-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KF5XVnR8nzHX8cNEnIx8uJnb/OoU+0Bb5FpO84HiuttAkcjk15m+YbJguJyjZiBF 0OyYl8k9isIpQRiVGb5qtQ== 0000950134-03-011483.txt : 20030813 0000950134-03-011483.hdr.sgml : 20030813 20030812181804 ACCESSION NUMBER: 0000950134-03-011483 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030629 FILED AS OF DATE: 20030813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LAKES ENTERTAINMENT INC CENTRAL INDEX KEY: 0001071255 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISCELLANEOUS AMUSEMENT & RECREATION [7990] IRS NUMBER: 411913991 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24993 FILM NUMBER: 03838681 BUSINESS ADDRESS: STREET 1: 130 CHESHIERE LANE CITY: MINNETONKA STATE: MN ZIP: 55305 BUSINESS PHONE: 6124499092 MAIL ADDRESS: STREET 1: 130 CHESHIRE LANE CITY: MINNETONKA STATE: MN ZIP: 55305 FORMER COMPANY: FORMER CONFORMED NAME: LAKES GAMING INC DATE OF NAME CHANGE: 19980929 10-Q 1 c78855e10vq.txt FORM 10-Q 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 June 29, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to _______________________ Commission File No. 0-24993 LAKES ENTERTAINMENT, INC. ------------------------- (Exact name of registrant as specified in its charter) Minnesota 41-1913991 --------- ---------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 130 Cheshire Lane Minnetonka, Minnesota 55305 --------------------- ----- (Address of principal executive offices) (Zip Code) (952) 449-9092 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of August 7, 2003, there were 10,638,320 shares of Common Stock, $0.01 par value per share, outstanding. LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES INDEX
PAGE OF FORM 10-Q --------- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of June 29, 2003 and December 29, 2002 3 Condensed Consolidated Statements of Earnings (Loss) for the three months ended June 29, 2003 and June 30, 2002 4 Condensed Consolidated Statements of Comprehensive Earnings (Loss) for the three months ended June 29, 2003 and June 30, 2002 5 Condensed Consolidated Statement of Loss for the six months ended June 29, 2003 and June 30, 2002 6 Condensed Consolidated Statements of Comprehensive Loss for the six months ended June 29, 2003 and June 30, 2002 7 Condensed Consolidated Statements of Cash Flows for the six months ended June 29, 2003 and June 30, 2002 8 Notes to Condensed Consolidated Financial Statements 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 19 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 31 ITEM 4. CONTROLS AND PROCEDURES 31 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 32 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 33 ITEM 5. OTHER INFORMATION 34 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 34
2 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED)
JUNE 29, 2003 DECEMBER 29, 2002 - ----------------------------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash and cash equivalents $ 23,354 $ 14,106 Accounts receivable, net 948 116 Deferred tax asset 4,481 6,771 Other current assets 741 547 - ----------------------------------------------------------------------------------------------------------------- Total Current Assets 29,524 21,540 - ----------------------------------------------------------------------------------------------------------------- Property and Equipment-Net 6,697 6,962 - ----------------------------------------------------------------------------------------------------------------- Other Assets: Land held under contract for sale 4,772 28,832 Land held for development 29,382 27,791 Notes receivable-less current installments 75,595 70,955 Cash and cash equivalents-restricted - 8,300 Investments in and notes from unconsolidated affiliates 8,423 1,013 Deferred tax asset 4,707 3,835 Other long-term assets 8,823 6,657 - ----------------------------------------------------------------------------------------------------------------- Total Other Assets 131,702 147,383 - ----------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $167,923 $175,885 ================================================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable $ 96 $ 226 Income taxes payable 4,312 5,564 Litigation and claims accrual 180 5,847 Accrued payroll and related 418 252 Other accrued expenses 2,944 3,486 - ----------------------------------------------------------------------------------------------------------------- Total Current Liabilities 7,950 15,375 - ----------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 7,950 15,375 - ----------------------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES Shareholders' Equity: Capital stock, $.01 par value; authorized 100,000 shares; 10,638 common shares issued and outstanding at June 29, 2003, and December 29, 2002 106 106 Additional paid-in-capital 131,526 131,525 Retained Earnings 28,341 28,879 - ----------------------------------------------------------------------------------------------------------------- Total Shareholders' Equity 159,973 160,510 - ----------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $167,923 $175,885 =================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 3 