 2003. Revenue2004. The Company anticipates that most of the remaining revenues from the second season will be recognized in 2004 as production milestones and other conditions are met. Costs and Expenses Total costs and expenses were $1.9 million for the three months ended June 29, 2003, compared to $9.7 million for the same period in the prior year. Selling, general and administrative expenses decreased from $9.6 million for the three months ended June 30, 2002 to $5.0 million for the three months ended June 29, 2003. This decrease is primarily due to a second quarter 2002 impairment of $4.02004. Although none of the existing casino development projects are expected to produce revenue in 2004, Lakes continues to evaluate potential new revenue-generating business opportunities. Lakes continues to closely monitor its operating expenses. After the anticipated initial public offering by World Poker Tour, Lakes will continue to own a majority of World Poker Tour's equity. Therefore, World Poker Tour's operating results will continue to be consolidated with our results. FINANCIAL CONDITION At April 4, 2004, Lakes had $25.0 million relating to a note receivablein unrestricted cash and cash equivalents. Lakes' operating revenues have been minimal since the expiration of the management contract with the Coushatta Tribe in January 2002. In 2003, the operating revenues derived from Living Benefits Financial Services, LLC, as well as a $3.0 million impairment charge taken on the Polo Plaza and Travelodge properties,World Poker Tour were offset almost entirely by production costs. The Company's primary source of cash the past two years has been from the planned sale of assets. We expect that proceeds from the sale of assets will decrease in 2004. During the first quarter of 2004, the 2022 Ranch land, which was partially offsetowned 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 WPTLakes and its joint venture partner Land Baron West, LLC, was sold. Lakes received cash 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 accrualapproximately $1.7 million. Our management contracts with our tribal partners require that we provide financial support in the amountform of $3.2 million. 23notes receivable prior to the beginning of construction (the 'Pre-construction Financing'). We also have commitments to provide additional financing to our tribal partners to fund the construction of the casinos ('the Construction Financing') if it is not available from other sources. These notes are interest bearing; however, the interest is deferred until the casino is built and has established profitable operations. In the event that the casinos are not built, our only recourse is to liquidate the assets of the development. We currently believe that our existing casino development projects included in the table below will be constructed and achieve profitable operation; however, no assurance can be made that this will occur. If this does not occur, it is likely that Lakes would incur substantial losses in the liquidation of the collateral. 20 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
Casino Development Advances/Commitments ---------------------------------------------------- (in millions) Pre-construction Land Held for Remaining Advances Development Commitment as of 4/4/04 as of 4/4/04 as of 4/4/04 ---------------- ------------- ------------ Jamul Indian Village $ 13.0 $ 6.6 $ 10.4 Shingle Springs Band of Miwok Indians 27.4 7.4 0.2 Pokagon Band of Potawatomi Indians 42.8 -- 25.7 Nipmuc Nation 5.1 -- 1.0
For the three months ended June 29, 2003, basic and diluted earnings per common share were $0.07, comparedPokagon project, the Company has agreed to basic and diluted losses of $0.67, for the same period in the prior year. Earnings for the three months ended June 29, 2003 were $0.8 million compared to losses of $7.2 million for the three months ended June 30, 2002. This increase in earnings relates primarily to the impairment charges of $7.0 million taken in the prior year period discussed above. Also contributing to the increase was the WPT revenue recognized in the current year quarter. 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, 2003, Lakes had $23.4 million in unrestricted cash and cash equivalents. Subsequent to June 29, 2003, Lakes has received $15.0 million in cash related to the sale of the Shark Club property and $1.0 million as repayment of a loan previously made to Chateaux by Lakes. Lakes considers its cash position, which includes the payments received upon the sale of the Shark Club property, adequate to cover expected remaining 2003 operating expenses. For the six months ended June 29, 2003, net cash used in operating activities totaled $4.0 million. For the six months ended June 30, 2002, net cash used in operating activities totaled $0.5 million. For the current year period, net cash provided by investing activities totaled $13.3 million. For the six months ended June 30, 2002, net cash used in investing activities totaled $15.6 million. Included in these investing activities for the periods ended June 29, 2003 and June 30, 2002 are advances on notes receivable of $6.6 million and $9.9 million, respectively. Net receipts from land held under contract for sale were $16.3 million during the six months ended June 29, 2003. Payments for land held under contract for sale were $0.7 million for the six months ended June 30, 2002. 24 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Unrestricted cash increased by $5.9 million during the 2003 period as a result of the reclassification of restricted cash as unrestricted. During the periods ended June 29, 2003 and June 30, 2002, payments for land held for development amounted to $1.6 million and $4.9 million, respectively. 