1 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 July 4, 1999 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. 1-12962 LAKES GAMING, 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) (612) 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 ____ As of August 13, 1999, there were 10,604,034 shares of Common Stock, $0.01 par value per share, outstanding. Page 1 of 32
2 LAKES GAMING, INC. AND SUBSIDIARIES INDEX <TABLE> <CAPTION> PAGE OF FORM 10-Q <S> <C> PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets as of 3 July 4, 1999 and January 3, 1999 Consolidated Statements of Earnings 4 for the three months ended July 4, 1999 and June 28, 1998 Consolidated Statements of Earnings for 5 the six months ended July 4, 1999 and June 28, 1998. Consolidated Statements of Cash Flows 6 for the six months ended July 4, 1999 and June 28, 1998 Notes to Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND 12 ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 20 ITEM 5. Other Information 28 ITEM 6. Exhibits and Reports On Form 8-K 29 </TABLE> - 2 -
3 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) <TABLE> <CAPTION> JULY 4, 1999 JANUARY 3, 1999 (UNAUDITED) - ---------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current Assets: Cash and cash equivalents $ 49,266 $ 56,774 Current installments of notes receivable 13,729 8,561 Accounts receivable 15,251 15,217 Other current assets 9,364 8,126 -------- -------- Total Current Assets 87,610 88,678 -------- -------- Property and Equipment-Net 1,406 1,265 -------- -------- Other Assets: Land held for development 36,679 26,647 Notes receivable-less current installments 22,496 25,118 Cash and cash equivalents-restricted 4,649 4,992 Investments in and notes from unconsolidated affiliates 14,846 8,590 Other long-term assets 5,553 6,079 -------- -------- Total Other Assets 84,223 71,426 -------- -------- TOTAL ASSETS $173,239 $161,369 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 191 $ - Income taxes payable 7,352 10,811 Litigation and claims accrual 9,053 10,554 Other accrued expenses 4,425 4,625 -------- -------- Total Current Liabilities 21,021 25,990 -------- -------- Long-term Liabilities: Long-term debt-less current installments 975 975 Deferred income taxes 2,557 2,733 -------- -------- Total Long-Term Liabilities 3,532 3,708 -------- -------- TOTAL LIABILITIES 24,553 29,698 -------- -------- COMMITMENTS AND CONTINGENCIES Shareholders' Equity: Capital stock, $.01 par value; authorized 100,000 shares; 10,591 and 10,576 common shares issued and outstanding at July 4, 1999, and January 3, 1999, respectively 106 106 Additional paid-in-capital 131,040 130,929 Accumulated other comprehensive earnings 356 636 Retained earnings 17,184 - -------- -------- Total Shareholders' Equity 148,686 131,671 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $173,239 $161,369 ======== ======== </TABLE> SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -3-
4 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) <TABLE> <CAPTION> THREE MONTHS ENDED JULY 4, 1999 JUNE 28, 1998 (UNAUDITED) <S> <C> <C> REVENUES: Management fee income $14,892 $19,718 COSTS AND EXPENSES: Selling, general and administrative 2,892 1,112 Depreciation and amortization 479 278 -------- --------- Total Costs and Expenses 3,371 1,390 -------- --------- EARNINGS FROM OPERATIONS 11,521 18,328 -------- --------- OTHER INCOME (EXPENSE): Interest income 2,423 1,262 Interest expense (24) (25) Equity in loss of unconsolidated affiliates (109) (177) Other 877 29 -------- --------- Total other income, net 3,167 1,089 -------- --------- Earnings before income taxes 14,688 19,417 Provision for income taxes 6,066 7,098 -------- --------- NET EARNINGS $ 8,622 $12,319 ======== ========= BASIC EARNINGS PER SHARE $ 0.81 $ 1.17 ======== ========= DILUTED EARNINGS PER SHARE $ 0.80 $ 1.14 ======== ========= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,587 10,534 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS 192 311 -------- --------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,779 10,845 ======== ========= </TABLE> SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -4-
5 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) <TABLE> <CAPTION> SIX MONTHS ENDED JULY 4, 1999 JUNE 28, 1998 (UNAUDITED) <S> <C> <C> REVENUES: Management fee income $30,001 $42,748 COSTS AND EXPENSES: Selling, general and administrative 4,602 5,988 Depreciation and amortization 955 649 ------- ------- Total Costs and Expenses 5,557 6,637 ------- ------- EARNINGS FROM OPERATIONS 24,444 36,111 ------- ------- OTHER INCOME (EXPENSE): Interest income 4,059 2,600 Interest expense (49) (49) Equity in loss of unconsolidated affiliates (364) (225) Other 1,288 228 ------- ------- Total other income, net 4,934 2,554 ------- ------- Earnings before income taxes 29,378 38,665 Provision for income taxes 12,194 14,643 ------- ------- NET EARNINGS $17,184 $24,022 ======= ======= BASIC EARNINGS PER SHARE $ 1.62 $ 2.28 ======= ======= DILUTED EARNINGS PER SHARE $ 1.60 $ 2.22 ======= ======= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,582 10,525 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS 153 282 ------- ------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,735 10,807 ======= ======= </TABLE> SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 5 -
6 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) <TABLE> <CAPTION> SIX MONTHS ENDED JULY 4, 1999 JUNE 28, 1998 (UNAUDITED) <S> <C> <C> OPERATING ACTIVITIES: Net earnings 17,184 24,022 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 955 649 Gain on sale of investment (875) - Changes in operating assets and liabilities: Current assets (1,272) (3,262) Income taxes (3,459) 14,785 Accounts payable 191 (77) Accrued expenses (1,701) 85 Other 364 (503) ------- ------- Net Cash Provided by Operating Activities 11,387 35,699 ------- ------- INVESTING ACTIVITIES: Payments for property and equipment (209) (36) Payments for notes receivable (6,764) (2,727) Proceeds from repayment of notes receivable 5,093 3,125 Decrease (increase) in restricted cash 343 (4,017) Investment in and notes receivable from unconsolidated affiliates (6,639) - Payments for land held for development (10,032) (6,610) Increase in other long-term assets (798) (694) ------- ------- Net Cash Used in Investing Activities (19,006) (10,959) ------- ------- FINANCING ACTIVITIES: Distribution to Grand - (24,830) Proceeds from issuance of common stock 111 - Payments on long-term debt - (6) ------- ------- Net Cash Provided by (Used in) Financing Activities 111 (24,836) ------- ------- Net decrease in cash and cash equivalents (7,508) (96) Cash and cash equivalents - beginning of period 56,774 33,208 ------- ------- CASH AND CASH EQUIVALENTS - END OF PERIOD 49,266 33,112 ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 49 $ 49 Income taxes 12,665 - </TABLE> SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 6 -