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (LOSS) (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED) THREE MONTHS ENDED ------------------ JUNE 29, 2003 JUNE 30, 2002 ------------- ------------- REVENUES: License fee income $ 2,954 $ - - ----------------------------------------------------------------------------------------------- Total Revenues 2,954 - - ----------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Selling, general and administrative 4,950 9,572 Reversal of litigation and claims accrual (3,212) - Depreciation and amortization 131 120 - ----------------------------------------------------------------------------------------------- Total Costs and Expenses 1,869 9,692 - ----------------------------------------------------------------------------------------------- EARNINGS (LOSS) FROM OPERATIONS 1,085 (9,692) - ----------------------------------------------------------------------------------------------- OTHER INCOME (EXPENSE): Interest income 314 436 Interest expense - (24) Equity in loss of unconsolidated affiliates (60) (108) Other (1) - - ----------------------------------------------------------------------------------------------- Total other income, net 253 304 - ----------------------------------------------------------------------------------------------- Earnings (Loss) before income taxes 1,338 (9,388) Provision (Benefit) for income taxes 549 (2,208) - ----------------------------------------------------------------------------------------------- NET EARNINGS (LOSS) $ 789 ($ 7,180) =============================================================================================== BASIC EARNINGS (LOSS) PER SHARE $ 0.07 ($ 0.67) =============================================================================================== DILUTED EARNINGS (LOSS) PER SHARE $ 0.07 ($ 0.67) =============================================================================================== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - - - ----------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,638 10,638 ===============================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 4 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (LOSS) (IN THOUSANDS)
(UNAUDITED) THREE MONTHS ENDED ----------------------------------- JUNE 29, 2003 JUNE 30, 2002 ----------------------------------- NET EARNINGS (LOSS) $ 789 ($7,180) OTHERCOMPREHENSIVE EARNINGS (LOSS), NET OF TAX: Unrealized losses on securities: Unrealized holding losses during the period - (2) Reclassification adjustment for losses included in net earnings (loss) - 47 ----------------------------------- COMPREHENSIVE EARNINGS (LOSS) $ 789 ($7,135) ===================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 5 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF LOSS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED) SIX MONTHS ENDED ---------------- JUNE 29, 2003 JUNE 30, 2002 ------------- ------------- REVENUES: Management fee income $ - $ 1,502 License fee income 3,504 - - ----------------------------------------------------------------------------------------------- Total Revenues 3,504 1,502 - ----------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Selling, general and administrative 7,929 11,671 Reversal of litigation and claims accrual (3,212) - Depreciation and amortization 259 219 - ----------------------------------------------------------------------------------------------- Total Costs and Expenses 4,976 11,890 - ----------------------------------------------------------------------------------------------- LOSS FROM OPERATIONS (1,472) (10,388) - ----------------------------------------------------------------------------------------------- OTHER INCOME (EXPENSE): Interest income 551 1,172 Interest expense - (47) Equity in loss of unconsolidated affiliates (147) (231) Other 158 - - ----------------------------------------------------------------------------------------------- Total other income, net 562 894 - ----------------------------------------------------------------------------------------------- Loss before income taxes (910) (9,494) Benefit for income taxes (372) (2,251) - ----------------------------------------------------------------------------------------------- NET LOSS ($ 538) ($ 7,243) =============================================================================================== BASIC LOSS PER SHARE ($ 0.05) ($ 0.68) =============================================================================================== DILUTED LOSS PER SHARE ($ 0.05) ($ 0.68) =============================================================================================== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 10,638 10,638 DILUTIVE EFFECT OF STOCK COMPENSATION PROGRAMS - - - ----------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON AND DILUTED SHARES OUTSTANDING 10,638 10,638 ===============================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 6 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (IN THOUSANDS)
(UNAUDITED) SIX MONTHS ENDED ------------------------------------ JUNE 29, 2003 JUNE 30, 2002 ------------------------------------ NET LOSS ($ 538) ($7,243) OTHER COMPREHENSIVE LOSS, NET OF TAX: Unrealized losses on securities: Unrealized holding losses during the period - (10) Reclassification adjustment for losses included in net loss - 47 ------------------------------------ COMPREHENSIVE LOSS ($ 538) ($7,206) ====================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 7 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
