10-Q 1 c72931e10vq.txt FORM 10-Q FOR QUARTER ENDING SEPTEMBER 29, 2002 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 September 29, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission File No. 0-24993 LAKES ENTERTAINMENT, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Minnesota 41-1913991 --------------------------------- ------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 130 Cheshire Lane Minnetonka, Minnesota 55305 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (952) 449-9092 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of November 8, 2002, there were 10,638,320 shares of Common Stock, $0.01 par value per share, outstanding. LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES INDEX
PAGE OF FORM 10-Q --------- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of 3 September 29, 2002 and December 30, 2001 Condensed Consolidated Statements of Earnings for 4 the three months ended September 29, 2002 and September 30, 2001 (Restated) Condensed Consolidated Statements of Comprehensive 5 Earnings for the three months ended September 29, 2002 and September 30, 2001 (Restated) Condensed Consolidated Statements of Earnings for the nine 6 months ended September 29, 2002 and September 30, 2001 (Restated) Condensed Consolidated Statements of Comprehensive 7 Earnings for the nine months ended September 29, 2002 and September 30, 2001 (Restated) Condensed Consolidated Statements of Cash Flows for 8 the nine months ended September 29, 2002 and September 30, 2001 (Restated) Notes to Condensed Consolidated Financial Statements 9 ITEM 2. MANAGEMENT'S DISCUSSION AND 20 ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 3. QUANTITATIVE AND QUALITATIVE 30 DISCLOSURES ABOUT MARKET RISK ITEM 4. CONTROLS AND PROCEDURES 31 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 32 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 35
2 LAKES GAMING, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED)
SEPTEMBER 29, 2002 DECEMBER 30, 2001 ------------------ ------------------ ASSETS Current Assets: Cash and cash equivalents $ 14,286 $ 42,638 Short-term investments -- 2,027 Current installments of notes receivable -- 67 Related party receivables -- 4,000 Accounts receivable, net 91 3,601 Income taxes receivable 813 -- Deferred tax asset 4,506 4,549 Other current assets 622 1,079 ------------------ ------------------ Total Current Assets 20,318 57,961 ------------------ ------------------ Property and Equipment-Net 7,078 6,300 ------------------ ------------------ Other Assets: Land held under contract for sale 28,609 30,826 Land held for development 28,713 24,965 Notes receivable-less current installments 67,950 53,201 Cash and cash equivalents-restricted 9,754 9,175 Investments in and notes from unconsolidated affiliates 882 839 Deferred tax asset 4,849 3,870 Other long-term assets 6,483 6,042 ------------------ ------------------ Total Other Assets 147,240 128,918 ------------------ ------------------ TOTAL ASSETS $ 174,636 $ 193,179 ================== ================== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 290 $ 105 Current maturities of long-term debt 975 1,325 Current installments of capital lease obligations -- 123 Income taxes payable -- 3,906 Litigation and claims accrual 5,857 6,572 Accrued payroll and related 705 671 Other accrued expenses 3,431 2,670 ------------------ ------------------ Total Current Liabilities 11,258 15,372 ------------------ ------------------ Long-term Liabilities: Capital lease obligations-less current installments -- 5,591 Other long-term liabilities 224 225 ------------------ ------------------ Total Long-Term Liabilities 224 5,816 ------------------ ------------------ TOTAL LIABILITIES 11,482 21,188 ------------------ ------------------ COMMITMENTS AND CONTINGENCIES Shareholders' Equity: Capital stock, $.01 par value; authorized 100,000 shares; 10,638 common shares issued and outstanding at September 29, 2002, and December 30, 2001 106 106 Additional paid-in-capital 131,525 131,525 Retained Earnings 31,523 40,420 Accumulated other comprehensive loss -- (60) ------------------ ------------------ Total Shareholders' Equity 163,154 171,991 ------------------ ------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 174,636 $ 193,179 ================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 3 LAKES GAMING, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) (UNAUDITED)
THREE MONTHS ENDED ---------------------------------------- SEPTEMBER 29, 2002 SEPTEMBER 30, 2001 ------------------ ------------------ (AS RESTATED, SEE NOTE 9) REVENUES: Management fee income $ -- $ 8,664 COSTS AND EXPENSES: Selling, general and administrative 2,700 2,541 Depreciation and amortization 130 323 ------------------ ------------------ Total Costs and Expenses 2,830 2,864 ------------------ ------------------ EARNINGS (LOSS) FROM OPERATIONS (2,830) 5,800 ------------------ ------------------ OTHER INCOME (EXPENSE): Interest income 134 231 Interest expense (23) (25) Equity in loss of unconsolidated affiliates (85) (103) ------------------ ------------------ Total other income, net 26 103 ------------------ ------------------ Earnings (loss) before income taxes (2,804) 5,903 Provision (benefit) for income taxes (1,150) 2,420 ------------------ ------------------ NET EARNINGS (LOSS) $ (1,654) $ 3,483 ================== ================== BASIC EARNINGS (LOSS) PER SHARE $ (0.16) $ 0.33 ================== ================== DILUTED EARNINGS (LOSS) PER SHARE $ (0.16) $ 0.33 ================== ================== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS -- -- ------------------ ------------------ WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,638 10,638 ================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED ---------------------------------------- SEPTEMBER 29, 2002 SEPTEMBER 30, 2001 ------------------ ------------------ (AS RESTATED, SEE NOTE 9) NET EARNINGS (LOSS) $ (1,654) $ 3,483 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: Unrealized change in fair value of available-for-sale securities: Unrealized holding gains during the period 21 194 Reclassification adjustment for losses included in net earnings (loss) 2 176 ------------------ ------------------ COMPREHENSIVE EARNINGS (LOSS) $ (1,631) $ 3,853 ================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 5 LAKES GAMING, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) (UNAUDITED)
NINE MONTHS ENDED ---------------------------------------- SEPTEMBER 29, 2002 SEPTEMBER 30, 2001 ------------------ ------------------ (AS RESTATED, SEE NOTE 9) REVENUES: Management fee income $ 1,502 $ 27,486 COSTS AND EXPENSES: Selling, general and administrative 14,371 8,061 Depreciation and amortization 349 983 ------------------ ------------------ Total Costs and Expenses 14,720 9,044 ------------------ ------------------ EARNINGS (LOSS) FROM OPERATIONS (13,218) 18,442 ------------------ ------------------ OTHER INCOME (EXPENSE): Interest income 1,306 1,704 Interest expense (70) (73) Equity in loss of unconsolidated affiliates (316) (365) Write-down of investment in unconsolidated affiliates -- (666) ------------------ ------------------ Total other income, net 920 600 ------------------ ------------------ Earnings (loss) before income taxes (12,298) 19,042 Provision (benefit) for income taxes (3,401) 7,807 ------------------ ------------------ NET EARNINGS (LOSS) $ (8,897) $ 11,235 ================== ================== BASIC EARNINGS (LOSS) PER SHARE $ (0.84) $ 1.06 ================== ================== DILUTED EARNINGS (LOSS) PER SHARE $ (0.84) $ 1.05 ================== ================== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS -- 40 ------------------ ------------------ WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,638 10,678 ================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 6 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED ---------------------------------------- SEPTEMBER 29, 2002 SEPTEMBER 30, 2001 ------------------ ------------------ (AS RESTATED, SEE NOTE 9) NET EARNINGS (LOSS) $ (8,897) $ 11,235 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: Unrealized change in fair value of available-for-sale securities: Unrealized holding gains during the period 10 10 Reclassification adjustment for losses included in net earnings (loss) 50 255 ------------------ ------------------ COMPREHENSIVE EARNINGS (LOSS) $ (8,837) $ 11,500 ================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 7 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED ---------------------------------------- SEPTEMBER 29, 2002 SEPTEMBER 30, 2001 ------------------ ------------------ (AS RESTATED, SEE NOTE 9) OPERATING ACTIVITIES: Net earnings (loss) $ (8,897) $ 11,235 Adjustments to reconcile net earnings (loss) to net cash (used in) provided by operating activities: Depreciation and amortization 349 983 Equity in loss of unconsolidated affiliates 316 364 Impairment of land held under contract for sale 3,000 -- Write down of investments in unconsolidated affiliates -- 666 Write down of related party receivables 4,000 -- Changes in operating assets and liabilities: Accounts receivable 3,510 (3,924) Income taxes (4,719) 5,192 Accounts payable 185 97 Accrued expenses 570 (457) Other 280 699 ------------------ ------------------ Net Cash (Used in) Provided by Operating Activities (1,406) 14,855 ------------------ ------------------ INVESTING ACTIVITIES: Short-term investments, purchases -- (12,708) Short-term investments, sales/maturities 2,130 42,572 Payments for land held under contract for sale (783) -- Payments for land held for development (3,748) (12,978) Advances on notes receivable (15,257) (24,024) Proceeds from repayment of notes receivable 67 9,037 Investment in and notes receivable from unconsolidated affiliates (165) (508) Increase in restricted cash, net (579) (3,026) Increase in other long-term assets (1,420) (154) Payments for property and equipment, net (1,127) (888) ------------------ ------------------ Net Cash Used in Investing Activities (20,882) (2,677) ------------------ ------------------ FINANCING ACTIVITIES: Payments on capital lease obligations (5,714) -- Payments on long-term debt (350) -- ------------------ ------------------ Net Cash Used in Financing Activities (6,064) -- ------------------ ------------------ Net increase (decrease) in cash and cash equivalents (28,352) 12,178 Cash and cash equivalents - beginning of period 42,638 10,469 ------------------ ------------------ CASH AND CASH EQUIVALENTS - END OF PERIOD $ 14,286 $ 22,647 ================== ================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 74 $ 73 Income taxes 9 4,002
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 8 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BUSINESS Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company") was established as a public corporation on December 31, 1998, via a distribution (the "Distribution") of its common stock, par value $.01 per share (the "Common Stock") to the shareholders of Grand Casinos, Inc. ("Grand"). Lakes currently has development and management agreements with four separate tribes for four new casino operations, one in Michigan, two in California and one with the Nipmuc Nation on the east coast. The Company also has agreements for the development of one additional casino on Indian owned land in California through a joint venture. Each of these projects is currently in the development phase. During March 2002, the Company made an investment in a joint venture with Steven Lipscomb, a producer of televised poker tournaments. The purpose of this joint venture, which is currently consolidated by Lakes, is to launch the World Poker Tour and establish poker as the next significant televised mainstream sport. The terms of this investment required Lakes to make an investment of $0.1 million for an approximate 78% ownership position in the joint venture. Lakes is also required to lend up to $3.2 million to the joint venture as needed. The joint venture has issued a note to Lakes at 6.2% interest per annum with principal payable at the end of three years. The amount outstanding on the note was $1.2 million as of September 29, 2002. The Lakes' note is secured by a blanket security interest in all assets of the joint venture. If certain predetermined goals are not achieved by the joint venture, Lakes has the right to stop advances on the note. If Lakes were to elect to stop funding the joint venture, all outstanding principal amounts would be due one year from the date Lakes stopped funding. LAND HELD UNDER CONTRACT FOR SALE On December 28, 2001, the Company transferred title and ownership obligations of the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and obligations of the adjacent Travelodge property consisting of a long-term land lease and a motel operation. This transaction was accounted for under the deposit method of accounting under the requirements of Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate, rather than as a sale. Therefore, the property is included as land held under contract for sale on the accompanying balance sheets as of September 29, 2002 and December 30, 2001. The total price for this combined transaction was approximately $30.9 million. Terms of the transaction include a $1.0 million down payment, a contractual commitment to pay Lakes $23.3 million by December 29, 2002, and a second contractual agreement to pay Lakes $7.5 million on June 30, 2004. Lakes' collateral for the two contractual commitments is the property and lease rights described above which would revert back to Lakes in the event of default by Metroflag. The transaction was closed subject to certain administrative post-closing conditions that must be satisfied within six months after the closing. This post-closing period was extended through September 27, 2002. These conditions were satisfied as of September 27, 2002. 9 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Lakes and Metroflag have restructured the terms of the Polo Plaza and Travelodge property transactions due to deteriorating economic conditions. The parties have reduced the purchase price for the Polo Plaza property from $23.3 million to $21.3 million. On the payment date, which is scheduled to be no later than January 31, 2003, $17.3 million of the purchase price is payable to Lakes in cash and $4.0 million is payable through the issuance to Lakes of a preferred membership interest in Metroflag. On or before December 24, 2003, Metroflag Polo may elect to distribute to Lakes $3.0 million in cash as full return of Lakes' preferred interest. If Lakes' preferred interest remains outstanding at any time on or after December 24, 2006, Lakes can require Metroflag to repurchase the preferred interest for $4.0 million plus a priority return of eight percent (8%) per annum. Effective June 30, 2002, Lakes recorded a $3.0 million impairment charge for these properties relating to the adjustment in the purchase price and the potential discount on the return of Lakes' preferred interest. LAND HELD FOR DEVELOPMENT Lakes continues to own the Shark Club property, which is an approximate 3.5 acre undeveloped site adjacent to the Polo Plaza shopping center and Travelodge sites. During August 2002, Lakes formed a joint venture with Diamond Resorts, LLC, a Nevada limited liability company and time-share developer for the purpose of developing the Shark Club parcel as an upscale time-share project. The terms of this joint venture agreement require that Diamond and Lakes each make an initial working capital contribution of $250,000. Subject to Diamond obtaining a financing commitment for a construction loan sufficient to fund at least the first phase of the building improvements contemplated by the time-share project, the joint venture agreement will require Lakes to contribute the relevant portion of the Shark Club parcel, valued at $16 million. Diamond has agreed to perform sales, marketing, administrative and managerial services for the project. The terms of the joint venture agreement provide for the repayment to Lakes of its contribution of property in cash based on the joint venture's cash flow and time-share unit sales. It is contemplated that Lakes will be required to make no other material contributions of cash or property to the project. On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest will accrue at a rate of 10.0% per annum. The loan is due and payable from first available cash flow of the joint venture (excluding any required capital contribution from a member) and no later than October 1, 2004. Also included in land held for development is land held for possible transfer to Indian tribes for use in future casino resort projects in the amount of $12.6 million and $8.9 million as of September 29, 2002 and December 30, 2001, respectively. 