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 1, 2001 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) (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 [ ] As of August 10, 2001, there were 10,637,953 shares of Common Stock, $0.01 par value per share, outstanding.
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 July 1, 2001 3 and December 31, 2000 Consolidated Statements of Earnings for the three 4 months ended July 1, 2001 and July 2, 2000 Consolidated Statements of Comprehensive Earnings for 5 the three months ended July 1, 2001 and July 2, 2000 Consolidated Statements of Earnings for the six months 6 ended July 1, 2001 and July 2, 2000 Consolidated Statements of Comprehensive 7 Earnings for the six months ended July 1, 2001 and July 2, 2000 Consolidated Statements of Cash Flows for the six 8 months ended July 1, 2001 and July 2, 2000 Notes to Consolidated Financial Statements 9 ITEM 2. MANAGEMENT'S DISCUSSION AND 15 ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 3. QUANTITATIVE AND QUALITATIVE 23 DISCLOSURES ABOUT MARKET RISK PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 24 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30 </TABLE> 2
3 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) <TABLE> <CAPTION> JULY 1, 2001 DECEMBER 31, 2000 - ---------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current Assets: Cash and cash equivalents $ 9,038 $ 10,469 Short-term investments 10,406 32,477 Current installments of notes receivable 13,402 16,679 Accounts receivable 7,109 2,373 Deferred tax asset 13,747 13,674 Other current assets 4,930 2,383 - ---------------------------------------------------------------------------------------------------- Total Current Assets 58,632 78,055 - ---------------------------------------------------------------------------------------------------- Property and Equipment-Net 1,880 1,414 - ---------------------------------------------------------------------------------------------------- Other Assets: Land held for development 70,853 58,671 Notes receivable-less current installments 51,388 35,337 Cash and cash equivalents-restricted 33,210 30,270 Investments in and notes from unconsolidated affiliates 2,477 3,209 Other long-term assets 5,683 5,853 - ---------------------------------------------------------------------------------------------------- Total Other Assets 163,611 133,340 - ---------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 224,123 $ 212,809 ==================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 166 $ 79 Current maturities of long-term debt 525 525 Income taxes payable 8,578 5,479 Litigation and claims accrual 24,752 25,078 Other accrued expenses 4,183 4,521 - ---------------------------------------------------------------------------------------------------- Total Current Liabilities 38,204 35,682 - ---------------------------------------------------------------------------------------------------- Long-term Liabilities: Long-term debt-less current installments 1,325 1,325 - ---------------------------------------------------------------------------------------------------- Total Long-Term Liabilities 1,325 1,325 - ---------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 39,529 37,007 - ---------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES Shareholders' Equity: Capital stock, $.01 par value; authorized 100,000 shares; 10,638 common shares issued and outstanding at July 1, 2001, and December 31, 2000 106 106 Additional paid-in-capital 131,525 131,525 Retained Earnings 53,401 44,504 Accumulated other comprehensive earnings (loss) (438) (333) - ---------------------------------------------------------------------------------------------------- Total Shareholders' Equity 184,594 175,802 - ---------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 224,123 $ 212,809 ==================================================================================================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE 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 1, 2001 JULY 2, 2000 <S> <C> <C> REVENUES: Management fee income $ 9,599 $ 10,655 COSTS AND EXPENSES: Selling, general and administrative 2,940 2,747 Depreciation and amortization 329 328 - ----------------------------------------------------------------------------------------- Total Costs and Expenses 3,269 3,075 - ----------------------------------------------------------------------------------------- EARNINGS FROM OPERATIONS 6,330 7,580 - ----------------------------------------------------------------------------------------- OTHER INCOME (EXPENSE): Interest income 1,599 2,116 Interest expense (24) (24) Equity in loss of unconsolidated affiliates (153) (397) Provision for litigation loss -- (18,000) Write-down of unconsolidated affiliates (666) -- - ----------------------------------------------------------------------------------------- Total other income (expense), net 756 (16,305) - ----------------------------------------------------------------------------------------- Earnings before income taxes 7,086 (8,725) Provision (benefit) for income taxes 2,906 (3,414) - ----------------------------------------------------------------------------------------- NET EARNINGS $ 4,180 ($ 5,311) ========================================================================================= BASIC EARNINGS PER SHARE $ 0.39 ($ 0.50) ========================================================================================= DILUTED EARNINGS PER SHARE $ 0.39 ($ 0.50) ========================================================================================= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,632 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS 120 10 - ----------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,758 10,642 ========================================================================================= </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 4
5 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (IN THOUSANDS) <TABLE> <CAPTION> THREE MONTHS ENDED ------------------------------ JULY 1, 2001 JULY 2, 2000 ------------------------------ <S> <C> <C> NET EARNINGS (LOSS) $ 4,180 ($5,311) OTHER COMPREHENSIVE INCOME, NET OF TAX: Unrealized gains on securities: Unrealized holding losses during the period (225) (26) Reclassification adjustment for losses included in net earnings 12 -- ------------------------------ COMPREHENSIVE EARNINGS (LOSS) $ 3,967 ($5,337) ============================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS 5