(UNAUDITED) SIX MONTHS ENDED ---------------- JUNE 29, 2003 JUNE 30, 2002 ------------- ------------- OPERATING ACTIVITIES: Net loss ($ 538) ($ 7,243) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 259 218 Equity in loss of unconsolidated affiliates 147 231 Impairment of land held under contract for sale - 3,000 Write down of related party receivables - 4,000 Changes in operating assets and liabilities: Accounts receivable (832) 3,601 Income taxes 167 (3,547) Accounts payable (130) (105) Accrued expenses (2,922) 915 Other (194) (1,565) - ----------------------------------------------------------------------------------------------------------- Net Cash Used in Operating Activities (4,043) (495) - ----------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Short-term investments, sales/maturities - 1,101 Payments for land held under contract for sale (433) (666) Payments received on land held under contract for sale 16,765 - Payments for land held for development (1,591) (4,910) Advances on notes receivable (6,642) (9,947) Proceeds from repayment of notes receivable - 67 Investment in and notes receivable from unconsolidated affiliates (495) (139) Decrease (increase) in restricted cash, net 5,906 (55) Increase in other long-term assets (225) (333) Reduction of (payments for) property and equipment, net 6 (716) - ----------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities 13,291 (15,598) - ----------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Payments on capital lease obligations - (5,714) Payments on long-term debt - (350) - ----------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities - (6,064) - ----------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 9,248 (22,157) Cash and cash equivalents - beginning of period 14,106 42,638 - ----------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 23,354 $ 20,481 =========================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ - $ 49 Income taxes 4 5
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 8 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BUSINESS Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company") was established as a public corporation on December 31, 1998, via a distribution (the "Distribution") of its common stock, par value $.01 per share (the "Common Stock") to the shareholders of Grand Casinos, Inc. ("Grand"). Lakes currently has development and management agreements with four separate tribes for four new casino operations, one in Michigan, two in California and one with the Nipmuc Nation on the east coast. The Company also has agreements for the development of one additional casino on Indian owned land in California through a joint venture which is currently being disputed by the tribe. Each of these projects is currently in the development phase. The Company has also formed a joint venture with a producer to launch the World Poker Tour ("WPT") and establish poker as the next significant televised mainstream sport. During March of 2003, the WPT signed an agreement with the Travel Channel, LLC (TRV), granting TRV the right to broadcast the first season of the WPT series which has now been completed. During July of 2003, WPT reached an agreement with TRV for a second season with options for five additional seasons. WPT receives a series of fixed license payments from TRV, subject in each case to satisfaction of production milestones and other conditions. Revenue is recognized ratably as production milestones and other conditions are met. LAND HELD UNDER CONTRACT FOR SALE On December 28, 2001, the Company transferred title and ownership obligations of the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and obligations of the adjacent Travelodge property consisting of a long-term land lease and a motel operation. This transaction was accounted for under the deposit method of accounting under the requirements of Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate, rather than as a sale. Therefore, the property was included as land held under contract for sale on the accompanying condensed consolidated balance sheet as of December 29, 2002. The total price for this combined transaction was approximately $30.9 million. Terms of the transaction included a $1.0 million down payment, which was received in January 2002, a contractual commitment to pay Lakes $23.3 million by December 29, 2002, and a second contractual agreement to pay Lakes $7.5 million on June 30, 2004. A $0.5 million payment on the notes receivable was received during 2002. During 2002, Lakes and Metroflag restructured the terms of the Polo Plaza and Travelodge property transactions due to deteriorating economic conditions. The parties reduced the purchase price for the Polo Plaza property from $23.8 million to $21.8 million. On the revised payment date, which was scheduled to be no later than January 31, 2003, $16.8 million of the purchase price was to be payable to Lakes in cash and $4.0 million was to be payable through the issuance to Lakes of a preferred membership interest in Metroflag. Effective June 30, 2002, Lakes recorded a $3.0 million impairment charge for these properties relating to the adjustment in the purchase price and the potential discount on the return of Lakes' preferred interest. 