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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________________ to __________________
Commission File No. 0-24993
LAKES ENTERTAINMENT, INC.
-------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-1913991
--------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
130 Cheshire Lane
Minnetonka, Minnesota 55305
--------------------- -----
(Address of principal executive offices) (Zip Code)
(952) 449-9092
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.
Yes [ ] No [X]
As of May 8, 2003, there were 10,638,320 shares of Common Stock, $0.01 par value
per share, outstanding.
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
INDEX
PAGE OF
FORM 10-Q
---------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of March 30, 2003 and 3
December 29, 2002
Condensed Consolidated Statements of Earnings for the three months 4
ended March 30, 2003 and March 31, 2002
Condensed Consolidated Statements of Comprehensive Earnings for the
three months ended March 30, 2003 and March 31, 2002 5
Condensed Consolidated Statements of Cash Flows for the three months 6
ended March 30, 2003 and March 31, 2002
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 19
AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 31
ITEM 4. CONTROLS AND PROCEDURES 32
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 33
ITEM 5. OTHER INFORMATION 35
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 36
2
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 30, 2003 DECEMBER 29, 2002
- --------------------------------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 5,500 $ 14,106
Accounts receivable, net 764 116
Deferred tax asset 6,771 6,771
Other current assets 1,116 547
- --------------------------------------------------------------------------------------------------------
Total Current Assets 14,151 21,540
- --------------------------------------------------------------------------------------------------------
Property and Equipment-Net 6,825 6,962
- --------------------------------------------------------------------------------------------------------
Other Assets:
Land held under contract for sale 29,053 28,832
Land held for development 29,224 27,791
Notes receivable 72,470 70,955
Cash and cash equivalents-restricted 8,313 8,300
Investments in and notes from unconsolidated affiliates 1,248 1,013
Deferred tax asset 4,165 3,835
Other long-term assets 8,754 6,657
- --------------------------------------------------------------------------------------------------------
Total Other Assets 153,227 147,383
- --------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 174,203 $ 175,885
========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 108 $ 226
Income taxes payable 5,517 5,564
Litigation and claims accrual 5,809 5,847
Accrued payroll and related 343 252
Other accrued expenses 3,242 3,486
- --------------------------------------------------------------------------------------------------------
Total Current Liabilities 15,019 15,375
- --------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 15,019 15,375
- --------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity:
Capital stock, $.01 par value; authorized 100,000 shares;
10,638 common shares issued and outstanding
at March 30, 2003, and December 29, 2002 106 106
Additional paid-in-capital 131,526 131,525
Retained Earnings 27,552 28,879
- --------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 159,184 160,510
- --------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 174,203 $ 175,885
========================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
3
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
THREE MONTHS ENDED
------------------
MARCH 30, 2003 MARCH 31, 2002
-------------- --------------
REVENUES:
Management fee income $ - $ 1,502
License fee income 550 -
- ----------------------------------------------------------------------------------------------------
Total Revenues 550 1,502
- ----------------------------------------------------------------------------------------------------
COSTS AND EXPENSES:
Selling, general and administrative 2,979 2,100
Depreciation and amortization 128 99
- ----------------------------------------------------------------------------------------------------
Total Costs and Expenses 3,107 2,199
- ----------------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (2,557) (697)
- ----------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest income 237 736
Interest expense - (23)
Equity in loss of unconsolidated affiliates (87) (123)
Other 159 -
- ----------------------------------------------------------------------------------------------------
Total other income, net 309 590
- ----------------------------------------------------------------------------------------------------
Loss before income taxes (2,248) (107)
Benefit for income taxes (921) (44)
- ----------------------------------------------------------------------------------------------------
NET LOSS ($ 1,327) ($ 63)
====================================================================================================
BASIC LOSS PER SHARE ($ 0.12) ($ 0.01)
====================================================================================================
DILUTED LOSS PER SHARE ($ 0.12) ($ 0.01)
====================================================================================================
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
====================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
4
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
----------------------------------
MARCH 30, 2003 MARCH 31, 2002
----------------------------------
NET LOSS ($ 1,327) ($ 63)
OTHER COMPREHENSIVE LOSS, NET OF TAX:
Unrealized losses on securities:
Unrealized holding losses during the period - (8)
------------------------------
COMPREHENSIVE LOSS ($ 1,327) ($ 71)
==============================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
5
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
------------------
MARCH 30, 2003 MARCH 31, 2002
-------------- --------------
OPERATING ACTIVITIES:
Net loss ($ 1,327) ($ 63)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 128 99
Equity in loss of unconsolidated affiliates 87 123
Changes in operating assets and liabilities:
Accounts receivable (648) 3,529
Income taxes (47) 338
Accounts payable (118) 47
Accrued expenses (191) 1,008
Other (899) (127)
- ---------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities (3,015) 4,954
- ---------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Payments for land held under contract for sale (221) (291)
Payments for land held for development (1,433) (265)
Advances on notes receivable (3,492) (4,557)
Proceeds from repayment of notes receivable - 67
Investment in and notes receivable from unconsolidated affiliates (285) (160)
Increase in restricted cash, net (13) (27)
Increase in other long-term assets (156) (851)
Reduction of (payments for) property and equipment, net 9 (832)
- ---------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (5,591) (6,916)
- ---------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Payments on capital lease obligations - (5,714)
- ---------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities - (5,714)
- ---------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (8,606) (7,676)
Cash and cash equivalents - beginning of period 14,106 42,638
- ---------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 5,500 $ 34,962
=========================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ - $ 25
Income taxes 5 5
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
6
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BUSINESS
Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")
was established as a public corporation on December 31, 1998, via a distribution
(the "Distribution") of its common stock, par value $.01 per share (the "Common
Stock") to the shareholders of Grand Casinos, Inc. ("Grand").
Lakes currently has development and management agreements with four separate
tribes for four new casino operations, one in Michigan, two in California and
one with the Nipmuc Nation on the east coast. The Company also has agreements
for the development of one additional casino on Indian owned land in California
through a joint venture which is currently being disputed by the tribe. Each of
these projects is currently in the development phase.
The Company has also formed a joint venture with a producer to launch the World
Poker Tour ("WPT") and establish poker as the next significant televised
mainstream sport. During March of 2003, the WPT signed an agreement with the
Travel Channel, LLC (TRV), granting TRV the right to broadcast the first season
of the WPT series. WPT receives a series of fixed license payments from TRV,
subject in each case to satisfaction of production milestones and other
conditions. Revenue is recognized ratably as production milestones and other
conditions are met. The license fees are expected to cover substantially all
anticipated first year production costs.
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 is included as land held under contract for sale
on the accompanying balance sheets as of March 30, 2003 and 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 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. This real estate is reported at its
adjusted carrying value in Land Held Under Contract for Sale. Lakes' collateral
is the property and lease rights described above which would revert back to
Lakes in the event of default by Metroflag.