7 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. UNAUDITED FINANCIAL STATEMENTS: Lakes Gaming, 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"). Pursuant to the terms of a Distribution Agreement entered into between Grand and Lakes and dated as of December 31, 1998 (the "Distribution Agreement"), Grand shareholders received .25 shares of Lakes common stock for each share held in Grand. Historical references to the Company which predate the Distribution give pro forma effect to the Distribution as if it had already occurred. Immediately following the Distribution, Grand merged with a subsidiary of Park Place Entertainment Corporation, a Delaware corporation ("Park Place"), pursuant to which Grand became a wholly owned subsidiary of Park Place (the "Merger"). Grand shareholders received one share of Park Place common stock in the Merger for each share they held in Grand. The Merger and Distribution received all necessary shareholder and regulatory approvals and was completed on December 31, 1998. Grand obtained a ruling from the Internal Revenue Service (IRS) that the Distribution qualified as a tax-free transaction, solely with respect to Grand shareholders except to the extent that Grand shareholders received cash in lieu of fractional shares. Lakes manages Indian-owned casinos and owns certain other assets related to potential gaming-related development. The Company manages two Indian-owned casinos in Louisiana and previously managed two Minnesota casinos through April 4, 1998 and November 30, 1998, respectively. On May 12, 1999, the Company announced that it has agreed to form a partnership for the purpose of developing a gaming facility on Indian-owned land near San Diego, California. Pursuant to the agreement, Lakes formed a limited liability company with Kean Argovitz Resorts ("KAR"), a limited liability company based in Houston, Texas. The partnership between Lakes and KAR will hold a contract to develop and manage a casino resort facility with a Tribe in California. The contract is subject to approval by the National Indian Gaming Association and placement of the land where the gaming facility is to be located into trust with the Bureau of Indian Affairs. Development of the casino resort will not begin until the Tribe has entered into a compact with the state of California. On June 22, 1999, the Company announced that it has been selected by the Pokagon Band of Potawatomi Indians (the "Band") to serve as the exclusive developer and manager of a proposed casino gaming resort facility to be owned by the Band in the state of Michigan. - 7 -
8 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) In connection with its selection, Lakes Gaming and the Band have executed a development and management agreement governing their relationship during the development, construction and management of the casino. This agreement is subject to ratification by the tribal council. Various regulatory approvals are needed prior to commencement of development activities. Casino construction cannot start until land is accepted into trust status by the Secretary of the Interior and the agreements are approved by the Chairman of the National Indian Gaming Commission ("NIGC"). MANAGEMENT CONTRACTS OF LIMITED DURATION 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. Management contracts for the two previously managed Minnesota casinos, Grand Casino Mille Lacs and Grand Casino Hinckley concluded during 1998. Management contracts for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. There can be no assurance that the Louisiana management contracts will be renewed upon expiration or approved by "NIGC" upon any such renewal. The failure to renew the Company's management contracts would result in the loss of revenues to the Company derived from such contracts, which would have a material adverse effect on the Company's results of operations. The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into tribal-state compacts with the State of Louisiana on September 29, 1992. These compacts were approved in November 1992 by the Secretary of the Interior. Each compact expires in November 1999 and the State of Louisiana has delivered a written notice of non-renewal. The Coushatta Tribe and the Tunica-Biloxi Tribe are actively negotiating with the State of Louisiana terms for a new compact. The Company's management agreements with the Tunica-Biloxi Tribe and the Coushatta Tribe expire after November 1999. In the event the compacts are not renewed, legal gaming may not be permitted at Grand Casino Avoyelles or Grand Casino Coushatta. There can be no assurance that these compacts will be renewed on acceptable terms and conditions. See Part II, Item 5. Other Information. The accompanying unaudited consolidated financial statements include the accounts of Lakes and its wholly-owned and majority-owned subsidiaries. Investments in unconsolidated affiliates representing between 20% and 50% of voting interests are accounted for on the equity method. All material intercompany balances and transactions have been eliminated in consolidation. - 8 -
9 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles 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 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 six months ended July 4, 1999, are not necessarily indicative of the results that may be expected for the fiscal year ending January 2, 2000. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended January 3, 1999. 2. COMMITMENTS AND CONTINGENCIES: LEASES The Company leases certain property and equipment under non-cancelable operating leases. Future minimum lease payments, excluding contingent rentals, due under non-cancelable operating leases as of July 4, 1999 are as follows (in thousands): <TABLE> <CAPTION> Operating Leases ---------------- <S> <C> 1999 $ 1,841 2000 3,225 2001 2,981 2002 3,109 2003 3,176 Thereafter 47,550 ------- $61,882 ======= </TABLE> As a condition to the Merger, the Company has agreed to exercise its call option to purchase the Shark Club property in Las Vegas, Nevada, not prior to April 9, 2000 and not later than January 10, 2001. The option purchase price would be approximately $10.1 million. The Company also has an option to purchase the Travelodge property in Las Vegas, Nevada for the purchase price of $30 million on October 31, 2017, and an option to purchase the Cable property in Las Vegas, Nevada for the purchase price of $18 million any time prior to October 31, 2000. - 9 -
10 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Loan Guaranty Agreements The Company has guaranteed a loan and security agreement entered into by the Tunica-Biloxi Tribe of Louisiana for $16.5 million for the purpose of purchasing a hotel and additional casino equipment. The agreement extends through 2000, and as of July 4, 1999, the amount outstanding was $5.0 million. On May 1, 1997, the Company entered into a guaranty agreement related to a loan agreement entered into by the Coushatta Tribe of Louisiana in the amount of $25.0 million, for the purpose of constructing a hotel and acquiring additional casino equipment. The guaranty will remain in effect until the loan is paid. The loan term is approximately five years. As of July 4, 1999, the amount outstanding was $21.9 million. The Company has entered into a guaranty agreement related to a construction loan agreement entered into by Nevada Resort Properties Polo Plaza Limited Partnership. The guaranty will remain in effect until the loan is paid. The maturity date is October 31, 2000, and as of July 4, 1999, the outstanding principal balance was $6.2 million. Indemnification Agreement As a part of the Transaction, 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 (see Item 1. Legal Proceedings). As security to support Lakes' indemnification obligations to Grand under each of the Distribution Agreement and the Agreement and Plan of Merger dated as of June 30, 1998, by and among Hilton Hotels Corporation, Park Place, Gaming Acquisition Corporation, Lakes and Grand (the "Merger Agreement"), and as a condition to the consummation of the Merger, Lakes has 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, on each annual anniversary of the Distribution and Merger. Any surplus proceeds remaining after all the secured obligations are indefeasibly paid in full and discharged shall be paid over to Lakes. - 10 -