9 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) This real estate was reported at its adjusted carrying value in Land Held Under Contract for Sale as of December 29, 2002. Lakes' collateral is the property and lease rights described above which would revert back to Lakes in the event of default by Metroflag. During March of 2003, Lakes and Metroflag agreed to additional revisions to the terms of the Polo Plaza and Travelodge property transactions. The parties have increased the price of the Polo Plaza property from $21.8 million to $25.8 million and extended the payment date to May 15, 2003. On the payment date, $16.8 million of the purchase price was paid to Lakes in cash, $4.0 million was paid through the issuance to Lakes of a preferred membership interest in Metroflag and $4.0 million was paid through the issuance to Lakes of a subordinated membership interest in Metroflag. On or before April 30, 2004, Metroflag Polo may elect to distribute to Lakes $3.0 million plus interest in cash as full return of Lakes' preferred interest. If paid after April 30, 2004, and in no event later than December 24, 2006, the entire $4.0 million plus interest will be payable. The subordinated interest must be repurchased for $4.0 million at the time of repayment of an outstanding $3.5 million contractual commitment in connection with the Travelodge property, which is scheduled on or before December 28, 2004. In March of 2003, the parties decreased the sale price of the Travelodge property from $7.5 million to $3.5 million. At that time, the contractual commitment to pay Lakes was also decreased from $7.5 million to $3.5 million. If the Travelodge commitment is not repaid by December 28, 2004, ownership of the Travelodge lease rights would revert back to Lakes. If at any time the Polo Plaza property is sold and the Travelodge commitment has not been repaid, Metroflag is required to repurchase the subordinated interest for the lesser of $4.0 million or any portion of the net cash proceeds from such sale or refinancing that exceeds $60.0 million. LAND HELD FOR DEVELOPMENT On April 7, 2003, Lakes announced that it has signed a Letter of Intent to sell the approximate 3.5 acre undeveloped site, known as the Shark Club Parcel, for a purchase price of $15.0 million in cash. The transaction closed on July 1, 2003. In addition to the $15.0 million payment, Lakes received $1.0 million as repayment of a loan previously made by Lakes to Chateaux, LLC, a joint venture entity originally formed by Lakes and a time-share developer for the purpose of developing the Shark Club Parcel as an upscale time-share project. Also included in land held for development is land held for possible transfer to Indian tribes for use in future casino resort projects in the amount of $14.4 million and $12.8 million as of June 29, 2003 and December 29, 2002, respectively. RECENT ACCOUNTING PRONOUNCEMENTS The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" in November 2002. This interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. 10 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The initial recognition and initial measurement provisions of this interpretation are applicable to all guarantees and modification to guarantees made after December 31, 2002. The Company's disclosure of the indemnification and guarantee agreements of the Company is in compliance with the interpretation. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ended after December 15, 2002. The adoption of the interpretation did not have a material impact on the Company's results of operations, financial position and cash flows. The Company does have an indemnification agreement with Grand Casinos which is fully described in Note 8 Commitments and Contingencies. In January 2003, the FASB issued Interpretation No. 46 (FIN46), "Consolidation of Variable Interest Entities", which addresses the consolidation of variable interest entities. The interpretation applicable immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which a Company obtains an interest after that date. For variable interests in variable interest entities acquired before February 1, 2003, the interpretation applicable applies in the first interim period beginning after June 15, 2003. The Company has determined that it has no investments or other interests in entities that may be deemed variable interest entities under the provisions of FIN 46, as the development projects subject to the management agreements with the Indian Tribes are not separate entities or legal structures. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123". SFAS No. 148 provides alternative transition methods for companies that make a voluntary change to the fair-value-based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the disclosure provisions of SFAS No. 148 and its adoption had no impact on the Company's consolidated financial position or results of operations. 2. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements include the accounts of Lakes and its wholly-owned and majority-owned subsidiaries. Investments in unconsolidated affiliates representing 50% or less of voting interests are accounted for on the equity method. All significant intercompany balances and transactions have been eliminated in consolidation. Lakes' investments in unconsolidated affiliates include a 50 percent ownership interest in PCG Santa Rosa, LLC, a joint venture formed to develop a casino on Indian-owned land in California and a 49 percent voting interest in the Chateaux, LLC, a joint venture formed to develop the Shark Club Parcel in Las Vegas, Nevada, into an upscale timeshare project. See Note 8 for current status of the Shark Club Parcel. 11 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information, in accordance with the rules and regulations of the Securities and Exchange Commission. Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the condensed consolidated financial statements have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the six months ended June 29, 2003 are not necessarily indicative of the results that may be expected for the year ending December 28, 2003. The condensed consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 29, 2002. 3. STOCK-BASED COMPENSATION At June 29, 2003, the Company has two stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Option No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
SIX MONTHS ENDED THREE MONTHS ENDED ---------------- ------------------ JUNE 29, 2003 JUNE 30, 2002 JUNE 29, 2003 JUNE 30, 2002 ------------- ------------- ------------- ------------- Net earnings (loss): $ (538) $ (7,243) $ 789 $ (7,180) As reported Less: Total stock-based compensation expense determined under the fair value method, net of related tax effects (767) (849) (383) (426) Pro forma (1,305) (8,092) 406 (7,606) Net earnings (loss) per share: As reported -- Basic $ (0.05) $ (0.68) $ 0.07 $ (0.67) Pro forma -- Basic (0.12) (0.76) 0.04 (0.71) As reported -- Diluted (0.05) (0.68) 0.07 (0.67) Pro forma -- Diluted (0.12) (0.76) 0.04 (0.71)
12 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 4. MANAGEMENT CONTRACTS FOR INDIAN-OWNED CASINOS The ownership, management and operation of gaming facilities are subject to extensive federal, state, provincial, tribal and/or local laws, regulation, and ordinances, which are administered by the relevant regulatory agency or agencies in each jurisdiction. These laws, regulations and ordinances vary from jurisdiction to jurisdiction, but generally concern the responsibility, financial stability and character of the owners and managers of gaming operations as well as persons financially interested or involved in gaming operations. The Company is prohibited by the Indian Gaming Regulatory Act ("IGRA") from having an ownership interest in any casino it manages for Indian tribes. The management contracts govern the relationship between the Company and the tribes with respect to the construction and management of the casinos. The construction or remodeling portion of the agreements commenced with the signing of the respective contracts and continued until the casinos opened for business; thereafter, the management portion of the respective management contracts continues for a period up to seven years. Under the terms of the contracts, the Company, as manager of the casino, receives a percentage of the distributable profits (as defined in the contract) of the operations as a management fee after payment of certain priority distributions, a cash contingency reserve, and guaranteed minimum payments to the tribes. Lakes has a contract to be the exclusive developer and manager of an Indian-owned gaming resort near New Buffalo, Michigan with the Pokagon Band of Potawatomi Indians. The Company has formed partnerships that hold contracts to develop and manage two casinos to be owned by Indian tribes in California, one near San Diego with the Jamul Indian Village, and the other near Sacramento with the Shingle Springs Band of Miwok Indians. Lakes and another company have formed a partnership with a contract to finance the construction of an Indian-owned casino 60 miles north of San Francisco, California for the Cloverdale Rancheria of Pomo Indians. The Rancheria is currently disputing the agreement with the partnership and has notified the partnership that it wishes to terminate the contract. The Company has also signed contracts with the Nipmuc Nation of Massachusetts for development and management of a potential future gaming resort in the eastern United States; however, this tribe has received a negative finding regarding federal recognition from the Bureau of Indian Affairs (BIA). The tribe has submitted additional information for reconsideration. 5. NOTES RECEIVABLE The notes receivable from Indian Tribes are generally for the development of gaming properties to be managed by the Company. The repayment terms are specific to each tribe and are largely dependent upon the operating performance of each gaming property. Repayments of the aforementioned notes receivable are required to be made only if distributable profits are available from the operation of the related casinos. Repayments are also the subject of certain distribution priorities specified in the management contracts. In addition, repayment of the notes receivable and the manager's fees under the management contracts are subordinated to certain other financial obligations of the respective tribes. Through June 29, 2003, no amounts have been withheld under these provisions. 13 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Notes receivable consist of the following (in thousands):