7
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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 the parties have agreed shall be extended to
no later than May 15, 2003, $16.8 million of the purchase price is payable to
Lakes in cash, $4.0 million is payable through the issuance to Lakes of a
preferred membership interest in Metroflag and $4.0 million is payable through
the issuance to Lakes of a subordinated membership interest in Metroflag. On or
before April 30, 2004, Metroflag Polo may elect to distribute to Lakes $3.0
million plus interest in cash as full return of Lakes' preferred interest. If
paid after April 30, 2004, and in no event later than December 24, 2006, the
entire $4.0 million plus interest will be payable. The subordinated interest
must be repurchased for $4.0 million at the time of repayment of an outstanding
$3.5 million contractual commitment in connection with the Travelodge property,
which is scheduled on or before December 28, 2004. In March of 2003, the parties
decreased the sale price of the Travelodge property from $7.5 million to $3.5
million. At that time, the contractual commitment to pay Lakes was also
decreased from $7.5 million to $3.5 million. If the Travelodge commitment is not
repaid by December 28, 2004, ownership of the Travelodge lease rights would
revert back to Lakes. If at any time the Polo Plaza property is sold and the
Travelodge commitment has not been repaid, Metroflag is required to repurchase
the subordinated interest for the lesser of $4.0 million or any portion of the
net cash proceeds from such sale or refinancing that exceeds $60.0 million.
LAND HELD FOR DEVELOPMENT
Lakes continues to own the Shark Club property, which is an approximate 3.5 acre
undeveloped site adjacent to the Polo Plaza shopping center and Travelodge
sites. During August 2002, Lakes formed a joint venture with Diamond Resorts,
LLC, a Nevada limited liability company and time-share developer for the purpose
of developing the Shark Club parcel as an upscale time-share project. The terms
of this joint venture agreement require that Diamond and Lakes each make an
initial working capital contribution of $250,000. Subject to Diamond obtaining a
financing commitment for a construction loan sufficient to fund at least the
first phase of the building improvements contemplated by the time-share project,
the joint venture agreement will require Lakes to contribute the relevant
portion of the Shark Club parcel, which was originally valued at $16 million.
During December of 2002, the Shark Club parcel was adjusted to its revised
estimated market value of $15 million, resulting in an impairment charge of
approximately $1.0 million, which was reflected in impairment losses in the
consolidated statement of loss for the year ended December 29, 2002. Diamond has
agreed to perform sales, marketing, administrative and managerial services for
the project. The terms of the joint venture agreement provide for the repayment
to Lakes of its contribution of property in cash based on the joint venture's
cash flow and time-share unit sales. It is contemplated that Lakes will be
required to make no other material contributions of cash or property to the
project. It is possible that Lakes may sell the Shark Club property or its
interest in the joint venture prior to or during construction in order to
monetize this investment. See Note 10 for current status.
8
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest
will accrue at a rate of 10.0% per annum. The loan is due and payable from first
available cash flow of the joint venture (excluding any required capital
contribution from a member) and no later than October 1, 2004.
Also included in land held for development is land held for possible transfer to
Indian tribes for use in future casino resort projects in the amount of $14.2
million and $12.8 million as of March 30, 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.
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 is in the process of evaluating all of its investments and other
interests in entities that may be deemed variable interest entities under the
provisions of FIN 46. If the Company's interests were deemed to constitute
variable interest entities, there would be no material impact because amounts
are already included as notes receivable on the accompanying condensed
consolidated balance sheets. The Company cannot make any definitive conclusion
until it completes its evaluation.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 supersedes previous guidance for financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies to legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset. This statement was effective January 1, 2003.
9
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 eliminates the definition and requirement
for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 where
a liability for an exit is recognized at the date of an entity's commitment to
an exit plan. This statement is effective for exit or disposal activities
initiated after December 31, 2002.
The adoption of SFAS No. 143 and 146 did not have a material impact on the
results of operations, financial position and cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123". SFAS No. 148 provides alternative transition methods for companies that
make a voluntary change to the fair-value-based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company has adopted the disclosure provisions of SFAS No. 148 and
its adoption had no impact on the Company's consolidated financial position or
results of operations.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements include
the accounts of Lakes and its wholly-owned and majority-owned subsidiaries.
Investments in unconsolidated affiliates representing 50% or less of voting
interests are accounted for on the equity method. All significant intercompany
balances and transactions have been eliminated in consolidation.
Lakes' investments in unconsolidated affiliates include a 50 percent ownership
interest in PCG Santa Rosa, LLC, a joint venture formed to develop a casino on
Indian-owned land in California and a 49 percent voting interest in the
Chateaux, LLC, a joint venture formed to develop the Shark Club parcel in Las
Vegas, Nevada, into an upscale timeshare project. See Note 9 for current status.
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 three months ended March 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 28,
2003. The condensed consolidated financial statements should be read in
conjunction with the condensed consolidated financial statements and notes
thereto included in the Company's annual report on Form 10-K for the year ended
December 29, 2002.
10
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
3. STOCK-BASED COMPENSATION
At March 30, 2003, the Company has two stock-based employee compensation plans.
The Company accounts for those plans under the recognition and measurement
principles of APB Option No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost is reflected
in net income, as all options granted under those plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
FIRST QUARTER FIRST QUARTER
2003 2002
---- ----
Net loss:
As reported $ (1,327) $ (63)
Less: Total stock-based compensation
expense determined under the fair value
method, net of related tax effects (383) (423)
Pro forma (1,710) (486)
Net loss per share:
As reported -- Basic $ ( 0.12) $ ( 0.01)
Pro forma -- Basic ( 0.16) ( 0.05)
As reported -- Diluted ( 0.12) ( 0.01)
Pro forma -- Diluted ( 0.16) ( 0.05)
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 contract for Grand Casino Coushatta expired January 16, 2002,
which is seven years from the date the casino opened, and was not renewed. This
non-renewal has resulted in the loss of revenues to the Company derived from
such contract, which has had a material adverse effect on the Company's results
of operations. As of March 30, 2003, the Company has no other management
contracts from which it will derive revenues in 2003.
11
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The management contracts govern the relationship between the Company and the
tribes with respect to the construction and management of the casinos. The
construction or remodeling portion of the agreements commenced with the signing
of the respective contracts and continued until the casinos opened for business;
thereafter, the management portion of the respective management contracts
continues for a period up to seven years. Under the terms of the contracts, the
Company, as manager of the casino, receives a percentage of the distributable
profits (as defined in the contract) of the operations as a management fee after
payment of certain priority distributions, a cash contingency reserve, and
guaranteed minimum payments to the tribes.