11 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 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. 3. SUBSEQUENT EVENTS On July 15, 1999, the Company announced that it has agreed to form a partnership for the purpose of developing a gaming facility on Indian-owned land near Sacramento, California. Pursuant to the agreement, Lakes has formed a limited liability company with KAR, a limited liability company based in Houston, Texas. The partnership between Lakes and KAR has been awarded a contract to develop and manage a casino resort facility with a tribe in California. The contract is subject to approval by the National Indian Gaming Association and placement of the land where the gaming facility is to be located into trust with the Bureau of Indian Affairs. Development of the casino resort will not begin until the tribe has entered into a compact with the state of California. - 11 -
12 LAKES GAMING, 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 was established as a public corporation on December 31, 1998, via a distribution of its common stock, par value $.01 per share to the shareholders of Grand. Pursuant to the terms of the Distribution Agreement entered into between Grand and Lakes and dated as of December 31, 1998, Grand shareholders received .25 shares of Lakes Common Stock for each share held in Grand. Historical references to the Company which predate the distribution give pro forma effect to the Distribution as if it had already occurred. Immediately following the Distribution, Grand merged with a subsidiary of Park Place pursuant to which Grand became a wholly owned subsidiary of Park Place (the "Merger"). Grand shareholders received one share of Park Place common stock in the Merger for each share they held in Grand. As a result of the Distribution, Lakes operates the Indian casino management business and holds various other assets previously owned by Grand. The Company's revenues are derived almost exclusively from management fees. Lakes manages two land-based, Indian-owned casinos in Louisiana: Grand Casino Avoyelles, in Marksville, Louisiana ("Grand Casino Avoyelles"), owned by the Tunica-Biloxi Tribe of Louisiana (the "Tunica-Biloxi Tribe") and Grand Casino Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta"), owned by the Coushatta Tribe of Louisiana (the "Coushatta Tribe"). Both management contracts expire seven years from the date the casino opened. For a portion of fiscal 1998, and prior to the Distribution, Grand also had management contracts for Indian-owned casinos located at Grand Casino Hinckley and Grand Casino Mille Lacs in Minnesota. The management contract at Grand Casino Mille Lacs expired at the end of the first quarter of 1998, and the management of Grand Casino Hinckley ended in December 1998, with the buyout of the remaining contract term. Lakes develops, constructs and manages casinos and related hotel and entertainment facilities in emerging and established gaming jurisdictions. Lakes' revenues are derived from management fee income from Grand Casino Avoyelles and Grand Casino Coushatta. Grand commenced operations in September 1990, and opened its first casino, Grand Casino Mille Lacs, in April 1991. Grand Casino Hinckley commenced operations in May 1992, Grand Casino Avoyelles commenced operations in June 1994 and Grand Casino Coushatta commenced operations in January 1995. - 12 -
13 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Pursuant to the Avoyelles and Coushatta management contracts, Lakes receives a fee based on the net distributable profits (as defined in the contracts) generated by Grand Casino Avoyelles and Grand Casino Coushatta. On May 12, 1999, the Company announced that it has agreed to form a partnership for the purpose of developing a gaming facility on Indian-owned land near San Diego, California. Under the agreement, Lakes has formed a limited liability company with KAR, a limited liability company based in Houston, Texas. The partnership between Lakes and KAR will hold a contract to develop and manage a casino resort facility with a Tribe in California. The contract is subject to approval by the National Indian Gaming Association and placement of the land where the gaming facility is to be located into trust with the Bureau of Indian Affairs. Development of the casino resort will not begin until the Tribe has entered into a compact with the state of California. On June 22, 1999, the Company announced that it has been selected by the Pokagon Band of Potawatomi Indians (the "Band") to serve as the exclusive developer and manager of a proposed casino gaming resort facility to be owned by the Band in the state of Michigan. In connection with its selection, Lakes Gaming and the Band have executed a development and management agreement governing their relationship during the development, construction and management of the casino. This agreement is subject to ratification by the tribal council. Various regulatory approvals are needed prior to commencement of development activities. Casino construction cannot start until land is accepted into trust status by the Secretary of the Interior and the agreements are approved by the Chairman of the NIGC. 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 during each year. Lakes' growth strategy contemplates the expansion of existing operations and the pursuit of opportunities to develop and manage additional gaming facilities. 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. The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended January 3, 1999. - 13 -
14 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) RESULTS OF OPERATIONS Lakes is prohibited by the IGRA from having an ownership interest in any casino it manages for Indian tribes. The management contracts for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. There can be no assurance that any of these management contracts will be renewed upon expiration or approved by NIGC upon any such renewal. The failure to renew the Lakes management contracts would result in the loss of revenues to Lakes derived from such contracts, which would have an adverse effect on Lakes' results of operations. The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into tribal-state compacts with the State of Louisiana on September 29, 1992. These compacts were approved in November 1992 by the Secretary of the Interior. Each compact expires in November 1999, and the State of Louisiana has delivered a written notice of non-renewal. The Coushatta Tribe and the Tunica-Biloxi Tribe are actively negotiating with the State of Louisiana terms for a new compact. Lakes' management agreements with the Tunica-Biloxi Tribe and the Coushatta Tribe expire after November 1999. In the event the compacts are not renewed, gaming may not be permitted at Grand Casino Avoyelles or Grand Casino Coushatta. There can be no assurance that these compacts will be renewed on terms and conditions acceptable to either of the tribes. See Part II, Item 5. Other Information. Revenues are calculated in accordance with generally accepted accounting principles and are presented in a manner consistent with industry practice. Net distributable profits from Grand Casino Avoyelles and Grand Casino Coushatta are computed using a modified cash basis of accounting in accordance with the management contracts. The effect of the use of the modified cash basis of accounting is to accelerate the write-off of capital equipment and leased assets, which thereby impacts the timing of net distributable profits. SIX MONTHS ENDED JULY 4, 1999 COMPARED TO THE SIX MONTHS ENDED JUNE 28, 1998 Revenues Grand Casino Avoyelles and Grand Casino Coushatta generated approximately $300 million in management fee income during the six months ended July 4, 1999. Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles and Grand Casino Coushatta generated $42.7 million in management fee income during the six months ended June 28, 1998. Gross revenue increases at Grand Casino Avoyelles and Grand Casino Coushatta partially offset the fact that the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley ended during 1998. Contributing to the increases were a 223-room hotel at Grand Casino Coushatta, which opened in November of 1998 along with a 28,000 square foot casino expansion at Coushatta which opened in December of 1998. Also contributing to the increases were a special events center and RV resort at Grand Casino Avoyelles, which opened during the first quarter of 1998, and the addition of approximately 180 slot machines at Avoyelles from June 28, 1998 to July 4, 1999. - 14 -
15 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Costs and Expenses Total costs and expenses were $5.6 million for the six months ended July 4, 1999, compared to $6.6 million for the same period in the prior year. Selling, general, and administrative expenses decreased in the amount of $1.4 million from $6.0 million for the six months ended June 28, 1998 to $4.6 million for the six months ended July 4, 1999 due primarily to fewer legal costs. Other Interest income increased from $2.6 million for the six months ended June 28, 1998 to $4.1 million for the six months ended July 4, 1999 due primarily to interest earned on increased cash balances and additional notes receivable during the six months ended July 4, 1999, compared to the same period in the prior year. Earnings per Common Share and Net Earnings For the six months ended July 4, 1999 basic and diluted earnings per common share were $1.62 and $1.60, respectively. This compares to basic and diluted earnings of $2.28 and $2.22 per common share for the six months ended June 28, 1998. Earnings decreased $6.8 million to $17.2 million for the six months ended July 4, 1999 compared to the same period in the prior year. This decrease is primarily due to the expiration of the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley during 1998. Total revenues during the period ended June 28, 1998 under these expired contracts was $15.2 million. The Company's current year period revenues and earnings do not include contributions from these operations. THREE MONTHS ENDED JULY 4, 1999 COMPARED TO THE THREE MONTHS ENDED JUNE 28, 1998 Revenues Grand Casino Avoyelles and Grand Casino Coushatta generated $14.9 million in management fee income during the three months ended July 4, 1999. Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles and Grand Casino Coushatta generated $19.7 million in management fee income during the three months ended June 28, 1998. Gross revenue increases at Grand Casino Avoyelles and Grand Casino Coushatta partially offset the fact that the management contract for Grand Casino Mille Lacs concluded during April of 1998 and the contract for Grand Casino Hinckley concluded during the fourth quarter of 1998. Contributing to the increases were a 223-room hotel at Grand Casino Coushatta, which opened in November of 1998 along with a 28,000 square foot casino expansion at Grand Casino Coushatta which opened in December of 1998, and the addition of approximately 180 slot machines at Grand Casino Avoyelles from June 28, 1998 to July 4, 1999. - 15 -
16 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Costs and Expenses Total costs and expenses were $3.4 million for the three months ended July 4, 1999, compared to $1.4 million for the same period in the prior year. Selling, general, and administrative expenses increased in the amount of $1.8 million from $1.1 million for the three months ended June 28, 1998 to $2.9 million for the three months ended July 4, 1999 due primarily to a payment made for the settlement of litigation relating to the Tulalip Tribe. Other Interest income was $2.4 million and $1.3 million for the three months ended July 4, 1999 and June 28, 1998, respectively. The increase is due primarily to additional interest earned on increased cash balances and additional notes receivable during the three months ended July 4, 1999, compared to the same period in the prior year. Earnings Per Common Share and Net Earnings For the three months ended July 4, 1999, basic and diluted earnings per common share were $.81 and $.80, respectively. This compares to basic and diluted earnings of $1.17 and $1.14 per common share for the three months ended June 28, 1998. Earnings decreased $3.7 million to $8.6 million for the three months ended July 4, 1999 compared to the same period in the prior year. This decrease is primarily due to the expiration of the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley during 1998. Total revenues during the three-month period ended June 28, 1998, under these expired contracts was $6.3 million. The company's current year period revenues and earnings do not include contributions from these operations. CAPITAL RESOURCES, CAPITAL SPENDING, AND LIQUIDITY At July 4, 1999 Lakes had $53.9 million in restricted and unrestricted cash and cash equivalents. The cash balances are planned to be used for loans to tribal partners to help develop operations, the pursuit of additional business opportunities, and potential settlement of pending litigation matters. For the six months ended July 4, 1999 and June 28, 1998 net cash provided by operating activities totaled $11.4 million and $35.7 million, respectively. Payments for income taxes were $12.7 million and $0 for the six months ended July 4, 1999 and June 28, 1998, respectively. For the same periods, net cash used in investing activities totaled $19 million and $11 million, respectively. Included in these investing activities for the six months ended July 4, 1999 and June 28, 1998, are proceeds, primarily from repayment of notes receivable from Indian-owned casinos, which amounted to $5.1 million and $3.1 million, respectively. Advances under notes receivable amounted to $6.8 million and $2.7 million for the six months ended July 4, 1999 and June 28, 1998. - 16 -