10 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under a single method, the purchase method. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board ("APB") Opinion No. 17, Intangible Assets. These statements were effective January 1, 2002 and adoption did not have a material impact on the Company's financial position or results of operation. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 supersedes previous guidance for financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset and will be effective on January 1, 2003. In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, which provides new accounting and financial reporting guidance for the impairment or disposal of long-lived assets and the disposal of segments of a business. This statement was effective January 1, 2002 and its adoption did not have a material impact on the Company's financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 eliminates the definition and requirement for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 where a liability for an exit is recognized at the date of an entity's commitment to an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of SFAS No. 143 and 146 will have a material impact on its financial position or results of operations. 2. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements include the accounts of Lakes and its wholly-owned and majority-owned subsidiaries. Investments in unconsolidated affiliates representing 50% or less of voting interests are accounted for on the equity method. All significant intercompany balances and transactions have been eliminated in consolidation. Lakes' investments in unconsolidated affiliates include a 50 percent ownership interest in PCG Santa Rosa, LLC, a joint venture formed to develop a casino on Indian-owned land in California. 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. Additionally, as a result of its spin-off from Grand, Lakes received a 27 percent ownership interest in New Horizon Kids Quest, Inc. (NHKQ), a publicly held provider of child care facilities. 11 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) In June 2001, Lakes entered into an agreement with NHKQ pursuant to which NHKQ acquired Lakes' interest in NHKQ. As a result of this transaction, Lakes incurred a one time write-down of $0.7 million before tax, during the second quarter of 2001. The condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information, in accordance with the rules and regulations of the Securities and Exchange Commission. Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the condensed consolidated financial statements have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the nine months ended September 29, 2002, are not necessarily indicative of the results that may be expected for the year ending December 29, 2002. The condensed consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K/A for the year ended December 30, 2001. 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. The management contract for Grand Casino Coushatta expired January 16, 2002, which is seven years from the date the casino opened, and was not renewed. This non-renewal has resulted in the loss of revenues to the Company derived from such contract, which has had a material adverse effect on the Company's results of operations. As of September 29, 2002, the Company has no other management contracts from which it will derive revenues in 2002. 4. NOTES RECEIVABLE The notes receivable from Indian Tribes are generally for the development of gaming properties to be managed by the Company. The repayment terms are specific to each tribe and are largely dependent upon the operating performance of each gaming property. Repayments of the aforementioned notes receivable are required to be made only if distributable profits are available from the operation of the related casinos. Repayments are also the subject of certain distribution priorities specified in the management contracts. In addition, repayment of the notes receivable and the manager's fees under the management contracts may be subordinated to certain other financial obligations of the respective casinos. Through September 29, 2002, no amounts have been withheld under these provisions. 12 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Notes receivable consist of the following (in thousands):
September 29, 2002 December 30, 2001 ------------------ ------------------ Properties under development: Notes from the Pokagon Band of Potawatomi Indians with variable interest rates (not to exceed 10%) (5.75% at September 29, 2002), receivable in 60 monthly installments subsequent to commencement date $ 38,923 $ 35,236 Notes from the Shingle Springs Band of Miwok Indians with variable interest rates (6.75% at September 29, 2002), receivable in varying monthly installments based on contract terms subsequent to commencement date 13,522 6,684 Notes from Jamul Indian Village with variable interest rates (6.75% at September 29, 2002), receivable in 12 monthly installments subsequent to commencement date 8,457 5,540 Other 7,048 5,741 Operating properties: Notes from the Coushatta Tribe with variable interest rates (5.75% at December 30, 2001), receivable in 84 monthly installments through January 2002 -- 67 ------------------ ------------------ Total notes receivable 67,950 53,268 Less - current installments of notes receivable -- (67) ------------------ ------------------ Notes receivable, less current installments $ 67,950 $ 53,201 ================== ==================
Interest income on notes receivable from Indian Tribes related to casino development projects is deferred because realizability of the interest is contingent upon the completion and positive operating cash flow of the casino. Interest deferred during the development period is recognized over the remaining life of the note using the effective interest method. As of September 29, 2002 and December 30, 2001, $9.6 million and $6.1 million of interest on notes related to properties under development has been deferred. Management periodically evaluates the recoverability of such notes receivable based on the current and projected operating results of the underlying facility and historical collection experience. No impairment losses on such notes receivable have been recognized through September 29, 2002. The terms of these notes require the casinos to be constructed and to generate positive cash flows prior to the Company receiving repayment. As such, an estimate of the fair value of these notes requires an assessment of the timing of the construction of the related casinos and the profitability of the related casinos. Due to the significant uncertainty involved in such an assessment, the Company does not believe that it is practicable to accurately estimate the fair value of these notes with the degree of precision necessary to make such information meaningful. 13 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 5. LONG-TERM DEBT The Company currently has one note payable with a third party. This note is collateralized by certificates of deposit, with $1.0 million outstanding at September 29, 2002 and December 30, 2001. Interest is compounded and paid on a quarterly basis at 10%. The principal and any unpaid interest are due December 22, 2002. A second note which was collateralized by property with $0.4 million outstanding at June 20, 2002 and December 30, 2001 was repaid on June 20, 2002. 6. CAPITAL LEASE OBLIGATIONS Pursuant to the terms of the Distribution Agreement, Grand assigned to Lakes, and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes' current corporate office space of approximately 65,000 square feet with a lease term of fifteen years. The lease commenced on October 14, 1996. During 2001, also pursuant to the terms of the Distribution Agreement, Lakes entered into a capital lease arrangement for the corporate office space at which time the operating lease was cancelled. Accordingly, Lakes recorded a capital leased asset and liability in the amount of approximately $5.8 million. These amounts are included in the accompanying condensed consolidated balance sheet as of December 30, 2001. On January 2, 2002, the Company completed the purchase of its corporate office building for $6.4 million, including transaction expenses. This transaction resulted in the extinguishment of the Company's capital lease obligation related to the building. 7. COMMITMENTS AND CONTINGENCIES: LEASES The Company leases an airplane under a non-cancelable operating lease. The airplane lease expires May 1, 2003 and provides for two one-year renewal terms. Approximate future minimum lease payments, due under this lease as of September 29, 2002, assuming both one-year renewals are exercised, are as follows (in thousands):