June 29, 2003 December 29, 2002 ------------- ----------------- Properties under development: Notes from the Pokagon Band of Potawatomi Indians with variable interest rates (not to exceed 10%) (5.00% at June 29, 2003), receivable in 60 monthly installments subsequent to commencement date $ 40,624 $ 39,470 Notes from the Shingle Springs Band of Miwok Indians with variable interest rates (6.00% at June 29, 2003), receivable in varying monthly installments based on contract terms subsequent to commencement date 17,539 14,035 Notes from Jamul Indian Village with variable interest rates (6.00% at June 29, 2003), receivable in 12 monthly installments subsequent to commencement date 10,795 9,492 Notes from the Nipmuc Nation with variable interest rates (6.00% at June 29, 2003) receivable in varying installments based on contract terms subsequent to commencement date 4,150 3,814 Other 2,487 4,144 --------- -------- Total notes receivable 75,595 70,955 ======== ========
Interest income on notes receivable from Indian Tribes related to casino development projects is deferred because realizability of the interest is contingent upon the completion and positive cash flow from operation of the casino. Interest deferred during the development period is recognized over the remaining life of the note using the effective interest method. As of June 29, 2003 and December 29, 2002, $12.2 million and $10.1 million of interest on notes related to properties under development has been deferred. Management periodically evaluates the recoverability of such notes receivable based on the current and projected operating results of the underlying facility and historical collection experience. No impairment losses on such notes receivable have been recognized through June 29, 2003. The terms of these notes require the casinos to be constructed and to generate positive cash flows prior to the Company receiving repayment. As such, an estimate of the fair value of these notes requires an assessment of the timing of the construction of the related casinos and the profitability of the related casinos. Due to the significant uncertainty involved in such an assessment, the Company does not believe that it is practicable to accurately estimate the fair value of these notes with the degree of precision necessary to make such information meaningful. 14 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 6. COMMITMENTS AND CONTINGENCIES: LEASES The Company leases certain property and equipment, including an airplane, under a non-cancelable operating lease. The airplane lease expired May 1, 2003 and was renewed for a one-year period. The lease provides for one additional one-year renewal term. Approximate future minimum lease payments, due under this lease as of June 29, 2003, assuming the second one-year renewal is exercised, are as follows (in thousands):
Operating Leases ---------------- 2003 $ 300 2004 600 2005 200 -------- $ 1,100 ========
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. 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 an aggregate of $30 million, in trust for the benefit of Grand, as a wholly owned subsidiary of Park Place, to cover various commitments and contingencies related to or arising out of Grand's non-Mississippi business and assets (including by way of example, but not limitation, tribal loan guarantees, real property lease guarantees for Lakes' subsidiaries and director and executive officer indemnity obligations). The deposits were to be made in four annual installments of $7.5 million, over the four-year period subsequent to December 31, 1998. Any proceeds remaining in this trust after all the secured obligations were indefeasibly paid in full and discharged were to be returned to Lakes. 15 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Lakes made the first deposit of $7.5 million on December 31, 1999 and deposited an additional $18 million in an escrow account in July 2000. The $18 million deposit represented partial satisfaction of Lakes indemnification obligation pursuant to a settlement agreement related to certain litigation claims brought against Grand by its shareholders. Upon receipt of a court order on August 14, 2001 giving final approval to the settlement, the $18 million in restricted cash was removed from the Company's condensed consolidated balance sheet. In January 2001, Lakes purchased the Shark Club property in Las Vegas for $10.1 million in settlement of another Grand obligation that was subject to the indemnification by Lakes. As of December 29, 2002, $7.5 million related to security to support Lakes' indemnification obligations to Grand was included as restricted cash in the accompanying condensed consolidated balance sheets. In May 2003, $2.3 million was paid out of the trust to Stratosphere Corporation to satisfy Lakes' indemnification obligations to Grand resulting from Grand's settlement of a