6 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) <TABLE> <CAPTION> SIX MONTHS ENDED ---------------- JULY 1, 2001 JULY 2, 2000 ------------ ------------ <S> <C> <C> REVENUES: Management fee income $ 18,822 $ 41,708 COSTS AND EXPENSES: Selling, general and administrative 5,520 4,800 Depreciation and amortization 660 2,249 - ---------------------------------------------------------------------------------------- Total Costs and Expenses 6,180 7,049 - ---------------------------------------------------------------------------------------- EARNINGS FROM OPERATIONS 12,642 34,659 - ---------------------------------------------------------------------------------------- OTHER INCOME (EXPENSE): Interest income 3,414 3,746 Interest expense (49) (49) Equity in loss of unconsolidated affiliates (260) (1,205) Provision for litigation loss -- (18,000) Write-down of unconsolidated affiliates (666) -- - ---------------------------------------------------------------------------------------- Total other income (expense), net 2,439 (15,508) - ---------------------------------------------------------------------------------------- Earnings before income taxes 15,081 19,151 Provision for income taxes 6,184 8,347 - ---------------------------------------------------------------------------------------- NET EARNINGS $ 8,897 $ 10,804 ======================================================================================== BASIC EARNINGS PER SHARE $ 0.84 $ 1.02 ======================================================================================== DILUTED EARNINGS PER SHARE $ 0.83 $ 1.02 ======================================================================================== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,631 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS 132 4 - ---------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,770 10,635 ======================================================================================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 6
7 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (IN THOUSANDS) <TABLE> <CAPTION> SIX MONTHS ENDED ------------------------------- JULY 1, 2001 JULY 2, 2000 ------------------------------- <S> <C> <C> NET EARNINGS $ 8,897 $ 10,804 OTHER COMPREHENSIVE INCOME, NET OF TAX: Unrealized gains on securities: Unrealized holding losses during the period (105) (17) Reclassification adjustment for losses included in net earnings 79 -- ------------------------------- COMPREHENSIVE EARNINGS $ 8,871 $ 10,787 =============================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 7
8 LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) <TABLE> <CAPTION> SIX MONTHS ENDED ---------------- JULY 1, 2001 JULY 2, 2000 ------------ ------------ <S> <C> <C> OPERATING ACTIVITIES: Net earnings $ 8,897 $ 10,804 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 660 2,249 Equity in loss of unconsolidated affiliates 260 1,205 Write down of assets held as investments 666 -- Provision for litigation loss -- 18,000 Changes in operating assets and liabilities: Accounts receivable (4,761) 648 Income taxes 3,099 (3,465) Accounts payable 87 (274) Accrued expenses (664) (557) Other (1,692) (64) - ------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 6,552 28,546 - ------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Short-term investments, purchases (11,708) (27,524) Short-term investments, sales/maturities 33,602 5,653 Payments for land held for development (12,182) (1,884) Payments for notes receivable (19,547) (16,771) Proceeds from repayment of notes receivable 5,936 12,503 Investment in and notes receivable from unconsolidated affiliates (404) (1,283) (Increase) decrease in restricted cash, net (2,940) 111 Increase in other long-term assets (187) (56) Payments for property and equipment, net (553) (26) - ------------------------------------------------------------------------------------------------------------- Net Cash Used in Investing Activities (7,983) (29,277) - ------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Proceeds from issuance of common stock -- 79 - ------------------------------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities -- 79 - ------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (1,431) (652) Cash and cash equivalents - beginning of period 10,469 24,392 - ------------------------------------------------------------------------------------------------------------- Cash and cash equivalents - end of period $ 9,038 $ 23,740 ============================================================================================================ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 49 $ 49 Income taxes 3,995 11,638 </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 8
9 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BUSINESS 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"). Lakes currently manages the largest casino resort in Louisiana under a management contract that expires in January 2002. The Company has entered into 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, and has entered into a joint venture agreement for the development of land on the Las Vegas strip. 2. PRINCIPLES OF CONSOLIDATION 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. 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. During the first quarter of 2001, Lakes wrote off its 50 percent investment in PCG Corning, LLC, also a joint venture formed to develop a casino on Indian-owned land in California. In addition, Lakes has a 27 percent ownership interest in New Horizon Kids Quest, Inc. (NHKQ), a publicly held provider of child care facilities. In June 2001, Lakes entered into an agreement with NHKQ pursuant to which NHKQ will acquire Lakes' interest in NHKQ. As a result of this transaction, Lakes incurred a one time write-down charge of $.7 million before tax, during the quarter. On December 31, 2000, the carrying value of former investments in Fanball.com, Inc., Trak 21 Development, LLC and Interactive Learning Group, Inc., were written down to zero. 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 1, 2001, are not necessarily indicative of the results that may be expected for the year ending December 30, 2001. 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 December 31, 2000. 9