Operating Leases ---------------- 2002 $ 150 2003 600 2004 600 2005 200 ------ $1,550 ======
PURCHASE OPTIONS The Company has the right to purchase the airplane it leases during the base lease term and any renewal term for approximately $8 million. During 2001, the option to purchase the Cable property in Las Vegas, Nevada for the purchase price of $39.1 million was allowed to lapse. 14 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) INDEMNIFICATION AGREEMENT As a part of the transaction establishing Lakes as a separate public company on December 31, 1998, the Company has agreed to indemnify Grand against all costs, expenses and liabilities incurred in connection with or arising out of certain pending and threatened claims and legal proceedings to which Grand and certain of its subsidiaries are likely to be parties. The Company's indemnification obligations include the obligation to provide the defense of all claims made in proceedings against Grand and to pay all related settlements and judgments. As security to support Lakes' indemnification obligations to Grand, Lakes agreed to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of Park Place, an aggregate of $30 million, to cover various commitments and contingencies related to or arising out of, Grand's non-Mississippi business and assets (including by way of example, but not limitation, tribal loan guarantees, real property lease guarantees for Lakes' subsidiaries and director and executive officer indemnity obligations) consisting of four annual installments of $7.5 million, during the four-year period subsequent to December 31, 1998. Any surplus proceeds remaining in this trust after all the secured obligations are indefeasibly paid in full and discharged shall be paid over to Lakes. Lakes made the first deposit of $7.5 million on December 31, 1999 and in July 2000, Lakes deposited $18 million in an escrow account in partial satisfaction of the indemnification obligation. The $18 million deposit represented a settlement agreement which was reached in June 2000 regarding both the Stratosphere Shareholders' litigation and the Grand Casinos, Inc. Shareholders' litigation. On August 14, 2001, the Court issued an order giving final approval to the settlement. As such, the $18 million in restricted cash was removed from the Company's condensed consolidated balance sheet. In January 2001, Lakes also purchased the Shark Club property in Las Vegas for $10.1 million in settlement of another obligation that was subject to the indemnification obligations. As of September 29, 2002 and December 30, 2001, $7.5 million related to security to support Lakes' indemnification obligations to Grand is included as restricted cash in the accompanying condensed consolidated balance sheets. As part of the indemnification agreement, Lakes has agreed that it will not declare or pay any dividends, make any distribution of Lakes' equity interests, or otherwise purchase, redeem, defease or retire for value any equity interests in Lakes without the written consent of Park Place. LEGAL PROCEEDINGS The following summaries describe certain known legal proceedings to which Grand is a party which Lakes has assumed, or with respect to which Lakes may have agreed to indemnify Grand, in connection with the Distribution. 15 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 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. 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. 16 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 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 August 2000, 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. On April 4, 2001, the Court entered judgment in favor of Grand and issued its findings of fact and conclusions of law. The plaintiff filed an appeal with the Ninth Circuit Court of Appeals on May 4, 2001, Case No. 01-15947. On August 13, 2002, the Ninth Circuit affirmed the prior ruling in favor of Grand. 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 denying that Stratosphere is entitled to recover the amounts described in the complaint. Discovery was completed on December 31, 2001 and the case proceeded to trial before the United States Bankruptcy Court for the District of Nevada on June 20, 2002. A decision has not yet been issued. 17 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) OTHER LITIGATION The Company has recorded a reserve assessment related to various of the above items based on management's best estimate. The reserve is reflected as a litigation and claims accrual on the accompanying condensed consolidated balance sheet as of September 29, 2002 and December 30, 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. 8. RELATED PARTY TRANSACTIONS During 2001 and 2000, Lakes made a total of $4.0 million in unsecured loans to ViatiCare Financial Services, LLC, which has since been acquired by Living Benefits Financial Services. In March 2001, the Board of Directors of Lakes decided not to make further loans to ViatiCare. A $4.0 million impairment charge for this note was recorded during the quarter ended June 30, 2002, due to increased competition in the viatical insurance business and restrictions on ability to make further policy acquisitions. Subsequent to the decision by the Lakes Board to make no further loans to ViatiCare, L. B. Acquisitions, LLC, which is owned by Lyle Berman, the Chief Executive Officer and a Director of Lakes, has made loans to Living Benefits. As an incentive to make the loans, L. B. Acquisitions was granted an initial 9% voting interest in Living Benefits and was given the option to convert the loan balance into 45% of the voting interest in Living Benefits. Therefore, Lyle Berman, through L. B. Acquisitions, beneficially owns a total of approximately 55% of the voting interest of Living Benefits. 9. RESTATEMENT Subsequent to the issuance of the Company's financial statements for the three and nine months ended September 30, 2001, management of the Company determined that the interest on notes receivable related to the development of casinos should have been deferred because the interest is not payable until the casinos are open and generating operating cash flow. As a result, the accompanying condensed consolidated financial statements for the three and nine month periods ended September 30, 2001 have been restated to correct the accounting for these transactions. 18 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) A summary of the significant effects of the restatement is as follows (in thousands):
Three Months Ended Nine Months Ended September 30, 2001 September 30, 2001 ----------------------------- ----------------------------- As previously As previously reported As restated reported As restated ------------- ------------- ------------- ------------- Statements of Earnings: Interest Income $ 1,350 $ 231 $ 4,763 $ 1,704 Earnings before income taxes 7,023 5,904 22,102 19,043 Provision for income taxes 2,880 2,420 9,062 7,807 Net earnings 4,143 3,483 13,040 11,235 Basic Earnings Per Share $ 0.39 $ 0.33 $ 1.23 $ 1.06 Diluted Earnings Per Share 0.39 0.33 1.22 1.05