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,provide additional financing willfrom its own funds if financing at an interest rate not to exceed 13% is not available from third parties. If this occurs and Lakes is required to provide all financing, this would be neededan additional commitment of up to complete the projects. It is currently plannedapproximately $54 million. Currently, it appears that this third-party financing will be obtained by each individual tribe.available for this project. However, there can be no assurance that if third-party financing is notwill be available and that 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,additional financing. Lakes may be required to provide a guarantee the tribes'of tribal debt financing or otherwise provide support for the tribes' obligations.tribal obligations related to any of the projects. 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. Our major use of cash over the past three years has been Pre-construction Financing provided to our tribal partners. At June 29, 2003,April 4, 2004, Lakes had approximately $75.6$89.9 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.tribes. See Note 5 to the Consolidated Financial Statements included in Item 1. The joint venture entitiesStatements. We believe that hold the management contracts for the San Diegoour cash and Sacramento area casino resorts were previously jointly ownedcash equivalents, along 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. Keanexpected cash receipts, 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 usedadequate to fund certain obligations of Mr. Kean related to a separate joint venture formed to acquire landoperating expenses and Pre-construction Financing 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 Company invested $0.1 million for an approximately 78% ownership position in the joint venture during 2002. The Company is also required to loan up to $3.2 million to the joint venture as needed. As of June 29, 2003, the Company had made net loans totaling $1.8 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. 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 commitmentPokagon casino project begins construction during 2004, it 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 millionanticipated that we will require additional capital through either public 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 $7.5private financings. Lakes loaned $0.3 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 salea former non-tribal partner in one of its Shark Club property in Las Vegas, Nevada to an entityIndian casino development projects. Repayment is expected to be managed and operated by Marriott Ownership Resorts, Inc. As consideration forreceived from 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 obligationformer partner's future consulting fees 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.certain Indian casino development projects. At April 4, 2004, $0.3 million is outstanding under this agreement. As a part of the agreements resulting from Lakes' spin-off from Grand Casinos and related transactions,transaction establishing Lakes hasas a separate public company on December 31, 1998, the Company agreed to indemnify Grand Casinosthrough December 28, 2004 against all costs, expenses and liabilities incurred in connection with or arising out of certain pending and threatened claims and legal proceedings against Grand and to which Grand Casinospay all related settlements and certain of its subsidiaries are likely to be parties.judgments. 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.21 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 outa part of the trust to Stratosphere. Following such payment,indemnification agreement, Lakes 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 trust account was terminated and the remaining restricted fundswritten consent 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.Grand. 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 PRONOUNCEMENTSOFF-BALANCE SHEET ARRANGEMENTS 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 elaboratesCompany has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect 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 undertakencondition, changes 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 interimcondition, revenues or annual periods ended after December 15, 2002. The adoption of the interpretation did not have a material impact on the Company'sexpenses, results of operations, financial positionliquidity, capital expenditures or capital resources that is material to investors, except for the financing commitments previously discussed, and cash flows. The Company does have an indemnification agreement with Grand Casinos which is fully describedexcept for Lakes' investments 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"unconsolidated affiliates (see Note 2). 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. 22 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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; inability to achieve financial results from the contemplated business expansion of World Poker Tour, LLC; 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. 3028, 2003. 23 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, 2003,April 4, 2004, 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 29 2003,April 4, 2004, Lakes had $75.5$89.9 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$5.0 million. A reference rate increase of 100 basis points would result in an increase in deferred interest income of $0.8$0.9 million. A 100 basis point decrease in the reference rate would result in a decrease of $0.8$0.9 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. 3124 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The following summaries describe certain known legal proceedings to which Grand isSLOT MACHINE LITIGATION In 1994, William H. Poulos filed a party which Lakes has assumed, or with respect to which Lakes may have agreed to indemnify Grand,class-action lawsuit 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. 