10 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 3. 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. On March 31, 2000 the Company announced that it had reached an agreement with the Tunica-Biloxi Tribe of Louisiana, effective March 31, 2000, for the early buyout of the management contract for Grand Casino Avoyelles. The Tunica-Biloxi Tribe of Louisiana elected to exercise its option for the early buyout of the contract, which was scheduled to expire on June 3, 2001. The early buyout of the contract was provided for in the original seven-year management agreement and, under the agreement, Lakes was compensated for the management fees the Company would have received had it managed Grand Casino Avoyelles through the original contract expiration date of June 3, 2001, discounted to their present value. Included in management fee income for the six months ended July 2, 2000 is approximately $16 million relating to the early buyout. Lakes was also repaid all amounts owing to it under its loan agreements with the Tribe. The management contract for Grand Casino Coushatta expires January 16, 2002 and will not be renewed. Although the Coushatta Tribe had previously agreed to a contract renewal in principle, the Coushatta Tribe decided to place the casino operations under their direct control. This non-renewal will result in the loss of revenues to the Company derived from such contract, which will have a material adverse effect on the Company's results of operations. The Coushatta Tribe entered into a tribal-state compact with the State of Louisiana on September 29, 1992. This compact was approved in November 1992 by the Secretary of the Interior. The compact expired November 4, 1999 and the State of Louisiana delivered a written notice of non-renewal. The Governor and the Tribe agreed on three extensions totaling thirteen months that were approved by the Department of the Interior. On July 20, 2001, the Tribe and the State of Louisiana agreed to terms of a new compact. The compact is subject to approval by the Department of the Interior. There can be no assurances that the compact will be approved by the Department of the Interior. 10
11 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 4. NOTES RECEIVABLE Notes receivable consist of the following (in thousands): <TABLE> <CAPTION> July 1, 2001 December 31, 2000 ------------ ----------------- <S> <C> <C> Notes from the Pokagon Band of Potawatomi Indians with variable interest rates (not to exceed 10%) (7.75% at July 1, 2001), receivable in 60 monthly installments subsequent to commencement date $ 31,635 $ 21,918 Notes from the Coushatta Tribe with variable interest rates (7.75% at July 1, 2001), receivable in 84 monthly installments through January 2002 6,292 12,227 Notes from the Shingle Springs Band of Miwok Indians with variable interest rates (8.75% at July 1, 2001), receivable in 12 monthly installments subsequent to commencement date 9,347 5,554 Notes from PCG Corning, LLC, with variable interest rates (7.75% at July 1, 2001) 5,174 2,679 Notes from the Jamul Indian Village with variable interest rates (8.75% at July 1, 2001), receivable in 12 monthly installments subsequent to commencement date 5,214 3,372 Notes from ViatiCare Financial Services, LLC, with variable interest rates (7.75% at July 1, 2001) 4,000 3,740 Other 3,128 2,526 -------- -------- Total notes receivable 64,790 52,016 Less - current installments of notes receivable (13,402) (16,679) -------- -------- Notes receivable, less current installments $ 51,388 $ 35,337 ======== ======== </TABLE> 11
12 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The notes receivable are generally advances made to Indian Tribes for the development of gaming properties 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 July 1, 2001, no amounts have been withheld 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. No impairment losses on such notes receivable have been recognized through July 1, 2001. The Company believes the costs and complexities of assembling the relevant facts and comparables needed to appraise the fair market values of these notes based on estimates of net present value of discounted cash flows or using other valuation techniques are excessive and the process exceedingly time consuming. It further believes that the determined results would not reasonably differ from the carrying values, which are believed to be reasonable estimates of fair market value based on past experience with similar receivables. 5. LITIGATION SETTLEMENT A settlement agreement was reached in June 2000 regarding both the Stratosphere shareholders' litigation and the Grand Casinos, Inc. shareholders' litigation. The agreement required Lakes to pay $9 million to the Grand Casinos, Inc. shareholders and $9 million to the Stratosphere shareholders for a total of $18 million, which was reflected as a non-operating expense in the second quarter of 2000. The net income impact of the litigation loss was $10.6 million or $1.00 per diluted share. The $18 million was placed by Lakes into escrow accounts on behalf of the recipients. On August 14, 2001, the Court issued an order giving final approval to the settlement. The complaints by the shareholder groups were originally filed in 1996 against various defendants including Grand Casinos, Inc. The complaints included allegations of misrepresentations, federal and state securities law violations and various other claims in connection with the Stratosphere project. As part of the transaction establishing Lakes as a separate public company on December 31, 1998, Lakes agreed to indemnify Grand for all obligations arising out of these lawsuits. 12
13 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 6. 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 1, 2001 are as follows (in thousands): <TABLE> <CAPTION> Operating Leases ---------------- <S> <C> 2001 $ 1,489 2002 3,109 2003 3,176 2004 3,246 2005 3,318 Thereafter 40,861 -------- $55,199 ======== </TABLE> PURCHASE OPTION AGREEMENTS The Company has an option to purchase the Travelodge property in Las Vegas, Nevada for the purchase price of $30 million on October 31, 2017, and options to purchase the Cable property in Las Vegas, Nevada for the purchase price of $39.1 million any time prior to January 2, 2003. LOAN GUARANTY AGREEMENTS 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 1, 2001 and December 31, 2000, the amounts outstanding were $9.4 million and $13.0 million, respectively. 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. 13
14 LAKES GAMING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) As security to support Lakes' indemnification obligations to Grand, 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, during the four-year period subsequent to December 31, 1998. Any surplus proceeds remaining 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. Such amounts are included as restricted cash on the accompanying balance sheets as of July 1, 2001 and December 31, 2000. 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. 14