19 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (UNAUDITED) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As discussed in Note 9 to the condensed consolidated financial statements included in Item 1, the accompanying condensed consolidated financial statements have been restated. The following Management's Discussion and Analysis reflects this restatement. OVERVIEW Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company") was established as a public corporation on December 31, 1998, via a distribution (the "Distribution") of its Common Stock, to the shareholders of Grand Casinos, Inc. ("Grand"). As a result of the Distribution, Lakes operates the Indian casino management business and holds various other assets previously owned by Grand. Lakes' main business is the development, construction and management of casinos and related hotel and entertainment facilities in emerging and established gaming jurisdictions. Lakes has entered into the following contracts for the development, management and/or financing of new casino operations, all of which are subject to various regulatory approvals before construction can begin: (1) Lakes has a contract to be the exclusive developer and manager of an Indian-owned gaming resort near New Buffalo, Michigan. (2) Lakes and another company have formed partnerships with contracts to develop and manage two casinos to be owned by Indian tribes in California, one near San Diego and the other near Sacramento. (3) Lakes and another company have formed a partnership with a contract to finance the construction of an Indian-owned casino approximately 75 miles north of San Francisco, California. (4) Lakes has also signed contracts with a Massachusetts Indian tribe for development and management of a potential future gaming resort in the eastern United States; however, this tribe has received a negative finding regarding federal recognition from the Bureau of Indian Affairs (BIA). The tribe has submitted additional information to the BIA for reconsideration. Additionally, in March 2002, the Company made an investment in World Poker Tour, LLC, a joint venture formed to film and produce poker tournaments for television broadcast. Lakes owns the Shark Club property which is an approximate 3.5 acre undeveloped site on the Las Vegas Strip in Las Vegas, Nevada. See "Capital Resources, Capital Spending and Liquidity" below. On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest will accrue at a rate of 10.0% per annum. The loan is due and payable from first available cash flow of the joint venture and no later than October 1, 2004. 20 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Lakes' historical revenues have been derived almost exclusively from management fees. During 2001, Lakes managed a land-based, Indian-owned casino, Grand Casino Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta"). Pursuant to the Coushatta management contract, Lakes received a fee based on the net distributable profits (as defined in the contracts) generated by Grand Casino Coushatta. The management contract expired January 16, 2002, and was not renewed. This non-renewal has resulted in the loss of revenues to the Company derived from such contract, which has had a material adverse effect on the Company's results of operations. Lakes' limited operating history may not be indicative of Lakes' future performance. In addition, a comparison of results from year to year may not be meaningful due to the opening of new facilities and the buy-out and/or cessation of other casino management contracts. Lakes' growth strategy contemplates the development of existing projects, the pursuit of opportunities to develop and manage additional gaming facilities and the pursuit of new business opportunities. The successful implementation of this growth strategy is contingent upon the satisfaction of various conditions, including obtaining governmental approvals, the impact of increased competition, and the occurrence of certain events, many of which are beyond the control of Lakes. CRITICAL ACCOUNTING POLICIES The significant accounting policies, which Lakes believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following: revenue recognition and realizability of notes receivable. REVENUE RECOGNITION: Revenue from the management of Indian-owned casino gaming facilities is recognized when earned according to the terms of the management contracts. Currently all of the Indian-owned casino projects that Lakes is involved with are in development stages and are not yet open. Therefore, Lakes is not currently recognizing revenue related to Indian casino management. REALIZABILITY OF NOTES RECEIVABLE: The Company's notes receivable from Indian Tribes are generally for the development of gaming properties to be managed by the Company. The repayment terms are specific to each tribe and are largely dependent upon the operating performance of each gaming property. Repayments of the notes receivable are required to be made only if distributable profits are available from the operation of the related casinos. Repayments are also the subject of certain distribution priorities specified in the management contracts. In addition, repayment of the notes receivable and the manager's fees under the management contracts may be subordinated to certain other financial obligations of the respective casinos. Through September 29, 2002, 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. 21 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Interest income on notes receivable from Indian Tribes related to casino development projects is deferred because realizability of the interest is contingent upon the completion and operating cash flow of the casino. Interest deferred during the development period is recognized over the remaining life of the note using the effective interest method. As of September 29, 2002 and December 30, 2001, $9.6 million and $6.1 million of interest on notes related to properties under development has been deferred. The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto and management's discussion and analysis included in the Company's Annual Report on Form 10-K/A for the year ended December 30, 2001. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under a single method, the purchase method. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board ("APB") Opinion No. 17, Intangible Assets. These statements were effective January 1, 2002 and adoption did not have a material impact on the Company's financial position or results of operations. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 supersedes previous guidance for financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset and will be effective on January 1, 2003. In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, which provides new accounting and financial reporting guidance for the impairment or disposal of long-lived assets and the disposal of segments of a business. This statement was effective January 1, 2002 and its adoption did not have a material impact on the Company's financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 eliminates the definition and requirement for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 where a liability for an exit is recognized at the date of an entity's commitment to an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of SFAS No. 143 and 146 will have a material impact on its financial position or results of operations. 22 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) RESULTS OF OPERATIONS Revenues are calculated in accordance with accounting principles generally accepted in the United States of America and are presented in a manner consistent with industry practice. Historically, net distributable profits by the Indian casinos were computed using a modified cash basis of accounting in accordance with the management contracts to calculate management fees. Under this modified cash basis of accounting prescribed by the management contracts, the write-off of capital equipment and leased assets for the casino operations was accelerated, which thereby impacted the timing of net distributable profits. NINE MONTHS ENDED SEPTEMBER 29, 2002 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2001 Revenues Total revenues were $1.5 million for the nine months ended September 29, 2002 compared to $27.5 million for the same period in the prior year. Revenues in both years were derived from fees related to the management of Grand Casino Coushatta. Revenues and earnings for the current year were less than the same period last year primarily due to the expiration of the management contract with the Coushatta Tribe of Louisiana for Grand Casino Coushatta on January 16, 2002. The Company's revenues and earnings will not include contributions from the Coushatta operation going forward. As of September 29, 2002, the Company has no other management contracts from which it will derive revenues in 2002. Costs and Expenses Total costs and expenses were $14.7 million for the nine months ended September 29, 2002, compared to $9.0 million for the same period in the prior year. Selling, general and administrative expenses increased from $8.1 million for the nine months ended September 30, 2001 to $14.4 million for the nine months ended September 29, 2002. This increase is primarily due to an impairment of the $4.0 million note receivable from Living Benefits Financial Services, LLC, as well as the $3.0 million additional impairment charge taken on the Polo Plaza and Travelodge properties during the second quarter of 2002. The impairment charge is described under "Liquidity and Capital Resources" below. This increase is partially offset by a decline in rent expense resulting from the purchase of the corporate office building in January 2002. Fewer costs relating to travel also partially offset the increase in selling, general and administrative expenses during the current year period. Other Interest income was $1.3 million for the nine months ended September 29, 2002 compared to $1.7 million for the nine months ended September 30, 2001. Equity in loss of unconsolidated affiliates was $0.3 million and $0.4 million for the nine months ended September 29, 2002 and September 30, 2001, respectively. Write-down of unconsolidated affiliates was $0.7 million for the nine months ended September 30, 2001. 