Lakes has a contract to be the exclusive developer and manager of an
Indian-owned gaming resort near New Buffalo, Michigan with the Pokagon Band of
Potawatomi Indians. The Company has formed partnerships that hold contracts to
develop and manage two casinos to be owned by Indian tribes in California, one
near San Diego with the Jamul Indian Village, and the other near Sacramento with
the Shingle Springs Band of Miwok Indians. Lakes and another company have formed
a partnership with a contract to finance the construction of an Indian-owned
casino 60 miles north of San Francisco, California for the Cloverdale Rancheria
of Pomo Indians. The Rancheria is currently disputing the agreement with the
partnership and has notified the partnership that it wishes to terminate the
contract. The Company has also signed contracts with the Nipmuc Nation of
Massachusetts for development and management of a potential future gaming resort
in the eastern United States; however, this tribe has received a negative
finding regarding federal recognition from the Bureau of Indian Affairs (BIA).
The tribe has submitted additional information for reconsideration.
5. NOTES RECEIVABLE
The notes receivable from Indian Tribes are generally for the development of
gaming properties to be managed by the Company. The repayment terms are specific
to each tribe and are largely dependent upon the operating performance of each
gaming property. Repayments of the aforementioned notes receivable are required
to be made only if distributable profits are available from the operation of the
related casinos. Repayments are also the subject of certain distribution
priorities specified in the management contracts. In addition, repayment of the
notes receivable and the manager's fees under the management contracts are
subordinated to certain other financial obligations of the respective tribes.
Through March 30, 2003, no amounts have been withheld under these provisions.
12
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Notes receivable consist of the following (in thousands):
March 30, 2003 December 29, 2002
-------------- -----------------
Properties under development:
Notes from the Pokagon Band of Potawatomi Indians with
variable interest rates (not to exceed 10%) (5.25% at
March 30, 2003), receivable in 60 monthly installments
subsequent to commencement date $ 39,978 $ 39,470
Notes from the Shingle Springs Band of Miwok Indians
with variable interest rates (6.25% at March 30, 2003),
receivable in varying monthly installments based on contract
terms subsequent to commencement date 15,886 14,035
Notes from Jamul Indian Village with variable interest rates
(6.25% at March 30, 2003), receivable in 12 monthly
installments subsequent to commencement date 10,148 9,492
Notes from the Nipmuc Nation with variable interest rates
(6.25% at March 30, 2003) receivable in varying installments
based on contract terms subsequent to commencement date 3,973 3,814
Other 2,485 4,144
---------- ----------
Total notes receivable 72,470 70,955
Less - current installments of notes receivable - -
---------- ----------
Notes receivable, less current installments $ 72,470 $ 70,955
========== ==========
Interest income on notes receivable from Indian Tribes related to casino
development projects is deferred because realizability of the interest is
contingent upon the completion and positive cash flow from operation of the
casino. Interest deferred during the development period is recognized over the
remaining life of the note using the effective interest method. As of March 30,
2003 and December 29, 2002, $10.9 million and $10.1 million of interest on notes
related to properties under development has been deferred.
Management periodically evaluates the recoverability of such notes receivable
based on the current and projected operating results of the underlying facility
and historical collection experience. No impairment losses on such notes
receivable have been recognized through March 30, 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.
13
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
6. LONG-TERM DEBT
During 2002, the Company had two notes payable with third parties. The first was
collateralized by certificates of deposit, in the amount of $1.0 million and was
repaid during the fourth quarter of 2002. The second, in the amount of $0.4
million, was repaid during the second quarter of 2002.
7. CAPITAL LEASE OBLIGATIONS
Pursuant to the terms of the Distribution Agreement, Grand assigned to Lakes,
and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes'
current corporate office space of approximately 65,000 square feet with a lease
term of fifteen years. The lease commenced on October 14, 1996. During 2001,
also pursuant to the terms of the Distribution Agreement, Lakes entered into a
capital lease arrangement for the corporate office space at which time the
operating lease was cancelled. Accordingly, Lakes recorded a capital leased
asset and liability in the amount of approximately $5.8 million. On January 2,
2002, the Company completed the purchase of its corporate office building for
$6.4 million, including transaction expenses. This transaction resulted in the
extinguishment of the Company's capital lease obligation related to the
building.
8. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company leases certain property and equipment, including an airplane, under
a non-cancelable operating lease. The airplane lease expires May 1, 2003 and
provides for two one-year renewal terms. Approximate future minimum lease
payments, due under this lease as of March 30, 2003, assuming both one-year
renewals are exercised, are as follows (in thousands):
Operating Leases
----------------
2003 $ 450
2004 600
2005 200
-------
$ 1,250
=======
PURCHASE OPTIONS
The Company has the right to purchase the airplane it leases during the base
lease term and any renewal term for approximately $8 million.
14
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
INDEMNIFICATION AGREEMENT
As a part of the transaction establishing Lakes as a separate public company on
December 31, 1998, the Company has agreed to indemnify Grand against all costs,
expenses and liabilities incurred in connection with or arising out of certain
pending and threatened claims and legal proceedings to which Grand and certain
of its subsidiaries are likely to be parties. The Company's indemnification
obligations include the obligation to provide the defense of all claims made in
proceedings against Grand and to pay all related settlements and judgments.
As security to support Lakes' indemnification obligations to Grand, Lakes agreed
to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of
Park Place, an aggregate of $30 million, to cover various commitments and
contingencies related to or arising out of, Grand's non-Mississippi business and
assets (including by way of example, but not limitation, tribal loan guarantees,
real property lease guarantees for Lakes' subsidiaries and director and
executive officer indemnity obligations) consisting of four annual installments
of $7.5 million, during the four-year period subsequent to December 31, 1998.
Any surplus proceeds remaining in this trust after all the secured obligations
are indefeasibly paid in full and discharged shall be paid over to Lakes.
Lakes made the first deposit of $7.5 million on December 31, 1999 and in July
2000, Lakes deposited $18 million in an escrow account in partial satisfaction
of the indemnification obligation. The $18 million deposit represented a
settlement agreement which was reached in June 2000 regarding both the
Stratosphere Shareholders' litigation and the Grand Casinos, Inc. Shareholders'
litigation. On August 14, 2001, the Court issued an order giving final approval
to the settlement. As such, the $18 million in restricted cash was removed from
the Company's condensed consolidated balance sheet. In January 2001, Lakes also
purchased the Shark Club property in Las Vegas for $10.1 million in settlement
of another obligation that was subject to the indemnification obligations. As of
March 30, 2003 and December 29, 2002, $7.5 million related to security to
support Lakes' indemnification obligations to Grand is included as restricted
cash in the accompanying condensed consolidated balance sheets. Lakes believes
it has satisfied all potential obligations beyond the amounts provided for in
the Company's financial statements. Lakes is seeking release of the restricted
cash that was deposited into trust. See Note 10 Subsequent Events.
As part of the indemnification agreement, Lakes has agreed that it will not
declare or pay any dividends, make any distribution of Lakes' equity interests,
or otherwise purchase, redeem, defease or retire for value any equity interests
in Lakes without the written consent of Park Place.