15 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 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, to the shareholders of Grand Casinos, Inc. ("Grand"). 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 a land-based, Indian-owned casino in Louisiana: Grand Casino Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta"), owned by the Coushatta Tribe of Louisiana (the "Coushatta Tribe"). The management contract expires January 16, 2002, which is seven years from the date the casino opened, and will not be renewed. This non-renewal will result in the loss of revenues to the Company derived from such contract, which will have a material adverse effect on the Company's results of operations. The Company also managed a second land-based, Indian-owned casino in Marksville, Louisiana ("Grand Casino Avoyelles"), owned by the Tunica-Biloxi Tribe of Louisiana (the "Tunica-Biloxi Tribe") through March 31, 2000. On March 31, 2000 the Company announced that it had reached an agreement with the Tunica-Biloxi Tribe of Louisiana, effective March 31, 2000 for the early buyout of the management contract for Grand Casino Avoyelles. The Tunica-Biloxi Tribe of Louisiana elected to exercise its option for the early buyout of the contract, which was scheduled to expire on June 3, 2001. The early buyout of the contract was provided for in the original seven-year management agreement and, under the agreement, Lakes was compensated for the management fees the company would have received had it managed Grand Casino Avoyelles through the original contract expiration date of June 3, 2001, discounted to their present value. Lakes was also repaid all amounts owing to it under its loan agreements with the Tribe. Lakes develops, constructs and manages Indian-owned casino properties that offer the opportunity for long-term development in emerging and established gaming jurisdictions. On May 12, 1999, the Company announced that it would 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 holds a contract to develop and manage a casino resort facility with the Jamul Indian Village in California. The contract is subject to approval by NIGC. In March of 2000, California voters approved an amendment to the State Constitution which allows for Nevada-style gaming on Indian land and ratifies the Tribal Compact. Development of the casino resort will begin once various regulatory approvals are received. 15
16 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (UNAUDITED) 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 and the Band have executed a development and management agreement governing their relationship during the development, construction and management of the casino. Various regulatory approvals are needed prior to commencement of development activities. On January 18, 2000, a Michigan Ingham County Circuit Judge ruled that the Michigan State Legislature acted improperly in 1998 when it approved casino compacts by joint resolution. The Governor of the State of Michigan has appealed the ruling. The ruling directly affects four tribes in Michigan, one of which is the Pokagon Band of Potawatomi Indians with whom Lakes has development and management contracts. In January 2001, the land comprising the casino site was accepted into trust by the Secretary of Interior, subject to a 30-day public comment period. During the 30-day period, a complaint was filed against the Secretary of the U.S. Department of the Interior in the District Court of Columbus by a group called "Taxpayers of Michigan Against Casinos", to stop the U.S. Department of Interior from placing into trust the land for the casino site. The Department of Justice will defend this lawsuit on behalf of the Secretary of the Interior. On July 15, 1999, the Company announced that it would 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 the Shingle Springs Band of Miwok Indians in California. The contract is subject to approval by NIGC and placement of the land where the gaming facility is to be located into trust with the Bureau of Indian Affairs ("BIA"). In March of 2000, California voters approved an amendment to the State Constitution which allows for Nevada-style gaming on Indian land and ratifies the Tribal Compact. Development of the casino resort will begin once various regulatory approvals are received. On October 1, 1999, the Company purchased the shopping center and land owned by the Nevada Resort Properties Polo Plaza Limited Partnership (the "Partnership") in lieu of exercising its right to purchase the remaining 51% interest in the Partnership. Prior to the purchase, the Company held a 49% ownership interest in the Partnership. In consideration for the purchase, the Company paid approximately $3.3 million and paid off the outstanding partnership mortgage of approximately $6.3 million. A $6.2 million loan to the Partnership made by the Company during January 1999 was repaid and satisfied at the closing by offsetting an appropriate amount against the purchase price as agreed by the Company and the Partnership. Pursuant to the purchase agreement relating to this transaction, the Partnership is in the process of being dissolved. 16
17 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) On June 19, 2000, the Company announced that a settlement agreement had been reached regarding both the Stratosphere shareholders' litigation and the Grand Casinos, Inc. shareholders' litigation. The agreement required Lakes to pay $9 million to the Grand Casinos, Inc. shareholders and $9 million to the Stratosphere shareholders for a total of $18 million, which was reflected as a non-operating expense in the second quarter of 2000. This amount was paid into escrow and related accounts in July 2000 for full and final settlement for all federal and state related actions. On August 8, 2001, the Court indicated that it would issue an order giving final approval to the settlement. The parties are currently awaiting receipt of the order. On July 31, 2000, the Company announced that it had formed a joint venture, Metroplex-Lakes, LLC, with Metroplex, LLC to develop Las Vegas real estate now controlled by Lakes. Metroplex-Lakes, LLC plans to develop an upscale retail, commercial, hotel and entertainment complex on approximately 16 acres surrounding the corner of Harmon Avenue and Las Vegas Boulevard (the "Strip") in Las Vegas. The joint venture has a two-year option to buy the majority of the site from Lakes at a price that will approximately equal Lakes' investment in the property plus the assumption of Lakes' future obligations under a long-term ground lease. The joint venture will also assume Lakes' option to purchase the remainder of the site from a third party. Lakes will have voting control of the joint venture, however, development decisions affecting the real estate purchased by the joint venture must be mutually agreed upon. Lakes and Metroplex will share results from the joint venture equally. On August 10, 2000, the Company announced that it had agreed to form a joint venture for the purpose of developing new gaming facilities on Indian owned land in California. Under the agreement, Lakes formed a limited liability company with MRD Gaming, a limited liability company. The partnership between Lakes and MRD holds the contract to develop casino facilities with the Cloverdale Rancheria of Pomo Indians. The planned site for the potential new casino development is located on Highway 101 in Cloverdale, California, approximately 60 miles north of San Francisco. Development at the casino will start as soon as various regulatory approvals are obtained by the tribe. Development is also subject to completion of definitive financing arrangements. The joint venture also entered into a contract relating to the Paskenta Band of Nomlaki Indians. However, in February 2001, Lakes announced its intention to discontinue its involvement with the Paskenta project. Lakes has made loans to the joint venture (PCG Corning, LLC) for this project which remain outstanding (see footnote 4). On July 9, 2001, the Company announced that it had signed development and management agreements with the Nipmuc Nation of Massachusetts for a potential future casino resort in the eastern United States. The Nipmuc Nation's petition for federal recognition received a proposed positive finding from the Bureau of Indian Affairs (BIA) this past January. If final approval is received, the Nipmuc Nation would need to put land in trust and come to a gaming agreement with the state where the land is located before proceeding with any such enterprise. 