23 LAKES ENTERTAINMENT, 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 acquired Lakes' interest in NHKQ. As a result, Lakes incurred a one-time write-down of $0.7 million before tax. There were no such write-downs during the current year period. Earnings per Common Share and Net Earnings For the nine months ended September 29, 2002, basic and diluted loss per common share were ($0.84). This compares to basic and diluted earnings per common share of $1.06 and $1.05, respectively, for the nine months ended September 30, 2001. Net losses totaled $8.9 million for the nine months ended September 29, 2002 compared to earnings of $11.2 million for the nine months ended September 30, 2001. The decrease in earnings relates primarily to the expiration of the management contract for Grand Casino Coushatta on January 16, 2002 described above, as well as the ViatiCare note receivable impairment and impairment on Polo Plaza and Travelodge properties described above. THREE MONTHS ENDED SEPTEMBER 29, 2002 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2001 Revenues Total revenues were $8.7 million for the three months ended September 30, 2001, which were derived from fees related to the management of Grand Casino Coushatta. There were no revenues during the current year quarter due to the expiration of the management contract with the Coushatta Tribe of Louisiana for Grand Casino Coushatta on January 16, 2002. The Company's revenues and earnings will not include contributions from the Coushatta operation going forward. As of September 29, 2002, the Company has no other management contracts from which it will derive revenues in 2002. Costs and Expenses Total costs and expenses were $2.8 million for the three months ended September 29, 2002, compared to $2.9 million for the same period in the prior year. Selling, general and administrative expenses increased from $2.5 million for the three months ended September 30, 2001 to $2.7 million for the three months ended September 29, 2002. This increase is primarily due to an increase in costs incurred associated with planned casino developments. Other Interest income was $0.1 million for the three months ended September 29, 2002 compared to $0.2 million for the same period in the prior year. Equity in loss of unconsolidated affiliates was $0.1 million for the three month periods ended September 29, 2002 and September 30, 2001. 24 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Earnings per Common Share and Net Earnings For the three months ended September 29, 2002, basic and diluted loss per common share were ($0.16). This compares to basic and diluted earnings of $0.33 per common share, for the three months ended September 30, 2001. Losses totaled $1.7 million for the three months ended September 29, 2002 compared to earnings of $3.5 million for the three months ended September 30, 2001. The decrease in earnings relates primarily to the expiration of the management contract for Grand Casino Coushatta on January 16, 2002 described above. Outlook Except for fees earned from the management of Grand Casino Coushatta through January 16, 2002, it is currently contemplated that there will be no additional operating revenues for the remainder of 2002. Although none of the existing casino development projects are expected to produce revenue in 2002, Lakes continues to evaluate potential new revenue-generating business opportunities. Lakes continues to closely monitor its operating expenses. Currently, operating expenses are expected to remain consistent for the remainder of 2002, except for the non-recurring effect of the Living Benefits note receivable impairment and impairment on Polo Plaza and Travelodge properties described above. The Company's cash position is considered adequate to cover expected 2002 operating expenses. CAPITAL RESOURCES, CAPITAL SPENDING, AND LIQUIDITY At September 29, 2002, Lakes had $9.8 million and $14.3 million in restricted and unrestricted cash and cash equivalents, respectively. The restricted cash balances are planned to be used to indemnify Grand against 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 as well as for the retirement of a note payable in the amount of $1.0 million. The remaining $0.5 million in restricted cash represents a deposit received related to the sale of the Polo Plaza property in Las Vegas, Nevada and will be transferred to Lakes' unrestricted cash once it is received from the escrow agent. The unrestricted cash balances are planned to be used to fund operating expenses and for loans to current joint venture and tribal partners to develop existing and anticipated Indian casino operations and for the pursuit of additional business opportunities. The amount and timing of Lakes' cash outlays for casino development loans will depend on the timing of the regulatory approval process and the availability of external financing. When approvals are received, additional financing will be needed to complete the projects. It is currently planned that this third-party financing will be obtained by each individual tribe. However, there can be no assurance that if third-party financing is not available, Lakes will not be required to finance these projects directly. If Lakes must provide this financing, Lakes expects to obtain debt or equity financing which it would loan to the respective tribes as necessary. 25 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) As part of a recently announced investment in World Poker Tour, LLC, a joint venture, which is currently consolidated by Lakes, formed to televise poker tournaments, the Company was required to invest $0.1 million for an approximately 78% ownership position in the joint venture. The Company is also required to loan up to $3.2 million to the joint venture as needed. As of September 29, 2002, $1.2 million in advances had been made by Lakes on this loan. For the nine months ended September 29, 2002, net cash used in operating activities totaled $1.4 million. For the nine months ended September 30, 2001, net cash provided by operating activities totaled $14.9 million. A $20.1 million reduction in net earnings was partially offset by changes in accounts receivable, which increased by $3.9 million during the 2001 period and decreased by $3.5 million during the 2002 period. Also contributing to the variance were changes in income taxes payable which increased by $5.2 million during the 2001 period and decreased by $4.7 million during the 2002 period, as well as a $3.0 million impairment of land held under contract for sale and a $4.0 million write-down of related party receivables, both in the 2002 period. For the nine months ended September 29, 2002 and September 30, 2001, net cash used in investing activities totaled $20.9 million and $2.7 million, respectively. Included in these investing activities for the nine months ended September 29, 2002 and September 30, 2001, are proceeds primarily from repayment of notes receivable from Indian-owned casinos, which amounted to $0.1 million and $9.0 million, respectively. Advances under notes receivable were $15.3 million and $24.0 million for the nine months ended September 29, 2002 and September 30, 2001, respectively. There was a net decrease in short-term investments of $2.1 million and $29.9 million for the nine months ended September 29, 2002 and September 30, 2001, respectively. Also during these periods, payments for land held for development amounted to $3.7 million and $13.0 million, respectively. Included in the payments for land held for development of $13.0 million during the nine months ended September 30, 2001 was the purchase of the Shark Club property in Las Vegas, Nevada for approximately $10.1 million. The remaining decrease in payments made for land held for development from the prior period to the current year period is the result of the transfer of title and ownership obligations related to the Polo Plaza Shopping Center to Metroflag Polo, LLC, and transfer of rights and obligations related to the Travelodge site to Metroflag BP, LLC, on December 28, 2001. 