17 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Also during these periods, payments for land in Las Vegas, Nevada, held for development amounted to $10 million and $6.6 million, respectively, and restricted cash decreased $0 and increased $4 million, respectively. For the six months ended July 4, 1999 and June 28, 1998, payments for investments in, and notes receivable from, unconsolidated affiliates totaled $6.6 million and $0, respectively. As security to support Lakes' indemnification obligations to Grand under each of the Distribution Agreement and the Merger Agreement, and as a condition to the consummation of the Merger, 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 illustration and 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, on each annual anniversary of the Distribution and Merger. Lakes' ability to satisfy this funding obligation is materially dependent upon the continued success of its operations and the general risks inherent in its business. In the event Lakes is unable to satisfy its funding obligation, it would be in breach of its agreement with Grand, possibly subjecting itself to additional liability for contract damages, which could have a material adverse effect on Lakes' business and results of operations. YEAR 2000 Lakes is currently working to fully determine and resolve the potential impact of the Year 2000 on the processing of date-sensitive information by its computerized information systems. The Year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of Lakes' programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the Year 2000, which could result in miscalculations or system failures. Lakes and its managed properties have a Year 2000 program, the objective of which is to determine and assess the risks of the Year 2000 issue, and plan and institute mitigating actions to minimize those risks. Pursuant to the Lakes Year 2000 program, the Company has established an internal review team to monitor and facilitate efficient Year 2000 compliance. Lakes is currently in the process of upgrading its financial reporting systems, to ensure that they are year 2000 compliant. Lakes' vendors and consultants have represented to management that the new systems meet year 2000 requirements. Lakes' standard for compliance requires that for a computer system or business process to be Year 2000 compliant, it must be designed to operate without error in dates and date-related data prior to, on and after January 1, 2000. Between now and the Year 2000, Lakes will proceed through its various phases of assessment, detailed planning, implementation, testing and management. Lakes expects to be fully Year 2000 compliant by fourth quarter 1999. - 17 -
18 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Generally, Lakes is confident that the implementation of its Year 2000 program in conjunction with the replacement of all of Lakes' financial reporting systems will resolve any IT system compliance issues. Lakes has not currently identified any material non-IT system Year 2000 issues. Throughout the remainder of 1999, Lakes will continually review its progress against its Year 2000 plans and determine what contingency plans are feasible and appropriate to reduce its exposure to Year 2000 related issues. Based on Lakes' current assessment, the costs of addressing potential problems at Lakes and its currently managed properties are estimated at $1.3 million, of which $.7 million is left to be spent. However, the historical and estimated costs relating to the resolution of Lakes' Year 2000 compliance issues cannot be fully and finally determined at this time. If significant customers or vendors identify Year 2000 issues in the future and are unable to resolve such issues in a timely manner, it could result in a material financial risk. Lakes has initiated formal communications with all of its material suppliers to determine the extent to which Lakes' interface systems are vulnerable to those third parties' failures to resolve their own Year 2000 issues. Lakes plans to devote the necessary resources to resolve all significant Year 2000 issues in a timely manner. While Lakes fully anticipates achieving Year 2000 compliance well in advance of January 1, 2000 there are certain risks which exist with respect to Lakes' business and the Year 2000. Those risks range from slight delays and inefficiencies in processing data and carrying out accounting and financial functions to, in a most reasonably likely worst case scenario, extensive and costly inability to process data, provide vital accounting functions and communicate with customers and suppliers. As of the date of this filing, Lakes has not finalized a contingency plan to address the failure to be Year 2000 compliant. SEASONALITY The Company believes that the operation of all casinos managed by the Company are affected by seasonal factors, including holidays, weather and travel conditions. REGULATION AND TAXES The Company is subject to extensive regulation by state gaming authorities. The Company will also be subject to regulation, which may or may not be similar to current state regulations, by the appropriate authorities in any other jurisdiction where it may conduct gaming activities in the future. Changes in applicable laws or regulations could have an adverse effect on the Company. - 18 -
19 LAKES GAMING, 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. PRIVATE SECURITIES LITIGATION REFORM ACT The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in this integrated Quarterly Report on Form 10-Q and other materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) contain statements that are forward-looking, such as plans for future expansion and other business development activities as well as other statements regarding capital spending, financing sources and the effects of regulation (including gaming and tax regulation) and competition. Such forward-looking information involves important risks and uncertainties that could significantly affect the anticipated results in the future and, accordingly, actual results may differ materially from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to development and construction activities, dependence upon existing management, pending litigation, domestic or global economic conditions and changes in federal or state tax laws or the administration of such laws and changes in gaming laws or regulations (including the legalization of gaming in certain jurisdictions). 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 year ended January 3, 1999. - 19 -
20 LAKES GAMING, 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 which Lakes has agreed to indemnify Grand, in connection with the Distribution. STRATOSPHERE SHAREHOLDERS LITIGATION - FEDERAL COURT In August 1996, a complaint was filed in the U.S. District Court for the District of Nevada -- Michael Ceasar, et al v. Stratosphere Corporation, et al - -- against Stratosphere and others, including Grand. The complaint was filed as a class action, and sought relief on behalf of Stratosphere shareholders who purchased their stock between December 19, 1995 and July 22, 1996. The complaint included allegations of misrepresentations, federal securities law violations and various state law claims. In August through October 1996, several other nearly identical complaints were filed by various plaintiffs in the U.S. District Court for the District of Nevada. The defendants in the actions submitted motions requesting that all of the actions be consolidated. Those motions were granted in January 1997, and the consolidated action is entitled In re: Stratosphere Corporation Securities Litigation -- Master File No. CV-S-96-00708 PMP (RLH). In February 1997, the plaintiffs filed a consolidated and amended complaint naming various defendants, including Grand and certain current and former officers and directors of Grand. The amended complaint includes claims under federal securities laws and Nevada laws based on acts alleged to have occurred between December 19, 1995 and July 22, 1996. In February 1997, various defendants, including Grand and Grand's officers and directors named as defendants, submitted motions to dismiss the amended complaint. Those motions were made on various grounds, including Grand's claim that the amended complaint failed to state a valid cause of action against Grand and Grand's officers and directors. In May 1997, the court dismissed the amended complaint. The dismissal order did not allow the plaintiffs to further amend their complaint in an attempt to state a valid cause of action. - 20 -