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. During the first quarter of 2001, Lakes wrote off its 50 percent investment in PCG Corning, LLC, also a joint venture formed to develop a casino on Indian-owned land in California. 17
18 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (UNAUDITED) In addition, Lakes has a 27 percent ownership interest in New Horizon Kids Quest, Inc. (NHKQ), a publicly held provider of child care facilities. In June 2001, Lakes entered into an agreement with NHKQ, pursuant to which NHKQ will acquire Lakes' interest in NHKQ. As a result of this transaction, Lakes incurred a one time write-down charge of $.7 million before tax, during the quarter. On December 31, 2000, the carrying value of former investments in Fanball.com, Inc., Trak 21 Development, LLC and Interactive Learning Group, Inc. were written down to zero. 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 and the buy-out and/or cessation of other casino management contracts. Lakes' business strategy contemplates, the pursuit of opportunities to develop and manage additional gaming facilities, maximizing the benefit of the land investment in Las Vegas, 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. The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto and the management's discussion and analysis included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. RESULTS OF OPERATIONS Revenues are calculated in accordance with accounting principles generally accepted in the United States and are presented in a manner consistent with industry practice. Net distributable profits 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. Lakes is prohibited by IGRA from having an ownership interest in any casino it manages for Indian tribes. The management contract with Grand Casino Coushatta expires January 16, 2002, and will not be renewed. The failure to renew the Lakes' Management Contract will result in the loss of revenues to Lakes derived from such contract, which will have a material adverse effect on Lakes' results of operations. The Coushatta Tribe entered into a tribal-state compact with the State of Louisiana on September 29, 1992. This compact was approved in November 1992 by the Secretary of the Interior. The compact for the Coushatta Tribe expired November 4, 1999 and the State of Louisiana delivered a written notice of non-renewal. The Governor and the Tribe agreed on two six-month extensions and one thirty-day extension, which were approved by the Department of the Interior. On July 20, 2001, the State of Louisiana and the Coushatta Tribe reached agreement on the terms of a new compact. The compact is subject to approval by the Department of the Interior. In the event the compact is not approved, gaming may not be permitted at Grand Casino Coushatta. 18
19 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) SIX MONTHS ENDED JULY 1, 2001 COMPARED TO THE SIX MONTHS ENDED JULY 2, 2000 Revenues Total revenues were $18.8 million for the six months ended July 1, 2001 compared to $41.7 million for the same period in the prior year. Revenues for the current year were derived from fees related to the management of Grand Casino Coushatta. Revenues for the current year were less than the same period last year primarily due to the early buyout of the Company's management contract for Grand Casino Avoyelles by the Tunica-Biloxi Tribe of Louisiana at the end of the first quarter 2000, pursuant to the terms of the contract. Revenues from Grand Casino Avoyelles contributed $19.8 million for the six months ended July 2, 2000, including approximately $16.0 million in management fee income recognized due to the buyout of the management contract. The decrease in revenues relates also to a decline in management fees of $3.2 million from Grand Casino Coushatta due to construction interruption on the main roads leading to the casino, along with increased competition from the Lake Charles riverboats and adverse weather conditions in the area. Costs and Expenses Total costs and expenses were $6.2 million for the six months ended July 1, 2001, compared to $7.0 million for the same period in the prior year. Selling, general, and administrative expenses increased in comparison with the prior year period, from $4.8 million for the six months ended July 2, 2000 to $5.5 million for the six months ended July 1, 2001, primarily due to increased costs related to development costs of new casino projects. Depreciation and amortization expense decreased from $2.2 million for the six months ended July 2, 2000 to $0.7 million for the six months ended July 1, 2001, due to increased amortization in the prior year period related to the early buyout of the management contract for Grand Casino Avoyelles at the end of the first quarter of 2000. Other Provision for litigation loss was $18 million for the six months ended July 2, 2000. This amount relates to a settlement agreement reached in June 2000 regarding both the Stratosphere shareholders' litigation and the Grand Casinos, Inc. shareholders' litigation. The agreement required Lakes to pay a total of $18 million, which has been reflected as a non-operating expense in the second quarter of 2000. This amount was paid into escrow and related accounts in July 2000 for full and final settlement for all federal and state related actions. On August 14, 2001, the Court issued an order giving final approval to the settlement. In June 2001, Lakes entered into an agreement with New Horizon Kids Quest (NHKQ), pursuant to which NHKQ will acquire Lakes' interest in NHKQ. As a result, Lakes incurred a one time write-down charge of $.7 million before tax, during the quarter. 19