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 Casinos, Inc. 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. 26 LAKES ENTERTAINMENT, 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. Any surplus proceeds remaining in this trust after all the secured obligations are indefeasibly paid in full and discharged shall be paid over to Lakes. 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. As the $18.0 million was paid out during 2001, the remaining deposit of $7.5 million is included as restricted cash in the accompanying condensed consolidated balance sheets as of September 29, 2002 and December 30, 2001. 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. On December 28, 2001, the Company transferred title and ownership obligations of the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and obligations of the adjacent Travelodge property consisting of a long-term land lease and a motel operation. This transaction was accounted for under the deposit method of accounting under the requirements of Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate rather than as a sale. Therefore, the property is included as land held under contract for sale in the accompanying condensed consolidated balance sheets as of September 29, 2002 and December 30, 2001. The transaction price for this combined transaction was approximately $30.9 million. Terms of the transaction include a $1.0 million down payment, a contractual commitment to pay Lakes $23.3 million by December 29, 2002, and a second contractual commitment to pay Lakes $7.5 million on June 30, 2004. Lakes' collateral for the two contractual commitments is the property and lease rights described above which would revert back to Lakes in the event of default by Metroflag. The transaction was closed subject to certain administrative post-closing conditions that must be satisfied within six months after the closing. This post-closing period was extended through September 27, 2002. These conditions were satisfied as of September 27, 2002. Lakes and Metroflag have restructured the terms of the Polo Plaza and Travelodge property transactions due to deteriorating economic conditions. The parties have reduced the purchase price of the Polo Plaza property from $23.3 million to $21.3 million. On the payment date, which is scheduled to be no later than January 31, 2003, $17.3 million of the purchase price is payable to Lakes in cash and $4.0 million is payable through the issuance to Lakes of a preferred membership interest in Metroflag. On or before December 24, 2003, Metroflag Polo may elect to distribute to Lakes $3.0 million in cash as full return of Lakes' preferred interest. 27 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) If Lakes' preferred interest remains outstanding at any time on or after December 24, 2006, Lakes can require Metroflag to repurchase the preferred interest for $4.0 million plus a priority return of eight percent (8%) per annum. Effective June 30, 2002, Lakes recorded a $3.0 million impairment charge for these properties relating to the adjustment in the purchase price and the potential discount on the return of Lakes' preferred interest. Lakes continues to own the Shark Club property, which is an approximate 3.5 acre undeveloped site adjacent to the Polo Plaza shopping center and Travelodge sites. During August 2002, Lakes formed a joint venture with Diamond Resorts, LLC, a Nevada limited liability company and experienced time-share developer for the purpose of developing the Shark Club parcel as an upscale time-share project. The terms of this joint venture agreement require that Diamond and Lakes each make an initial working capital contribution of $250,000. Subject to Diamond obtaining a financing commitment for a construction loan sufficient to fund at least the first phase of the building improvements contemplated by the time-share project, the joint venture agreement will require Lakes to contribute the relevant portion of the Shark Club parcel, valued at $16 million. Diamond has agreed to perform sales, marketing, administrative and managerial services for the project. The terms of the agreement provide for the repayment to Lakes of its contribution of property in cash based on the joint venture's cash flow and time-share unit sales. It is contemplated that Lakes will be required to make no other material contributions of cash or property to the project. On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest will accrue at a rate of 10.0% per annum. The loan is due and payable from first available cash flow of the joint venture (excluding any required capital contribution from a member) and no later than October 1, 2004. Lakes has approximately $68.0 million in notes receivable from Indian tribes and other parties. Most of these amounts are advances made to the tribes for the development of gaming properties managed by Lakes. See Note 4 to the condensed consolidated financial statements included in Item 1. Notes receivable from the Coushatta Tribe of Louisiana were $0.1 million at December 30, 2001. The outstanding balance was repaid at the conclusion of the management agreement on January 16, 2002. In addition, Lakes was previously the guarantor of a loan agreement entered into by the Coushatta Tribe in the amount of $25.0 million, with a balance of $6.8 million outstanding at December 30, 2001. Lakes was released from the guaranty agreement on January 16, 2002. On January 2, 2002, the Company completed the purchase of its corporate office building in Minnetonka, Minnesota for $6.4 million, including transaction expenses. This transaction resulted in the extinguishment of the Company's capital lease obligation related to the building. 28 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) OBLIGATIONS The Company currently has one note payable with a third party. This note is collateralized by certificates of deposit, with $1.0 million outstanding at September 29, 2002 and December 30, 2001. Interest is compounded and paid on a quarterly basis at 10%. The principal and any unpaid interest are due December 22, 2002. A second note which was collateralized by property with $0.4 million outstanding at June 20, 2002 and December 30, 2001, was repaid on June 20, 2002. Pursuant to the terms of the Distribution Agreement, Grand assigned to Lakes, and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes' current corporate office space of approximately 65,000 square feet with a lease term of fifteen years. The lease commenced on October 14, 1996. During 2001, also pursuant to the terms of the Distribution Agreement, Lakes entered into a capital lease arrangement for the corporate office space at which time the operating lease was cancelled. Accordingly, Lakes recorded a capital leased asset and liability in the amount of approximately $5.8 million. These amounts are included in the accompanying condensed consolidated balance sheet as of December 30, 2001. On January 2, 2002, as per the agreement with Grand Casinos, Lakes purchased the building as discussed above. SEASONALITY The Company believes that the operations of all casinos to be managed by the Company will be affected by seasonal factors, including holidays, weather and travel conditions. REGULATION AND TAXES The Company is subject to extensive regulation by state gaming authorities. The Company will also be subject to regulation, which may or may not be similar to current state regulations, by the appropriate authorities in any 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. 