21 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) In June 1997, the plaintiffs asked the court to reconsider its dismissal order, and to allow the plaintiffs to submit a second amended complaint in an attempt to state a valid cause of action. In July 1997, the court allowed the plaintiffs to submit a second amended complaint. In August 1997, the plaintiffs filed a second amended complaint. In September 1997, certain of the defendants, including Grand and Grand's officers and directors named as defendants, submitted a motion to dismiss the second amended complaint. The motion was based on various grounds, including Grand's claim that the second amended complaint failed to state a valid cause of action against Grand and Grand's officers and directors. In April 1998, the Court granted Grand's motion to dismiss, in part, and denied the motion in part. Thus, the plaintiffs are pursuing the claims in the second amended complaint that survived the motion to dismiss. In June 1998, certain of the defendants, including Grand and Grand's officers and directors named as defendants, submitted a motion for summary judgment seeking an order that such defendants are entitled to judgment as a matter of law. In December 1998, the plaintiffs completed fact discovery related to the issues raised by the summary judgment motion. Expert discovery was completed in March of 1999. As of June 1, 1999, all papers had been filed and the parties were waiting for the Court to set a hearing and rule on the motion. STRATOSPHERE SHAREHOLDERS LITIGATION - NEVADA STATE COURT In August 1996, a complaint was filed in the District Court for Clark County, Nevada -- Victor M. Opitz, et al v. Robert E. Stupak, et al -- Case No. A363019 - -- against various defendants, including Grand. The complaint seeks relief on behalf of Stratosphere Corporation shareholders who purchased stock between December 19, 1995 and July 22, 1996. The complaint alleges misrepresentations, state securities law violations and other state claims. Grand and certain defendants submitted motions to dismiss or stay the state court action pending resolution of the federal court action described above. The court has stayed further proceedings pending the resolution of In re: Stratosphere Securities Litigation. - 21 -
22 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) GRAND CASINOS, INC. SHAREHOLDERS LITIGATION In September and October 1996, two actions were filed by Grand shareholders in the U.S. District Court for the District of Minnesota against Grand and certain of Grand's current and former directors and officers. The complaints allege misrepresentations, federal securities law violations and other claims in connection with the Stratosphere project. The actions have been consolidated as In re: Grand Casinos, Inc. Securities Litigation -- Master File No. 4-96-890 -- and the plaintiffs filed a consolidated complaint. The defendants submitted a motion to dismiss the consolidated complaint, based in part on Grand's claim that the consolidated complaint failed to properly state a cause of action. In December 1997, the court granted Grand's motion to dismiss in part, and denied the motion in part. Thus, the plaintiffs are pursuing the claims in the consolidated complaint that survived Grand's motion to dismiss. Discovery in the action has begun. The defendants have submitted a motion for summary judgment seeking an order that the defendants are entitled to judgment as a matter of law. In December 1998, the plaintiffs completed fact discovery related to the issues raised by the summary judgement motion. Expert discovery was completed in March of 1999. The parties have completed follow-up discovery pertaining to the summary judgment motion and the court has set a hearing date of 9/2/99. In early February 1999, the plaintiffs filed a motion for leave to amend the complaint in this action to include, as defendants in the case, both the Company and Park Place. The motion for leave to amend the complaint has been granted and Lakes has filed its answer. Lakes will defend this action vigorously. - 22 -
23 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) DERIVATIVE LITIGATION In February 1997, certain shareholders of Grand brought an action in the Hennepin County, Minnesota District Court -- Lloyd Drilling, et al v. Lyle Berman, et al -- Court File No. MC97-002807 -- against certain current and former officers and director of Grand. The plaintiffs allege that those officers and directors breached certain fiduciary duties to the shareholders of Grand as a result of certain transactions involving the Stratosphere project. Pursuant to Minnesota law, Grand's Board of Directors appointed an independent special litigation committee to evaluate whether Grand should pursue the claims made in the action against the officers and directors. The special litigation committee completed its evaluation in December 1997, and filed a report with the court recommending that such claims not be pursued. Grand provided the defense for Grand's current and former officers and directors who are defendants in the action pursuant to Grand's indemnification obligations to such defendants. In January 1998, Grand submitted a motion for summary judgment based on the special litigation committee's report. In May 1998, the court granted the motion, thereby dismissing the plaintiffs' claims. In August 1998, the plaintiffs appealed the Court's ruling. On March 9, 1999, the Minnesota Court of Appeals affirmed the dismissal of the plaintiffs' claims. The plaintiffs sought further review of the ruling by the Minnesota Supreme Court. The Court declined to grant further review. SLOT MACHINE LITIGATION In April 1994, William H. Poulos brought an action in the U.S. District Court for the Middle District of Florida, Orlando Division -- William H. Poulos, et al v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various parties (including Grand) alleged to operate casinos or be slot machine manufacturers were named as defendants. The plaintiff sought to have the action certified as a class action. A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was consolidated with the Poulos action. - 23 -