LEGAL PROCEEDINGS
The following summaries describe certain known legal proceedings to which Grand
is a party which Lakes has assumed, or with respect to which Lakes may have
agreed to indemnify Grand, in connection with the Distribution.
15
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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
Bankruptcy Court for the District of Nevada on June 20, 2002.
On December 31, 2002, the Bankruptcy Court issued its final judgment holding
that: (i) payments to Grand Media for electronic equipment totaling
approximately $3.3 million are not recoverable by Stratosphere as avoidable
preferences, and (ii) payment to Grand for management services in the
approximate amount of $2.3 million is recoverable by Stratosphere and an
avoidable preference. On May 8, 2003, this judgment was satisfied out of
amounts held as security to support Lakes' indemnification obligations
to Grand.
OTHER LITIGATION
The Company has recorded a reserve assessment related to the Stratosphere
Preference Action. The reserve is included in the litigation and claims accrual
on the accompanying condensed consolidated balance sheets as of March 30, 2003
and December 29, 2002.
Lakes is involved in various other inquiries, administrative proceedings, and
litigation relating to contracts and other matters arising in the normal course
of business. While any proceeding or litigation has an element of uncertainty,
management currently believes that the final outcome of these matters is not
likely to have a material adverse effect upon the Company's consolidated
financial position or results of operations.
9. RELATED PARTY TRANSACTIONS
During 2001 and 2000, Lakes made a total of $4.0 million in unsecured loans to
ViatiCare Financial Services, LLC, which has since been acquired by Living
Benefits Financial Services ("Living Benefits"). In March 2001, the Board of
Directors of Lakes decided not to make further loans to ViatiCare. A $4.0
million impairment charge for this note was recorded during the quarter ended
June 30, 2002, due to increased competition in the viatical insurance business
and restrictions on ability to make further policy acquisitions.
16
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Subsequent to the decision by the Lakes Board to make no further loans to
ViatiCare, L. B. Acquisitions, LLC, which is owned by Lyle Berman, the Chief
Executive Officer and a Director of Lakes, made loans to Living Benefits. As an
incentive to make the loans, L. B. Acquisitions was granted an initial 9% voting
interest in Living Benefits and was given the option to convert the loan balance
into 45% of the voting interest in Living Benefits. Therefore, Lyle Berman,
through L. B. Acquisitions, beneficially owns a total of approximately 55% of
the voting interest of Living Benefits.
Previously, Lakes formed two joint venture partnerships with Kean Argovitz
Resorts, LLC ("KAR"), a limited liability company based in Houston, Texas for
the purpose of developing and managing casino resort projects with the Shingle
Springs Band of Miwok Indians and the Jamul Indian Village, both in California.
On January 30, 2003, Lakes restructured a series of arrangements with KAR and
its individual members such that Lakes has effectively acquired 100% ownership
of the joint ventures in exchange for restructuring indebtedness of $1.8 million
from the joint venture partnerships to Lakes and an agreement to make certain
conditional payments to the individual KAR members from profits received under
the respective management contracts. While these conditional payments could
total up to $2 million per year for each project, Lakes believes these payments
will be substantially less than KAR would have received under their original
interest. The individual KAR members have options to repurchase their interest
or obtain a comparable financial interest, in the event they are found suitable
by relevant gaming regulatory authorities.
During 2002, Lakes rented the use of Company equipment to another company that
had a mutual Board member during a portion of 2001. The transaction was for full
value of the associated use and all payments for such use have been received.
10. SUBSEQUENT EVENTS
SHARK CLUB
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, which
had been previously designated for development of the Chateau time share project
with Diamond Resorts in Las Vegas, Nevada. Under the terms of the Letter of
Intent, Lakes will sell the property to an entity to be managed and operated by
Marriott Ownership Resorts, Inc. for a purchase price of $15.0 million in cash.
Certain terms and conditions of this Letter of Intent will need to be satisfied
prior to the completion of this sale, which is also subject to negotiation of a
definitive purchase agreement. In addition to the $15.0 million payment, Lakes
will receive $1.0 million as repayment of a loan previously made to Chateau by
Lakes. Subject to the satisfaction of the necessary terms and conditions, Lakes
anticipates the closing will occur in the second quarter of 2003.
17
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
INDEMNIFICATION AGREEMENT
On May 8, 2003, the trust account set up as security to support Lakes'
indemnification obligations to Grand Casinos was terminated since Lakes has
satisfied all known material indemnification obligations. Prior to the
termination, the Stratosphere Preference Action Settlement of approximately $2.3
million was paid out of the trust to Stratosphere. Following such payment, the
remaining restricted funds of approximately $5.9 million including interest,
were released to Lakes and reclassified as unrestricted. Subsequent
indemnification obligations to Grand Casinos, if any, would be paid directly by
Lakes.
The amount accrued for the Stratosphere Preference Action Litigation in excess
of the amount paid totaled $3.2 million. Therefore, this amount will be
reversed in the second quarter of 2003 resulting in a reduction in operating
expenses of $3.2 million in the second quarter of 2003.
18
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(UNAUDITED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")
was established as a public corporation on December 31, 1998, via a distribution
(the "Distribution") of its Common Stock, to the shareholders of Grand Casinos,
Inc. ("Grand").
As a result of the Distribution, Lakes operates the Indian casino management
business and holds various other assets previously owned by Grand. Lakes' main
business is the development, construction and management of casinos and related
hotel and entertainment facilities in emerging and established gaming
jurisdictions. Lakes has entered into the following contracts for the
development, management and/or financing of new casino operations, all of which
are subject to various regulatory approvals before construction can begin: (1)
Lakes has a contract to be the exclusive developer and manager of an
Indian-owned gaming resort near New Buffalo, Michigan. (2) Lakes has entered
into contracts to develop and manage two casinos to be owned by Indian tribes in
California, one near San Diego with the Jamul Indian Village and the other near
Sacramento with the Shingle Springs Band of Miwok Indians. (3) Lakes and another
company have formed a partnership with a contract to finance the construction of
an Indian-owned casino 60 miles north of San Francisco, California. The
Cloverdale Rancheria has notified the partnership that the Rancheria wishes to
terminate the relationship between the two parties. The partnership has advised
the Rancheria that the partnership believes the contract is enforceable. The
Rancheria acknowledges that the partnership has loaned the Rancheria money and
that the Rancheria will endeavor to repay the money in a timely manner. (4)
Lakes has also signed contracts with a Massachusetts Indian tribe for
development and management of a potential future gaming resort in the eastern
United States; however, this tribe has received a negative finding regarding
federal recognition from the Bureau of Indian Affairs (BIA). The tribe has
submitted additional information to the BIA for reconsideration.