29 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) Such forward-looking information involves important risks and uncertainties that could significantly affect the anticipated results in the future and, accordingly, actual results may differ materially from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to possible delays in completion of Lakes' casino projects, including various regulatory approvals and numerous other conditions which must be satisfied before completion of these projects; possible termination or adverse modification of management contracts; continued indemnification obligations to Grand; highly competitive industry; possible changes in regulations; reliance on continued positive relationships with Indian tribes; possible impairment of notes receivable of Indian tribes held by Lakes, which represent a large portion of Lakes' assets; possible need for future financing to meet Lakes' expansion goals; risks of entry into new businesses; and reliance on Lakes' management. For further information regarding the risks and uncertainties, see the "Business -- Risk Factors" section of the Company's Annual Report on Form 10-K/A for the fiscal year ended December 30, 2001. 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 September 29, 2002, 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. The floating rate receivables will generate more or less interest income if interest rates rise or fall. As of September 29, 2002, Lakes had $68.0 million of floating rate notes receivable. Based on the applicable current reference rates and assuming all other factors remain constant, deferred interest income for a twelve month period would be $4.2 million. A reference rate increase of 100 basis points would result in an increase in deferred interest income of $0.7 million. A 100 basis point decrease in the reference rate would result in a decrease of $0.7 million in deferred interest income over the same twelve month period. 30 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) (UNAUDITED) ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), within 90 days of the filing date of this report. Based on their evaluation, our chief executive officer and chief financial officer concluded that Lakes Entertainment, Inc.'s disclosure controls and procedures are effective. There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced above. 31 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The following summaries describe certain known legal proceedings to which Grand is a party which Lakes has assumed, or with respect to which Lakes may have agreed to indemnify Grand, in connection with the Distribution. 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. 32 LAKES ENTERTAINMENT, 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 August 2000, 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. On April 4, 2001, the Court entered judgment in favor of Grand and issued its findings of fact and conclusions of law. The plaintiff filed an appeal with the Ninth Circuit Court of Appeals on May 4, 2001, Case No. 01-15947. On August 13, 2002, the Ninth Circuit affirmed the prior ruling in favor of Grand. 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. 33 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) 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 denying that Stratosphere is entitled to recover the amounts described in the complaint. Discovery was completed on December 31, 2001 and the case proceeded to trial before the United States Bankruptcy Court for the District of Nevada on June 20, 2002. A decision has not yet been issued. OTHER LITIGATION The Company has recorded a reserve assessment related to various of the above items based on management's best estimate. The reserve is reflected as a litigation and claims accrual on the accompanying condensed consolidated balance sheet as of September 29, 2002 and December 30, 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. 34 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Amendment to Purchase Agreement, dated September 27, 2002, and effective July 1, 2002, by and among Grand Casinos Nevada I, Inc., a Minnesota corporation, and Metroflag Polo, LLC, a Nevada limited liability company. 10.2 Amended and Restated Note Secured by Deed of Trust, dated December 28, 2001, and amended and restated as of July 1, 2002, by and among Metroflag Polo, LLC, a Nevada limited liability company, and Grand Casinos Nevada I, Inc., a Minnesota corporation. 10.3 Amendment to Purchase Agreement, dated September 27, 2002, and effective July 1, 2002, by and among Grand Casinos Nevada I, Inc., a Minnesota corporation, and Metroflag BP, LLC, a Nevada limited liability company. 10.4 Amended and Restated Note Secured by Deed of Trust, dated December 28, 2001, and amended and restated as of July 1, 2002, by and among Metroflag BP, LLC, a Nevada limited liability company, and Grand Casinos Nevada I, Inc., a Minnesota corporation. 10.5 Operating Agreement of The Chateaux, LLC dated as of September 26, 2002 by and between Grand Casinos Nevada I, Inc. and Diamond Resorts, LLC. 10.6 Loan Agreement dated as of September 25, 2002 by and between Grand Casinos Nevada I, Inc. and The Chateaux, LLC. 10.7 Promissory Note of The Chateaux, LLC dated as of September 25, 2002. 99.1 Certification of Chief Executive Officer 99.2 Certification of Chief Financial Officer (b) Reports on Form 8-K (i) A Form 8-K, Item 5. Other Events, was filed on August 7, 2002. (ii) A Form 8-K, Item 5. Other Events, was filed on August 23, 2002. (iii) A Form 8-K, Item 5. Other Events, was filed on September 10, 2002. 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: November 13, 2002 LAKES ENTERTAINMENT, INC. ------------------------- Registrant /s/ Lyle Berman --------------------------------------- Lyle Berman Chairman of the Board, Chief Executive Officer and President CERTIFICATIONS I, Lyle Berman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Lakes Entertainment, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Lakes Entertainment, Inc., and have: a. designed such disclosure controls and procedures to ensure that material information relating to Lakes Entertainment, Inc., including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of Lakes Entertainment, Inc.'s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and 36 c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. I have disclosed, based on our most recent evaluation, to Lakes Entertainment, Inc.'s auditors and the audit committee of Lakes Entertainment, Inc.'s board of directors: a. all significant deficiencies in the design or operation of internal controls which could adversely affect Lakes Entertainment, Inc.'s ability to record, process, summarize and report financial date and have identified for Lakes Entertainment, Inc.'s auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in Lakes Entertainment, Inc.'s internal controls; and 6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ Lyle Berman -------------------- --------------------------- Lyle Berman Chief Executive Officer CERTIFICATIONS I, Timothy J. Cope, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Lakes Entertainment, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Lakes Entertainment, Inc., and have: a. designed such disclosure controls and procedures to ensure that material information relating to Lakes Entertainment, Inc., including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; 37 b. evaluated the effectiveness of Lakes Entertainment, Inc.'s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. I have disclosed, based on our most recent evaluation, to Lakes Entertainment, Inc.'s auditors and the audit committee of Lakes Entertainment, Inc.'s board of directors: a. all significant deficiencies in the design or operation of internal controls which could adversely affect Lakes Entertainment, Inc.'s ability to record, process, summarize and report financial date and have identified for Lakes Entertainment, Inc.'s auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in Lakes Entertainment, Inc.'s internal controls; and 6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ Timothy J. Cope -------------------- ----------------------------------- Timothy J. Cope Chief Financial Officer 38