20 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Interest income was $3.4 million for the six months ended July 1, 2001, compared to $3.7 million for the same period in the prior year. Equity in loss of unconsolidated affiliates decreased to $.3 million for the six months ended July 1, 2001 from $1.2 million for the six months ended July 2, 2000, due primarily to the write down of investments in Fanball.com, Interactive Learning Group, Inc. and Trak 21 on December 31, 2000. Current year period results do not include losses from these operations. Earnings per Common Share and Net Earnings For the six months ended July 1, 2001 basic and diluted earnings per common share were $.84 and $.83, respectively. This compares to basic and diluted earnings of $1.02 per common share, for the six months ended July 2, 2000. Earnings totaled $8.9 million for the six months ended July 1, 2001 compared to earnings of $10.8 million for the same prior year period. Excluding results from Grand Casino Avoyelles and the $18 million provision for litigation loss, Lakes' earnings before taxes for the six months ended July 1, 2001, decreased approximately $3.9 million compared to the same period in the prior year. The decrease in earnings relates primarily to the $3.2 million decline in management fees from Grand Casino Coushatta described above. THREE MONTHS ENDED JULY 1, 2001 COMPARED TO THE THREE MONTHS ENDED JULY 2, 2000 Revenues Total revenues were $9.6 million for the three months ended July 1, 2001 compared to $10.7 million for the same period in the prior year. Revenues for the current year quarter were derived from fees related to the management of Grand Casino Coushatta. Revenues for the quarter were less than the same period last year primarily due to a decline in management fees of $1.1 million from Grand Casino Coushatta due to construction interruption on the main roads leading to the casino, along with adverse weather conditions. Costs and Expenses Total costs and expenses were $3.3 million for the three months ended July 1, 2001, compared to $3.1 million for the same period in the prior year. The increase is due to a slight increase in selling, general, and administrative expenses in comparison with the prior year period, primarily due to increased costs related to development costs of new casino projects. Other Provision for litigation loss was $18 million for the three months ended July 2, 2000. This amount relates to a settlement agreement reached in June 2000 regarding both the Stratosphere shareholders' litigation and the Grand Casinos, Inc. shareholders' litigation. The agreement required Lakes to pay a total of $18 million, which has been reflected as a non-operating expense in the second quarter of 2000. This amount was paid into escrow and related accounts in July 2000 for full and final settlement for all federal and state related actions. On August 14, 2001, the Court issued an order giving final approval to the settlement. 20
21 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) In June 2001, Lakes entered into an agreement with New Horizon Kids Quest (NHKQ), pursuant to which NHKQ will acquire Lakes' interest in NHKQ. As a result, Lakes incurred a one time write-down charge of $.7 million before tax, during the quarter. Interest income was $1.6 million for the three months ended July 1, 2001, compared to $2.1 million for the same period in the prior year. Earnings per Common Share and Net Earnings For the three months ended July 1, 2001, basic and diluted earnings per common share were $.39. This compares to basic and diluted losses of $.50 per common share, for the three months ended July 2, 2000. Earnings totaled $4.2 million for the three months ended July 1, 2001 compared to a net loss of $5.3 million for the same prior year period. Excluding the $18 million provision for litigation loss, Lakes' second quarter earnings before taxes decreased approximately $2.2 million compared to the second quarter in the prior year. The decrease in earnings relates primarily to the $1.1 million decline in management fees from Grand Casino Coushatta and to the one time write-down charge of $.7 million relating to the sale of Lakes' interest in NHKQ described above. CAPITAL RESOURCES, CAPITAL SPENDING, AND LIQUIDITY At July 1, 2001, Lakes had $42.2 million in restricted and unrestricted cash and cash equivalents. The Company also had $10.4 million in short-term, available-for-sale investments, consisting primarily of a fixed income portfolio made up of various types of bonds which are rated A1 or better. The cash and short-term investment balances are planned to be used for loans to current joint venture and tribal partners to develop existing and anticipated Indian casino operations, costs associated with the Las Vegas real estate, 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. For the six months ended July 1, 2001 and July 2, 2000, net cash provided by operating activities totaled $6.6 million and $28.5 million, respectively. For the same periods, net cash used in investing activities totaled $8.0 million and $29.3 million, respectively. Included in these investing activities for the six months ended July 1, 2001 and July 2, 2000, are proceeds primarily from repayment of notes receivable from Indian-owned casinos, which amounted to $5.9 million and $12.5 million, respectively. Advances under notes receivable were $19.5 million and $16.8 million for the six months ended July 1, 2001 and July 2, 2000. Also during these periods, payments for land in Las Vegas, Nevada, held for development amounted to $12.2 million and $1.9 million, respectively. As a part of the agreements dated as of June 30, 1998, by and among Hilton Hotels Corporation, Park Place, Gaming Acquisition Corporation, Lakes and Grand, the Company has agreed to indemnify Grand against all costs, expenses and liabilities incurred in connection with or arising out of certain pending and threatened claims and legal proceedings to which Grand and certain of its subsidiaries are likely to be parties. The Company's indemnification obligations include the obligation to provide the defense of all claims made in proceedings against Grand and to pay all related settlements and judgments. See Part II, Item 1. Legal Proceedings. 21
22 LAKES GAMING, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) As security to support Lakes' indemnification obligations to Grand, Lakes agreed to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of Park Place, an aggregate of $30 million, consisting of four annual installments of $7.5 million during the four-year period subsequent to December 31, 1998. Lakes' ability to satisfy this funding obligation is materially dependent upon the continued success of its operations and the general risks inherent in its business. In the event Lakes is unable to satisfy its funding obligation, it would be in breach of its agreement with Grand, possibly subjecting itself to additional liability for contract damages, which could have a material adverse effect on Lakes' business and results of operations. The Company made the first deposit of $7.5 million on December 31, 1999. In 2000, Lakes deposited $18.0 million into an escrow account on behalf of the recipients in the Stratosphere shareholders' litigation and the Grand Casinos, Inc. shareholders' litigation. Such amounts are included as restricted cash on the accompanying consolidated balance sheets as of July 1, 2001 and July 2, 2000. In January 2001, Lakes also purchased the Shark Club property in Las Vegas for $10.1 million in settlement of another claim that was subject to the indemnification obligations. SEASONALITY The Company believes that the operation of 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. 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. 22