24 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) Both actions included claims under the federal Racketeering-Influenced and Corrupt Organizations Act and under state law, and sought compensatory and punitive damages. The plaintiffs claimed that the defendants are involved in a scheme to induce people to play electronic video poker and slot machines based on false beliefs regarding how such machines operate and the extent to which a player is likely to win on any given play. In December 1994, the consolidated actions were transferred to the U.S. District Court for the District of Nevada. In September 1995, Larry Schreier brought an action in the U.S. District Court for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier action were similar to those made by the plaintiffs in the Poulos and Ahearn actions, except that Schreier claimed to represent a more precisely defined class of plaintiffs than Poulos or Ahearn. In December 1996, the court ordered the Poulos, Ahearn and Schreier actions consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the plaintiffs to file a consolidated and amended complaint. In February 1997, the plaintiffs filed a consolidated and amended complaint. In March 1997, various defendants (including Grand) filed motions to dismiss or stay the consolidated action until the plaintiffs submitted their claims to gaming authorities and those authorities considered the claims submitted by the plaintiffs. In December 1997, the court denied all of the motions submitted by the defendants, and ordered the plaintiffs to file a new consolidated and amended complaint. That complaint has been filed. Grand has filed its answer to the new complaint. The plaintiffs have filed a motion seeking an order certifying the action as a class action. Grand and certain of the defendants have opposed the motion. The Court has not ruled on the motion. - 24 -
25 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) STRATOSPHERE NOTEHOLDER COMMITTEE BANKRUPTCY COURT ACTION In June 1997, the Official Committee of Noteholders (the "Committee") in the Chapter 11 bankruptcy proceeding for Stratosphere filed a motion with the U.S. Bankruptcy Court for the District of Nevada (the "Bankruptcy Court") by which the Committee sought Bankruptcy Court approval for assumption (on behalf of Stratosphere's estate) of the March 1995 Standby Equity Commitment (the "Standby Equity Commitment") between Stratosphere and Grand. In the motion, the Committee sought Bankruptcy Court authorization to compel Grand to fund up to $60 million in "capital contributions" to Stratosphere over three years, based on the Committee's claim that such "contributions" are required by the Standby Equity Commitment. Grand opposed the Committee's motion. Grand asserted, in its opposition to the Committee's motion, that the Standby Equity Commitment is not enforceable in the Stratosphere bankruptcy proceeding as a matter of law. The Bankruptcy Court held a preliminary hearing on the Committee's motion in June 1997, and an evidentiary hearing in February 1998 on the issues raised by the Committee's motion and Grand's opposition to that motion. In February 1998, the Bankruptcy Court denied the Committee's motion, and determined that the Standby Equity Commitment cannot be assumed (or enforced) by Stratosphere under applicable bankruptcy law. No appeal was taken. STANDBY EQUITY COMMITMENT LITIGATION In September 1997, the Stratosphere Trustee under the indenture pursuant to which Stratosphere issued its first mortgage notes filed a complaint in the U.S. District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company, Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand as defendant. The complaint alleges that Grand failed to perform under the Standby Equity Commitment entered into between Stratosphere and Grand in connection with Stratosphere's issuance of such first mortgage notes in March 1995. The complaint seeks an order compelling specific performance of what the Trustee claims are Grand's obligations under the Standby Equity Commitment. - 25 -
26 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) The Stratosphere Trustee filed the complaint in its alleged capacity as a third party beneficiary under the Standby Equity Commitment. Pursuant to the Second Amended Plan, a new limited liability company (the "Stratosphere LLC") was formed to pursue certain alleged claims and causes of action that Stratosphere and other parties may have against numerous third parties, including Grand and/or officers and/or directors of Grand. The Stratosphere LLC has been substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding. Discovery and motion practice is pending and Lakes will continue to defend this lawsuit diligently. 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 as management fees and for costs and expenses under a management agreement between Stratosphere and Grand, and (ii) Grand Media for electronic equipment purchased by Stratosphere from Grand Media. Stratosphere claims 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. That response denies that Stratosphere is entitled to recover the amounts described in the complaint. Discovery is pending. TULALIP TRIBES LITIGATION In 1995, Grand entered into discussions with Seven Arrows, LLC ("Seven Arrows"), a Delaware limited liability company, regarding the possible participation of Grand in a proposed casino resort development on land in the State of Washington held in trust by the United State for the Tulalip Tribes. Grand and Seven Arrows entered into a letter of intent providing for the negotiation of a revision to the Seven Arrows limited liability company agreement by which Grand (or a subsidiary of Grand) would become a member of Seven Arrows. Those negotiations were not completed and no revision to the limited liability company agreement was signed. During the negotiations, Grand entered into an agreement (the "Advance Agreement") with Seven Arrows and the Tulalip Tribes. The Advance Agreement provided for the loan by Grand and Seven Arrows of certain amounts to the Tulalip Tribes upon the satisfaction of certain conditions. - 26 -
27 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) These negotiations between Seven Arrows and Grand along with the execution of the Advance Agreement gave rise to two lawsuits involving Grand, Seven Arrows and the Tulalip Tribes. In April 1996, the Tulalip Tribes brought a legal action in Tulalip Tribal Court - Tulalip Tribes of Washington v. Seven Arrows LLC, et al. - Case No. TUL-Ci4/96-499 - against Seven Arrows and Grand. In May 1996, Seven Arrows and Grand brought a legal action in the U.S. District Court for the Western District of Washington - Seven Arrows LLC, et al. v. Tulalip Tribes of Washington - Case No. C96-0709Z - against the Tulalip Tribes. On May 17, 1999, the Tulalip Tribes of Washington, Seven Arrows, Morgan, Lewis, Githens & Ahn LP ("MLGA"); (through Red Rocks LLC the majority member of seven arrows LLC), Grand and Lakes entered into a settlement agreement resolving all claims between them. Pursuant to the settlement agreement, the Tulalip Tribes and Grand made a one time settlement payment to Seven Arrows. In turn, the Tulalip Tribes, Seven Arrows, and MLGA, each on their own behalf and on behalf of all affiliated persons, released Grand and Lakes from any claim each may have. For their part, Grand and Lakes, each on their own behalf and on behalf of all affiliated persons, released the Tulalip Tribes, Seven Arrows, and MLGA from any claim each may have. The federal lawsuit was dismissed with prejudice and without costs by order dated June 2, 1999. The Tulalip Tribal Court lawsuit was dismissed with prejudice and without costs by order dated June 2, 1999. OTHER LITIGATION The Company has recorded a reserve assessment related to various of the above items. The reserve is reflected as a litigation and claims accrual on the accompanying consolidated balance sheet as of July 4, 1999. Grand and Lakes are involved in various other inquiries, administrative proceedings, and litigation relating to contracts and other matters arising in the normal course of business. While any proceeding or litigation has an element of uncertainty, management currently believes that the final outcome of these matters is not likely to have a material adverse effect upon Grand's or the Company's consolidated financial position or results of operations. - 27 -