In addition, Lakes owns options to purchase various new casino games and is
actively marketing these new games to the casino industry in an attempt to have
a casino accept the games for use in their operations. Lakes has also formed a
joint venture with another company to develop approximately 2,000 acres owned by
the joint venture in eastern San Diego County in California. It is possible the
land will be sold in lieu of a development by the joint venture. Lakes has also
formed a joint venture with a producer to launch the World Poker Tour and
establish poker as the next significant televised mainstream sport. The joint
venture recently signed a three-year agreement with the Travel Channel for
broadcast of the World Poker Tour series. Revenue is recognized ratably as
production milestones and other conditions are met. During the first quarter of
2003, Lakes recognized approximately $0.6 million in revenue related to the
World Poker Tour.
19
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Lakes' historical revenues have been derived almost exclusively from management
fees. Through January 16, 2002, Lakes managed a land-based, Indian-owned casino,
Grand Casino Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta").
Pursuant to the Coushatta management contract, Lakes received a fee based on the
net distributable profits (as defined in the contracts) generated by Grand
Casino Coushatta. The management contract expired January 16, 2002, and was not
renewed. This non-renewal has resulted in the loss of revenues to the Company
derived from such contract, which has had a material adverse effect on the
Company's results of operations.
Lakes' limited operating history may not be indicative of Lakes' future
performance. In addition, a comparison of results from year to year may not be
meaningful due to the opening of new facilities and the buy-out and/or cessation
of other casino management contracts. Lakes' growth strategy contemplates the
development of existing projects, the pursuit of opportunities to develop and
manage additional gaming facilities and the pursuit of new business
opportunities. The successful implementation of this growth strategy is
contingent upon the satisfaction of various conditions, including obtaining
governmental approvals, the impact of increased competition, and the occurrence
of certain events, many of which are beyond the control of Lakes.
SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies, which Lakes believes are the most critical
to aid in fully understanding and evaluating its reported financial results,
include the following: revenue recognition and realizability of notes
receivable.
REVENUE RECOGNITION: Revenue from the management of Indian-owned casino gaming
facilities is recognized when earned according to the terms of the management
contracts. Currently all of the Indian-owned casino projects that Lakes is
involved with are in development stages and are not yet open. Therefore, until a
project is open and operating, Lakes will not recognize revenue related to
Indian casino management. Interest income on notes receivable for Indian tribes
related to casino development projects is deferred because realizability of the
interest is contingent upon the completion and generation of cash flow from the
operation of the casino. Interest deferred during the development period is
recognized over the remaining life of the note using the effective interest
method. Revenue from the World Poker Tour series is recognized ratably as
production milestones and other conditions are met.
IMPAIRMENT OF LONG-TERM ASSETS: The Company's notes receivable from Indian
Tribes are generally for the development of gaming properties to be managed by
the Company. The repayment terms are specific to each tribe and are largely
dependent upon the operating performance of each gaming property. Repayments of
the notes receivable are required to be made only if distributable profits are
available from the operation of the related casinos. Repayments are also the
subject of certain distribution priorities specified in the management
contracts. In addition, repayment of the notes receivable and the manager's fees
under the management contracts may be subordinated to certain other financial
obligations of the respective tribes.
20
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Through March 30, 2003, no impairments have been recorded under these
provisions. Management periodically evaluates the recoverability of such notes
receivable based on the current and projected operating results of the
underlying facility and historical collection experience. The Company currently
holds land held for development and land held under contract for sale. The
Company periodically evaluates whether events and circumstances have occurred
that may affect the recoverability of the net book value of these assets. If
such events or circumstances indicate that the carrying amount of an asset may
not be recoverable, the Company estimates the future cash flows expected to
result from the use of the asset. If the sum of the expected future undiscounted
cash flows does not exceed the carrying value of the asset, the Company will
recognize an impairment loss. During 2002, the Company recognized an impairment
loss of $3.0 million on land held under contract for sale and an impairment loss
of $1.0 million on land held for development.
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, 2003.
21
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
The Company is in the process of evaluating all of its investments and other
interests in entities that may be deemed variable interest entities under the
provisions of FIN 46. If the Company's interests were deemed to constitute
variable interest entities, there would be no material impact because amounts
are already included as notes receivable on the accompanying condensed
consolidated balance sheets. The Company cannot make any definitive conclusion
until it completes its evaluation.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 supersedes previous guidance for financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies to legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset. This statement was effective January 1, 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 eliminates the definition and requirement
for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 where
a liability for an exit is recognized at the date of an entity's commitment to
an exit plan. This statement is effective for exit or disposal activities
initiated after December 31, 2002.
The adoption of SFAS No. 143 and 146 did not have a material impact on the
results of operations, financial position and cash flows of the Company.
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.
22
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
RESULTS OF OPERATIONS
Revenues are calculated in accordance with accounting principles generally
accepted in the United States of America and are presented in a manner
consistent with industry practice. Historically, net distributable profits by
the Indian casinos were computed using a modified cash basis of accounting in
accordance with the management contracts to calculate management fees. Under
this modified cash basis of accounting prescribed by the management contracts,
the write-off of capital equipment and leased assets for the casino operations
was accelerated, which thereby impacted the timing of net distributable profits.
THREE MONTHS ENDED MARCH 30, 2003 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2002
Revenues
Total revenues were $0.6 million for the three months ended March 30, 2003
compared to $1.5 million for the same period in the prior year. Revenues for the
current year quarter were derived entirely from license fees related to the
World Poker Tour series. Revenues for the prior year quarter were derived
entirely from management fees from the management of Grand Casino Coushatta. The
management contract with the Coushatta Tribe of Louisiana for Grand Casino
Coushatta expired on January 16, 2002. The Company currently has no other
management contracts from which it will derive revenues in 2003.
Costs and Expenses
Total costs and expenses were $3.1 million for the three months ended March 30,
2003, compared to $2.2 million for the same period in the prior year. Selling,
general and administrative expenses increased from $2.1 million for the three
months ended March 31, 2002 to $3.0 million for the three months ended March 30,
2003. This increase is primarily due to an increase in costs incurred associated
with World Poker Tour.
Other
Interest income was $0.2 million for the three months ended March 30, 2003
compared to $0.7 million for the same period in the prior year. This decrease is
primarily due to a decline in cash balances.
Losses Per Common Share and Net Losses
For the three months ended March 30, 2003, basic and diluted losses per common
share were $0.12, compared to basic and diluted losses of $0.01, for the same
period in the prior year. Losses for the period ended March 30, 2003 were $1.3
million compared to $0.1 million for the three months ended March 31, 2002. This
increase in losses relates primarily to the expiration of the management
contract for Grand Casino Coushatta on January 16, 2002. In addition, increases
in costs incurred associated with World Poker Tour in excess of revenues related
to World Poker Tour added to the increase in net losses for the three months
ended March 30, 2003.