23 LAKES GAMING, 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 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 these risks and uncertainties, see the "Business -- Risk Factors" section of the Company's Annual Report on Form 10-K for the year ended December 31, 2000. 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 July 1, 2001, the carrying value of the Company's cash and cash equivalents approximates fair value. The Company's marketable debt securities (principally consisting of commercial paper, corporate bonds, and government securities) have a weighted average duration of one year or less. Consequently such securities are not 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. If interest rates rise or fall, the floating rate receivables may generate more or less interest income than what is currently recorded. As of July 1, 2001, Lakes had $66.5 million of floating rate notes receivable. Based on the applicable current reference rates and assuming all other factors remain constant, interest income for a twelve-month period would be $5.5 million. A reference rate increase of 100 basis points would result in an increase in 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 interest income over the same twelve-month period. 23
24 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 with respect to 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. 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. 24
25 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) 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. All papers relating to this matter were filed on June 1, 1999. On October 6, 1999, the District Court entered its Order, granting in part and denying in part, defendants' Motion for Summary Judgment and Summary Adjudication. The Court dismissed all allegations in reference to (1) Phase II funding levels; (2) "over-allotments uses", as stated in the December 19, 1995 Prospectus; (3) the purpose and use of the Grand Casino Completion Guaranty, as stated in the June 6, 1996 Press Statement; (4) the vague expressions of general optimism (issued within the December 19, 1995 Prospectus, the 10-Q and 10-K Filings, press releases and other public statements) referred to in this Order; (5) the adoption of statements in securities analysts reports; (6) the alleged utterance of misleading statements before the Nevada Gaming Commission; and (7) the temporary diversion of Phase II proceeds to fund Phase I. The remaining claims relate to the accuracy of defendants' budgetary estimates issued in Stratosphere's December 1995 Prospectus and SEC 10-Q and 10-K Reports. The Court concluded that there were triable issues as to whether defendants misstated anticipated construction costs or omitted to disclose material cost overruns. The Court added the Company as an additional defendant because of its indemnity obligation and stipulation. The parties have reached a settlement covering the Stratosphere shareholders litigation. A stipulation of settlement was approved by the Court on December 4, 2000. The Stratosphere state and federal settlement was for $9 million, inclusive of all plaintiffs fees and costs. Pursuant to the settlement agreement no distributions could occur until the Minnesota federal litigation was dismissed. On August 14, 2001, the Court issued an order granting final approval to the settlement agreement. Distributions should now proceed in accordance with the settlement agreement. 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. 25
26 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) 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. As described under "Stratosphere Shareholders Litigation - Federal Court" above, the parties have reached a $9 million settlement covering the Stratosphere shareholders litigation in federal and state courts. A Stipulation and Order for Dismissal with Prejudice was entered on January 11, 2001, providing that the state court litigation be dismissed with prejudice inasmuch as the parallel federal court action has been resolved. 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. The consolidated complaint sought class action treatment for a class comprising all persons (other than the defendants) who purchased Grand common stock during the period from December 19, 1995 through July 19, 1996. In December 1997, the court granted Grand's motion to dismiss in part, and denied the motion in part. The plaintiffs pursued the claims in the consolidated complaint that survived Grand's motion to dismiss and discovery in the action commenced. The defendants 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 judgment motion. Expert discovery was completed in March of 1999. The parties completed follow-up discovery pertaining to the summary judgment motion. The court heard the motion on September 2, 1999. On March 28, 2000, the court granted the motion in part, and denied the motion in part. The court dismissed, with prejudice, all claims against the defendants as to the members of the putative class who did not purchase Grand common stock during the period from December 19, 1995 through June 6, 1996, inclusive. 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 was granted and Lakes filed its answer. 26