28 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) ITEM 5. OTHER INFORMATION The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into Tribal-State compacts with the State of Louisiana on September 29, 1992. These compacts were approved in November, 1992 by the Secretary of the Interior. Each compact expires in November, 1999, but would automatically renew for an additional seven year term unless either the tribe or the State of Louisiana delivered to the other written notice of non-renewal at least 180 days prior to the applicable expiration date. On April 7, 1999, the State of Louisiana provided written notice to each of the Coushatta Tribe of Louisiana and the Tunica-Biloxi Tribe of Louisiana of the State's intent not to renew the Tribal-State compacts which expire for each tribe on November 4, 1999 and November 18, 1999, respectively. The State further extended an invitation to each such Tribe to continue to discuss mutually advantageous terms and conditions under which the State and the Tribes can enter into new gaming compacts. IGRA requires that for Class III gaming to occur on Indian land,it must be conducted in accord with an effective state compact. IGRA further imposes an obligation on state governments, upon the request of a Tribe, to negotiate with Indian Tribes regarding the operation of gaming activities which are otherwise allowable within the state "by any person, organization or entity." Louisiana currently permits various forms of legalized, non-Indian gaming. Each Tribe is actively negotiating with the State to establish suitable alternative compacts. It is unclear what consequences, if any, might result, in the event the Tribes and the State are unable to either negotiate suitable alternative compacts or agree to an extension of the existing compacts. To the knowledge of the Company, there has been no prior instance where an existing compact has expired without either a replacement compact in place or an extension (temporary or permanent) of the present compact. Nonetheless, the Company's Management Agreements with each of the Tribes provides that, absent a determination by (i) NIGC, (ii) the Congress of the United States, (iii) the Department of the Interior or (iv) a final judgment from a court of competent jurisdiction that the operation of either Grand Casino Coushatta or Grand Casino Avoyelles would be unlawful under either federal or state law, Lakes and the Tribes are obligated in their duties to each other, as set forth in the applicable Management Agreements. It is possible that one or both of the current Tribal-State compacts may expire without the execution of a replacement compact or an extension of the existing compact. If that were to occur, each Tribe has indicated to the Company that they will assert their legal rights to continue gaming operations at both Grand Casino Coushatta and Grand Casino Avoyelles. - 28 -
29 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) As outlined above, in the absence of a determination by (i) NIGC, (ii) the Congress of the United States, (iii) the Department of the Interior or (iv) a final judgment from a court of competent jurisdiction that the operation of either Grand Casino Coushatta or Grand Casino Avoyelles would be unlawful under either federal or state law, so long as the Tribes continue to conduct gaming activities at Grand Casino Coushatta and Grand Casino Avoyelles, Lakes intends to continue to operate and manage these casinos and to abide by the terms and obligations of the applicable Management Agreements. If the terms of the current Tribal-State compacts expire, without the execution of new compacts or the extension of the current compacts, there is a risk that (i) NIGC, (ii) the Congress of the United States, (iii) the Department of the Interior, (iv) the United States Department of Justice or (v) a court of competent jurisdiction could take action against either or both of the Tribes and/or Grand Casino Coushatta and Grand Casino Avoyelles resulting in the cessation of gaming operations at these casinos and/or the inability of Lakes to manage either or both of these casinos. The cessation of gaming operations at either or both of Grand Casino Coushatta and Grand Casino Avoyelles or the inability of Lakes to manage the gaming operations at these casinos would result in the loss of revenues to Lakes derived from such contracts, which would have a material adverse effect on Lakes' results of operations. Currently, the management contracts for Grand Casino Coushatta and Grand Casino Avoyelles generate all of Lakes' operating revenues. Without the realization of new business opportunities or new management contracts, the cessation of gaming operations at these casinos or the inability of Lakes to manage those operations, would have a material adverse impact on Lakes' results of operations and financial condition. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a)Exhibits Description -------- ----------- 10.1 Equipment Loan Promissory Note in the principal amount of $6,000,000 by and among the Tunica-Biloxi Tribe of Louisiana, as Borrower and Hibernia National Bank, as Lender executed as of May 28, 1999. 10.2 Dominion Account Agreement, dated effective as of May 28, 1999, between the Tunica-Biloxi Tribe of Louisiana, a federally recognized Indian tribe, Grand Casinos of Louisiana, LLC - Tunica-Biloxi, a Minnesota limited liability company, Lakes Gaming, Inc., a Minnesota corporation, the Cottonport Bank, a bank chartered under the laws of the State of Louisiana, and Hibernia National Bank, a national banking association. - 29 -
30 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) 10.3 Subordination Agreement Granted by Lakes Gaming, Inc., in Favor of Hibernia National Bank entered into as of May 28, 1999. 10.4 Intercreditor Agreement dated as of May 28, 1999, between The Cottonport Bank, Hibernia National Bank and Grand Casinos of Louisiana, LLC - Tunica-Biloxi and Lakes Gaming, Inc. 10.5 Commercial Security Agreement entered into between the Tunica-Biloxi Tribe of Louisiana (as Grantor) and Hibernia National Bank (as Lender). 10.6 Subordination Agreement Granted by Grand Casinos of Louisiana, LLC - Tunica-Biloxi in Favor of Hibernia National Bank entered into as of May 28, 1999. 10.7 Equipment Loan Agreement dated effective as of May 28, 1999 made by and between the Tunica-Biloxi Tribe of Louisiana and Hibernia National Bank, a national banking association. 27 Financial Data Schedule (for SEC use only). (b) Reports on Form 8-K (i) A Form 8-K, Item 5. Other Events; and Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, was filed on April 23, 1999. -30-
31 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: August 17 , 1999 LAKES GAMING, INC. ------------------------------- Registrant / S / THOMAS J. BROSIG ------------------------------- Thomas J. Brosig President / S / TIMOTHY J. COPE ------------------------------- Timothy J. Cope Executive Vice President and Chief Financial Officer (LAKES10Q899C) - 31 -