23
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Outlook
It is currently contemplated that there will be no operating revenues for the
remainder of 2003 from existing casino development projects. Revenue from the
World Poker Tour is being recognized, however, this revenue is not expected to
exceed production costs during the remainder of 2003. 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. Lakes continues to closely monitor its operating expenses. In the
second quarter of 2003, the Company will recognize a non-recurring reduction in
operating expenses of approximately $3.2 million. This amount represents the
excess of the amount previously accrued for the Stratosphere Preference Action
Litigation over the amount of the final judgment paid by the Company in May
2003. The Company's cash position coupled with payment to be received on the
sale of the Polo Plaza property, are considered adequate to cover expected 2003
operating expenses.
FINANCIAL CONDITION
At March 30, 2003, Lakes had $8.3 million in restricted cash and $5.5 million in
unrestricted cash and cash equivalents. Subsequent to March 30, 2003, Lakes has
received a $5.9 million cash distribution from the termination of a trust
established as security for indemnification obligations to Grand Casinos, Inc.
For the three months ended March 30, 2003, net cash used in operating activities
totaled $3.0 million. For the three months ended March 31, 2002, net cash
provided by operating activities totaled $5.0 million. For the same periods, net
cash used in investing activities totaled $5.6 million and $6.9 million,
respectively. Included in these investing activities for the periods ended March
30, 2003 and March 31, 2002 are advances on notes receivable of $3.5 million and
$4.6 million, respectively. Also, during these periods, payments for land held
for development amounted to $1.4 million and $0.3 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,
additional financing will be needed to complete the projects. It is currently
planned that this third-party financing will be obtained by each individual
tribe. However, there can be no assurance that if third-party financing is not
available, Lakes will not be required to finance these projects directly. If
Lakes must provide this financing, Lakes expects to obtain debt or equity
financing which it would loan to the respective tribes as necessary. In the
alternative, Lakes may be required to guarantee the tribes' debt financing or
otherwise provide support for the tribes' obligations. Any guarantees by Lakes
or similar off-balance sheet liabilities will increase Lakes' potential exposure
in the event of a default by any of these tribes.
At March 30, 2003, Lakes had approximately $72.5 million in notes receivable
from Indian tribes and other parties. Most of these amounts are advances made to
the tribes for the development of gaming properties managed by Lakes. See Note 5
to the Consolidated Financial Statements included in Item 1.
24
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
The joint venture entities that hold the management contracts for the San Diego
and Sacramento area casino resorts were previously jointly owned with two LLC's
owned by Kevin M. Kean and Jerry A. Argovitz, (the "KAR Entities"). On January
30, 2003, subsidiaries of Lakes purchased the respective joint venture interests
of the KAR Entities for nominal consideration, at which time the joint venture
entities became indirect wholly owned subsidiaries of Lakes. At the time of the
purchase, Lakes or its subsidiaries had notes receivable from the KAR Entities
and a long-term receivable from Kevin M. Kean that, as of December 29, 2002,
were in the amounts of $1.8 million and $1.9 million, respectively. In
connection with the purchase transactions, Lakes and certain of its subsidiaries
entered into separate agreements with Kevin M. Kean and Jerry A. Argovitz, the
two individual owners of the KAR Entities. Under these agreements, Lakes and its
subsidiaries have forgiven the notes receivable from the KAR Entities, subject
to the agreements of Messrs. Kean and/or Argovitz to assume the obligations
under the notes in certain circumstances.
Under the agreements with Kevin M. Kean, Mr. Kean may elect to serve as a
consultant to Lakes' subsidiaries during the term of each subsidiary's casino
management contract if he is found suitable by relevant gaming regulatory
authorities. In such event, Mr. Kean will be entitled to receive annual
consulting fees equal to 20% of the management fees from the San Diego area
casino operations and 15% of the management fees from the Sacramento area casino
operations, less certain costs of these operations. If Mr. Kean is found
suitable by relevant gaming regulatory authorities and elects to serve as a
consultant, he will be obligated to repay 50% of the notes receivable from the
KAR Entities. If Mr. Kean is not found suitable by relevant gaming regulatory
authorities or otherwise elects not to serve as a consultant, he will be
entitled to receive annual payments of $1 million from each of the San Diego and
Sacramento area casino projects during the term of the respective casino
management contracts (but not during any renewal term of such management
contracts). Regardless of whether Mr. Kean serves as a consultant, a Lakes
subsidiary has agreed to loan up to $1.25 million to Mr. Kean, $1 million of
which must be used to fund certain obligations of Mr. Kean related to a separate
joint venture formed to acquire land in the San Diego area. Mr. Kean's personal
indebtedness to Lakes remained outstanding. Mr. Kean has agreed that 50% of the
consulting fees or other payments payable to him under the agreements with Lakes
and its subsidiaries shall be applied toward repayment of his indebtedness to
Lakes. In the event of a default under the agreements, 100% of the fees and
payments will be applied toward repayment of his indebtedness to Lakes.
Under the agreements with Jerry A. Argovitz, if Mr. Argovitz is found suitable
by relevant gaming regulatory authorities, he will be entitled to purchase for
nominal consideration a 20% equity interest in the Lakes subsidiary holding a
management contract with the San Diego area casino and a 15% equity interest in
the Lakes subsidiary holding a management contract with the Sacramento area
casino. Upon such purchase, Mr. Argovitz will become obligated to repay 50% of
the notes receivable from the KAR Entities. If he is not found suitable or does
not elect to purchase equity interests in the Lakes subsidiaries, Mr. Argovitz
may elect to receive annual payments of $1 million from each of the San Diego
and Sacramento area casino projects from the date of election through the term
of the respective casino management contracts (but not during any renewal term
of such management contracts).
25
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
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 March 30, 2003, the Company had made net
loans totaling $3.1 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 is included as land held under
contract for sale on the accompanying balance sheet as of December 29, 2002 and
December 30, 2001. 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. 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 the parties have agreed shall be extended to
no later than May 15, 2003, $16.8 million of the purchase price is payable to
Lakes in cash, $4.0 million is payable through the issuance to Lakes of a
preferred membership interest in Metroflag and $4.0 million is payable through
the issuance to Lakes of a subordinated membership interest in Metroflag. On or
before April 30, 2004, Metroflag Polo may elect to distribute to Lakes $3.0
million plus interest in cash as full return of Lakes' preferred interest. If
paid after April 30, 2004 and in no event later than December 24, 2006, the
entire $4.0 million plus interest will be payable. The subordinated interest
must be repurchased for $4.0 million at the time of repayment of an outstanding
$3.5 million contractual commitment in connection with the Travelodge property,
which is scheduled on or before December 28, 2004. If the Travelodge commitment
is not repaid by December 28, 2004, ownership of the Travelodge lease rights
would revert back to Lakes. If at any time the Polo Plaza property is sold and
the Travelodge commitment has not been repaid, Metroflag is required to
repurchase the subordinated interest for the lesser of $4.0 million or any
portion of the net cash proceeds from such sale or refinancing that exceeds
$60.0 million.