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 BankruptcyDistrict Court for the Middle District of Florida against various parties, including Grand and numerous other parties alleged to be casino operators or slot machine manufacturers. This lawsuit was followed by several additional lawsuits of the same nature against the same, as well as additional defendants, all of which were subsequently consolidated into a single class-action pending in the United States District Court for the District of NevadaNevada. Following a court order dismissing all pending pleadings and allowing the plaintiffs to re-file a single complaint, a complaint has been filed containing substantially identical claims, alleging that the defendants fraudulently marketed and operated casino video poker machines and electronic slot machines, and asserting common law fraud and deceit, unjust enrichment and negligent misrepresentation and claims under the federal Racketeering-Influenced and Corrupt Organizations Act. Various motions were filed by the defendants seeking to have this new complaint dismissed or otherwise limited. In December 1997, the Court, in general, ruled on all motions in favor of the plaintiffs. The plaintiffs then filed a motion seeking class certification and the defendants opposed it. In June 20, 2002. On December 31, 2002, the Bankruptcy Court entered an order denying class certification, and the plaintiffs have appealed this order to the 9th Circuit Court of Appeals. Briefing is complete, an oral hearing took place in January 2004, and no ruling has yet been issued. 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 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 its finalagainst Smith by the Harris County, Texas state court in October 2000. However, in September 2003, the court vacated the prior 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 servicesagainst Smith. Lakes acquired KAR's interests in the approximate amountShingle 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 Lakes and its affiliates from damages of $2.3 millionthe KAR entities and related principals concerning the projects. Lakes will vigorously defend against the allegations made against it and will pursue its indemnification rights against the KAR entities and their principals under the buyout agreements if necessary. 25 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) EL DORADO COUNTY, CALIFORNIA LITIGATION On January 3, 2003, El Dorado County filed an action in the Superior Court of the State of California, seeking to prevent the construction of a highway interchange that was approved by a California state agency. The action does not seek relief directly against Lakes. However, the interchange is recoverablenecessary to permit the construction of a casino to be developed and managed by StratosphereLakes through a joint venture. The casino will be owned by the Shingle Springs Band of Miwok Indians. The matter was tried to the court on August 22, 2003. On January 2, 2004, Judge Lloyd G. Connelly, Judge of the Superior Court for the State of California, issued his ruling on the matter. The Court denied the petition in all respects except one. As to the one exception, the Court sought clarification as to whether the transportation conformity determination used to determine the significance of the air quality impact of the interchange operations considered the impact on attainment of the state ambient air quality standard for ozone. The California Department of Transportation prepared and an avoidable preference. Onfiled the clarification sought by the Court. Prior to the Court's determination of the adequacy of the clarification, El Dorado County appealed Judge Connelly's ruling to the California Court of Appeals. Judge Connelly ruled on April 9, 2004 that he has jurisdiction to determine the adequacy of the clarification and has scheduled another hearing for May 8, 2003, this judgment was satisfied out of amounts held in trust as security21, 2004 to support Lakes' indemnification obligations to Grand.hear argument on whether the last issue has been satisfactorily resolved. 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, including the matters discussed above, is not likely to have a material adverse effect upon the Company's consolidated financial position or results of operations. 3226 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 3.1 (i) Articles of Incorporation of Lakes Entertainment, Inc. (as amended through May 4, 2004) 10.1 PurchaseMaster Agreement, dated as of June 26,August 22, 2003, by and between Grand Casinos Nevada I,World Poker Tour, LLC and the Travel Channel, LLC (incorporated by reference to Exhibit 10.2 to the registration statement on Form S-1 of WPT Enterprises, Inc. and Diamond Resorts,filed with the Commission on April 15, 2004) * 10.2 Letter dated as of April 12, 2004 from the Travel Channel, LLC to World Poker Tour, LLC (incorporated by reference to Exhibit 10.3 to the registration statement on Form S-1 of WPT Enterprises, Inc. filed with the Commission on April 15, 2004)* 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)- ---------- * Confidential treatment has been requested as to certain portions of this exhibit pursuant to Rule 406 of the Securities Act of 1933, as amended. (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 AprilJanuary 7, 20032004 (ii) A Form 8-K, Item 5. Other Events, and Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, and Item 9. Regulation FD Disclosure, was filed on April 14, 2003January 28, 2004 (iii) A Form 8-K, Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, and Item 12. Results of Operations and Financial Condition,9. Regulation FD Disclosure, 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, 2003 35February 23, 2004 27 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, 2003May 19, 2004 LAKES ENTERTAINMENT, INC. ------------------------- Registrant /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 3628