27 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) On June 19, 2000, the Company announced that a settlement agreement had been reached regarding the litigation. The agreement called for the Company to pay $9 million to the Grand shareholders for full and final settlement of all claims covering the original class period. The $9 million was placed into an escrow account by Lakes on behalf of the recipients in July 2000. On May 2, 2001, the settlement agreement received preliminary approval from the U.S. District Court for the District of Minnesota. The settlement agreement is subject to final approval by the U.S. District Court for the District of Minnesota. The Court issued an order granting final approval to the settlement agreement on August 14, 2001. SLOT MACHINE LITIGATION In April 1994, William H. Poulos brought an action in the U.S. District Court for the Middle District of Florida, Orlando Division -- William H. Poulos, et al v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various parties (including Grand) alleged to operate casinos or be slot machine manufacturers were named as defendants. The plaintiff sought to have the action certified as a class action. A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was consolidated with the Poulos action. Both actions included claims under the federal Racketeering-Influenced and Corrupt Organizations Act and under state law, and sought compensatory and punitive damages. The plaintiffs claimed that the defendants are involved in a scheme to induce people to play electronic video poker and slot machines based on false beliefs regarding how such machines operate and the extent to which a player is likely to win on any given play. In December 1994, the consolidated actions were transferred to the U.S. District Court for the District of Nevada. In September 1995, Larry Schreier brought an action in the U.S. District Court for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al - -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier action were similar to those made by the plaintiffs in the Poulos and Ahearn actions, except that Schreier claimed to represent a more precisely defined class of plaintiffs than Poulos or Ahearn. In December 1996, the court ordered the Poulos, Ahearn and Schreier actions consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the plaintiffs to file a consolidated and amended complaint. In February 1997, the plaintiffs filed a consolidated and amended complaint. In March 1997, various defendants (including Grand) filed motions to dismiss or stay the consolidated action until the plaintiffs submitted their claims to gaming authorities and those authorities considered the claims submitted by the plaintiffs. 27
28 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) In December 1997, the court denied all of the motions submitted by the defendants, and ordered the plaintiffs to file a new consolidated and amended complaint. That complaint has been filed. Grand has filed its answer to the new complaint. The plaintiffs have filed a motion seeking an order certifying the action as a class action. Grand and certain of the defendants have opposed the motion. The Court has not ruled on the motion. STANDBY EQUITY COMMITMENT LITIGATION In September 1997, the Stratosphere Trustee under the indenture pursuant to which Stratosphere issued its first mortgage notes filed a complaint in the U.S. District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company, Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand as defendant. The complaint alleges that Grand failed to perform under the Standby Equity Commitment entered into between Stratosphere and Grand in connection with Stratosphere's issuance of such first mortgage notes in March 1995. The complaint seeks an order compelling specific performance of what the Trustee claims are Grand's obligations under the Standby Equity Commitment. The Stratosphere Trustee filed the complaint in its alleged capacity as a third party beneficiary under the Standby Equity Commitment. Pursuant to the Second Amended Plan, a new limited liability company (the "Stratosphere LLC") was formed to pursue certain alleged claims and causes of action that Stratosphere and other parties may have against numerous third parties, including Grand and/or officers and/or directors of Grand. The Stratosphere LLC has been substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding. In October of 1999, portions of the Motions for Summary Judgment by both parties were denied in part. The Court subsequently denied Grand's request for expedited appellate court review as to the portions of Motions that were denied. During the August 30, 2000 scheduled pretrial conference call, the Court and the parties agreed to try the action upon an amended joint pre-trial order and a series of post-trial briefs. Post-trial briefing concluded on December 12, 2000 and oral argument was held on January 22, 2001. Upon the Court's request, both parties submitted findings of fact and conclusions of law. On April 4, 2001, the Court entered judgment in favor of Grand and issued its findings of fact and conclusions of law. The plaintiff has filed a notice of appeal. Grand has filed a notice of cross appeal to seek review of the portion of the trial court's summary judgment order which denied relief to Grand. The propriety of Grand's cross appeal, given its status as the prevailing party, is currently the subject of an Order to Show Cause in the Ninth Circuit. 28
29 LAKES GAMING, 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 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. The matter is pending. 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 1, 2001. 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Annual Meeting of Shareholders was held on May 23, 2001. (b) At the Annual Meeting, all of management's nominees for directors as listed in the proxy statement were elected with the following vote: (1) Directors elected at meeting: <TABLE> <CAPTION> Affirmative Votes Authority Withheld ----------------- ------------------ <S> <C> <C> Lyle Berman 8,423,622 1,425,051 Timothy J. Cope 8,424,513 1,424,159 Morris Goldfarb 8,429,522 1,419,150 Ronald Kramer 8,434,810 1,413,862 Neil I. Sell 8,434,705 1,413,967 </TABLE> 29
30 LAKES GAMING, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) (2) The appointment of Arthur Andersen, LLP, Certified Public Accountants, as independent auditors of the Company for the 2001 fiscal year was ratified with the following vote: <TABLE> <CAPTION> Affirmative Votes Negative Votes Abstentions ----------------- -------------- ----------- <S> <C> <C> <C> 9,827,673 8,173 12,826 </TABLE> ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Gaming Development Agreement For Class III Gaming Facility by and between The Nipmuc Nation and Lakes Nipmuc, LLC, dated as of July 5, 2001. 10.2 Management Agreement For Class III Gaming Enterprise by and between The Nipmuc Nation and Lakes Nipmuc, LLC, dated as of July 5, 2001. 10.3 Interim Promissory Note, dated as of July 5, 2001, by and between The Nipmuc Nation and Lakes Nipmuc, LLC. 10.4 Security Agreement by and between The Nipmuc Nation and Lakes Nipmuc, LLC, dated July 5, 2001. 10.5 Guaranty Agreement by Lakes Gaming, Inc. and agreed to by The Nipmuc Nation, dated as of July 5, 2001. (b) Reports on Form 8-K (i) A Form 8-K, Item 5. Other Events, was filed on June 26, 2001. (ii) A Form 8-K, Item 5. Other Events, was filed on July 9, 2001. (iii) A Form 8-K, Item 5. Other Events, was filed on July 20, 2001. 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 15, 2001 LAKES GAMING, INC. ------------------ Registrant / S / LYLE BERMAN ----------------------- Lyle Berman Chairman of the Board, Chief Executive Officer and President / S / TIMOTHY J. COPE ----------------------- Timothy J. Cope Executive Vice President and Chief Financial Officer 31