26
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
In March of 2003, the parties decreased the sale price of the Travelodge
property from $7.5 million to $3.5 million. The contractual commitment to pay
Lakes was also decreased from $7.5 million to $3.5 million and is now payable no
later than December 28, 2004.
Lakes continues to own the Shark Club property, which is an approximate 3.5 acre
undeveloped site adjacent to the Polo Plaza shopping center and Travelodge
sites. During August 2002, Lakes formed a joint venture with Diamond Resorts,
LLC, a Nevada limited liability company and time-share developer for the purpose
of developing the Shark Club parcel as an upscale time-share project. The terms
of this joint venture agreement require that Diamond and Lakes each make an
initial working capital contribution of $250,000. Subject to Diamond obtaining a
financing commitment for a construction loan sufficient to fund at least the
first phase of the building improvements contemplated by the time-share project,
the joint venture agreement will require Lakes to contribute the relevant
portion of the Shark Club parcel, which was originally valued at $16.0 million.
During December of 2002, the Shark Club parcel was adjusted to its revised
estimated market value of $15.0 million resulting in an impairment charge of
approximately $1.0 million, which was reflected in impairment losses in the
consolidated statement of loss for the year ended December 29, 2002. Diamond has
agreed to perform sales, marketing, administrative and managerial services for
the project. The terms of the joint venture agreement provide for the repayment
to Lakes of its contribution of property in cash based on the joint venture's
cash flow and time-share unit sales. It is contemplated that Lakes will be
required to make no other material contributions of cash or property to the
project. On October 2, 2002, Lakes loaned $1.0 million to the joint venture.
Interest accrues at a rate of 10% per annum. The loan is due and payable from
first available cash flow of the joint venture (excluding any required capital
contribution from a member) and no later than October 1, 2004.
On April 7, 2003, Lakes announced that it has signed a Letter of Intent to sell
the Shark Club property. Under the terms of the Letter of Intent, Lakes will
sell the property to an entity to be managed and operated by Marriott Ownership
Resorts, Inc. for a purchase price of $15.0 million in cash. Certain terms and
conditions of this Letter of Intent will need to be satisfied prior to the
completion of this sale, which is also subject to negotiation of a definitive
purchase agreement. In addition to the $15.0 million payment, Lakes will receive
$1.0 million as repayment of a loan previously made to Chateau by Lakes. Subject
to the satisfaction of the necessary terms and conditions, Lakes anticipates the
closing will occur in May 2003.
Pursuant to the terms of the Distribution Agreement, Grand Casinos assigned to
Lakes, and Lakes assumed, a lease agreement dated February 1, 1996 covering
Lakes' current corporate office space of approximately 65,000 square feet with a
lease term of fifteen years. The lease commenced on October 14, 1996. During
2001, also pursuant to the terms of the Distribution Agreement, Lakes entered
into a capital lease arrangement for the corporate office space at which time
the operating lease was cancelled. Accordingly, Lakes recorded a capital leased
asset and liability in the amount of approximately $5.8 million. On January 2,
2002, as per the agreement with Grand Casinos, Lakes purchased the building for
$6.4 million, including transaction expenses. This transaction resulted in the
extinguishment of the Company's capital lease obligation related to the
building.
27
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
The Company had two notes payable with third parties, which were repaid during
2002. The first was collateralized by certificates of deposit, in the amount of
$1.0 million. The second was collateralized by property in the amount of $0.4
million.
As a part of the agreements resulting from Lakes' spin-off from Grand Casinos
and related transactions, Lakes has agreed to indemnify Grand Casinos against
all costs, expenses and liabilities incurred in connection with or arising out
of certain pending and threatened claims and legal proceedings to which Grand
Casinos and certain of its subsidiaries are likely to be parties. The Company's
indemnification obligations include the obligation to provide the defense of all
claims made in proceedings against Grand Casinos and to pay all related
settlements and judgments. See Part II Item 1. Legal Proceedings. As security to
support Lakes' indemnification obligations to Grand Casinos, Lakes deposited
$7.5 million in trust for the benefit of Grand Casinos, as a wholly owned
subsidiary of Park Place. In May of 2003, the Stratosphere Preference Action
Settlement of approximately $2.3 million was paid out of the trust to
Stratosphere. Following such payment, the remaining restricted funds of
approximately $5.9 million, including interest, were released to Lakes and
reclassified as unrestricted and the trust was terminated, since Lakes has
satisfied all known material indemnification obligations. Subsequent
indemnification obligations to Grand Casinos, if any, would be paid directly by
Lakes.
SEASONALITY
The Company believes that the operations of all casinos to be managed by the
Company will be affected by seasonal factors, including holidays, weather and
travel conditions.
REGULATION AND TAXES
The Company is subject to extensive regulation by state gaming authorities. The
Company will also be subject to regulation, which may or may not be similar to
current state regulations, by the appropriate authorities in any 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)
(UNAUDITED)
The gaming industry represents a significant source of tax revenues. From time
to time, various federal legislators and officials have proposed changes in tax
law, or in the administration of such law, affecting the gaming industry. It is
not possible to determine the likelihood of possible changes in tax law or in
the administration of such law. Such changes, if adopted, could have a material
adverse effect on the Company's results of operations and financial results.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" in November 2002. This interpretation elaborates on the disclosures to
be made by a guarantor in its financial statements about its obligations under
certain guarantees that it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee.
The initial recognition and initial measurement provisions of this
interpretation are applicable to all guarantees and modification to guarantees
made after December 31, 2002. The Company's disclosure of the indemnification
and guarantee agreements of the Company is in compliance with the
interpretation. The disclosure requirements in this interpretation are effective
for financial statements of interim or annual periods ended after December 15,
2002. The Company does not believe the adoption of the interpretation will have
a material impact on its results of operations, financial position and cash
flows. The Company does have an indemnification agreement with Grand Casinos
which is fully described in the Financial Condition section of this Management's
Discussion and Analysis.
In January 2003, the FASB issued Interpretation No. 46 (FIN46), "Consolidation
of Variable Interest Entities", which addresses the consolidation of variable
interest entities. The interpretation applicable immediately to variable
interest entities created after January 31, 2003, and to variable interest
entities in which a Company obtains an interest after that date. For variable
interests in variable interest entities acquired before February 1, 2003, the
interpretation applicable applies in the first interim period beginning after
June 15, 2003.
The Company is in the process of evaluating all of its investments and other
interests in entities that may be deemed variable interest entities under the
provisions of FIN 46. If the Company's interests were deemed to constitute
variable interest entities, there would be no material impact because amounts
are already included as notes receivable on the accompanying condensed
consolidated balance sheets. The Company cannot make any definitive conclusion
until it completes its evaluation.
29
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 supersedes previous guidance for financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies to legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset. This statement was effective January 1, 2003.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 eliminates the definition and requirement
for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 where
a liability for an exit is recognized at the date of an entity's commitment to
an exit plan. This statement is effective for exit or disposal activities
initiated after December 31, 2002.
The Company does not believe the adoption of SFAS No. 143 and 146 will have a
material impact on its results of operations, financial position and cash flows.
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.
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.
30
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
Such forward looking information involves important risks and uncertainties that
could significantly affect the anticipated results in the future and,
accordingly, actual results may differ materially from those expressed in any
forward-looking statements made by or on behalf of the Company.
These risks and uncertainties include, but are not limited to, those relating to
possible delays in completion of Lakes' casino projects, including various
regulatory approvals and numerous other conditions which must be satisfied
before completion of these projects; possible termination or adverse
modification of management contracts; continued indemnification obligations to
Grand Casinos; highly competitive industry; possible changes in regulations;
reliance on continued positive relationships with Indian tribes and repayment of
amounts owed to Lakes by Indian tribes; possible need for future financing to
meet Lakes' expansion goals; risks of entry into new businesses; and reliance on
Lakes' management. For further information regarding the risks and
uncertainties, see the "Business -- Risk Factors" section of the Company's
Annual Report on Form 10-K for the fiscal year ended December 29, 2002.
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 March 30,
2003, the carrying value of the Company's cash and cash equivalents approximates
fair value. The Company has in the past and may in the future obtain marketable
debt securities (principally consisting of commercial paper, corporate bonds,
and government securities) having a weighted average duration of one year or
less. Consequently, such securities would not be subject to significant interest
rate risk.
The Company's primary exposure to market risk associated with changes in
interest rates involves the Company's notes receivable related to loans for the
development and construction of Native American owned casinos. The loans and
related note balances earn various interest rates based upon a defined reference
rate. The floating rate receivables will generate more or less interest income
if interest rates rise or fall. Interest income is deferred during development
of the casinos because realizability of the interest is contingent upon the
completion and positive cash flow from operation of the casino. As of March 30,
2003, Lakes had $72.4 million of floating rate notes receivables. Based on the
applicable current reference rates and assuming all other factors remain
constant, deferred interest income for a twelve month period would be $4.1
million. A reference rate increase of 100 basis points would result in an
increase in deferred interest income of $0.7 million. A 100 basis point decrease
in the reference rate would result in a decrease of $0.7 million in deferred
interest income over the same twelve month period.
31
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
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-14(c) promulgated under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), within 90 days of the filing date of this 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.
32
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following summaries describe certain known legal proceedings to which Grand
is a party which Lakes has assumed, or with respect to which Lakes may have
agreed to indemnify Grand, in connection with the Distribution.
33
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
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
Bankruptcy Court for the District of Nevada on June 20, 2002.
On December 31, 2002, the Bankruptcy Court issued its final judgment holding
that: (i) payments to Grand Media for electronic equipment totaling
approximately $3.3 million are not recoverable by Stratosphere as avoidable
preferences, and (ii) payment to Grand for management services in the
approximate amount of $2.3 million is recoverable by Stratosphere and an
avoidable preference. On May 8, 2003, this judgment was satisfied out of
amounts held as security to support Lakes' indemnification obligations
to Grand.
OTHER LITIGATION
The Company has recorded a reserve assessment related to the Stratosphere
Preference Action. The reserve is included in the litigation and claims accrual
on the accompanying condensed consolidated balance sheets as of March 30, 2003
and December 29, 2002.
Lakes is involved in various other inquiries, administrative proceedings, and
litigation relating to contracts and other matters arising in the normal course
of business. While any proceeding or litigation has an element of uncertainty,
management currently believes that the final outcome of these matters is not
likely to have a material adverse effect upon the Company's consolidated
financial position or results of operations.
34
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.
On May 12, 2003, Timothy J. Cope was named President of Lakes. Prior to such
time, Mr. Cope, who also serves as Chief Financial Officer, served as Executive
Vice-President. Lyle Berman, Lakes' previous President, continues to serve as
Chairman of the Board and Chief Executive Officer.
35
LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Acquisition Master Agreement dated January 22, 2003,
by and between The Travel Channel, L.L.C. and World Poker
Tour, L.L.C. (portions of this exhibit have been omitted
pursuant to a request for confidential treatment and have been
filed separately with the Commission pursuant to Rule 24b-2 of
the Securities Exchange Act of 1934)
10.2 Amendment to Member Control Agreement of Pacific Coast Gaming
- Santa Rosa, LLC
10.3 Third Amendment to Acquisition and Participation Agreement
dated as of February 28, 2003, by and among MRD Gaming, LLC,
Lakes Cloverdale, LLC and Lakes Corning, LLC
10.4 Assignment dated as of February 28, 2003 by and between Lakes
Corning, LLC and Lakes Cloverdale, LLC
10.5 Assignment dated as of February 28, 2003 by and among Pacific
Coast Gaming - Corning, LLC, MRD Gaming, LLC and Lakes
Corning, LLC
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(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 March 11, 2003.
(ii) A Form 8-K, Item 5. Other Events, and Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, was
filed on April 7, 2003.
(iii) A Form 8-K, Item 5. Other Events, and Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, was
filed on April 14, 2003.
(iv) A Form 8-K, Item 7. Financial Statements, Pro Forma Financial
Information and Exhibits, and Item 12. Results of Operations
and Financial Condition, was filed on April 28, 2003.
36
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: May 14, 2003 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
CERTIFICATIONS
I, Lyle Berman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lakes Entertainment,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statement made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Lakes
Entertainment, Inc., and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to Lakes Entertainment, Inc., including
its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this quarterly
report is being prepared;
37
b. evaluated the effectiveness of Lakes Entertainment, Inc.'s disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. I have disclosed, based on our most recent evaluation, to Lakes
Entertainment, Inc.'s auditors and the audit committee of Lakes
Entertainment, Inc.'s board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect Lakes Entertainment, Inc.'s
ability to record, process, summarize and report financial date and
have identified for Lakes Entertainment, Inc.'s auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in Lakes Entertainment, Inc.'s
internal controls; and
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Lyle Berman
-------------------------
Lyle Berman
Chief Executive Officer
CERTIFICATIONS
I, Timothy J. Cope, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lakes Entertainment,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statement made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Lakes
Entertainment, Inc., and have:
38
a. designed such disclosure controls and procedures to ensure that
material information relating to Lakes Entertainment, Inc., including
its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of Lakes Entertainment, Inc.'s disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. I have disclosed, based on our most recent evaluation, to Lakes
Entertainment, Inc.'s auditors and the audit committee of Lakes
Entertainment, Inc.'s board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect Lakes Entertainment, Inc.'s
ability to record, process, summarize and report financial date and
have identified for Lakes Entertainment, Inc.'s auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in Lakes Entertainment, Inc.'s
internal controls; and
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Timothy J. Cope
-------------------------
Timothy J. Cope
Chief Financial Officer
39