litigation claim seeking recovery of certain amounts paid by Stratosphere to Grand and a subsidiary of Grand that were alleged to be preferential payments under the bankruptcy laws. As this litigation claim was the last remaining known material Grand obligation that was subject to indemnification by Lakes, the trust account was terminated on May 8, 2003 and the remaining restricted funds of approximately $5.9 million, including interest, were released to Lakes and reclassified as unrestricted cash on Lakes' condensed consolidated balance sheet as of June 29, 2003. Notwithstanding termination of the trust account, Lakes' indemnification obligations to Grand remain in effect. Subsequent indemnification obligations to Grand Casinos, if any, would be paid directly by Lakes. As part of the indemnification agreement, Lakes has agreed that it will not declare or pay any dividends, make any distribution on account of Lakes' equity interests, or otherwise purchase, redeem, defease or retire for value any equity interests in Lakes without the written consent of Park Place. 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. STRATOSPHERE PREFERENCE ACTION In April 1998, Stratosphere served on Grand and Grand Media & Electronics Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a complaint in the Stratosphere bankruptcy case seeking recovery of certain amounts paid by Stratosphere to (i) Grand Media for electronic equipment purchased by Stratosphere from Grand Media, and (ii) Grand as management fees and for costs and expenses under a management agreement between Stratosphere and Grand. 16 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Stratosphere claimed in its complaint that such amounts are recoverable by Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand responded to Stratosphere's complaint denying that Stratosphere is entitled to recover the amounts described in the complaint. Discovery was completed on December 31, 2001 and the case proceeded to trial before the United States Bankruptcy Court for the District of Nevada on June 20, 2002. On December 31, 2002, the Bankruptcy Court issued its final judgment holding that: (i) payments to Grand Media for electronic equipment totaling approximately $3.3 million are not recoverable by Stratosphere as avoidable preferences, and (ii) payment to Grand for management services in the approximate amount of $2.3 million is recoverable by Stratosphere and an avoidable preference. On May 8, 2003, this judgment was satisfied out of amounts held in trust as security to support Lakes' indemnification obligations to Grand. The Company had recorded a reserve assessment related to this litigation which exceeded the final judgment amount by $3.2 million. This amount was reversed during the second quarter of 2003 resulting in a $3.2 million pre-tax decrease in costs and expenses in the accompanying consolidated statement of loss for the six months ended June 29, 2003 and the accompanying consolidated statement of earnings for the three months ended June 29, 2003. OTHER LITIGATION Lakes is involved in various other inquiries, administrative proceedings, and litigation relating to contracts and other matters arising in the normal course of business. While any proceeding or litigation has an element of uncertainty, management currently believes that the final outcome of these matters is not likely to have a material adverse effect upon the Company's consolidated financial position or results of operations. 7. RELATED PARTY TRANSACTIONS During 2001 and 2000, Lakes made a total of $4.0 million in unsecured loans, which were receivable in full on December 31, 2002, to ViatiCare Financial Services, LLC, which has since been acquired by Living Benefits Financial Services ("Living Benefits"). In March 2001, the Board of Directors of Lakes decided not to make further loans to ViatiCare. A $4.0 million impairment charge for this note was recorded during the quarter ended June 30, 2002, due to increased competition in the viatical insurance business and restrictions on ability to make further policy acquisitions. Subsequent to the decision by the Lakes Board to make no further loans to ViatiCare, L. B. Acquisitions, LLC, which is owned by Lyle Berman, the Chief Executive Officer and a Director of Lakes, made loans to Living Benefits. As an incentive to make the loans, L. B. Acquisitions was granted an initial 9% voting interest in Living Benefits and was given the option to convert the loan balance into 45% of the voting interest in Living Benefits. Therefore, Lyle Berman, through L. B. Acquisitions, beneficially owns a total of approximately 55% of the voting interest of Living Benefits. 17 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Previously, Lakes formed two joint venture partnerships with Kean Argovitz Resorts, LLC ("KAR"), a limited liability company based in Houston, Texas for the purpose of developing and managing casino resort projects with the Shingle Springs Band of Miwok Indians and the Jamul Indian Village, both in California. On January 30, 2003, Lakes restructured a series of arrangements with KAR and its individual members such that Lakes has effectively acquired 100% ownership of the joint ventures in exchange for restructuring indebtedness of $1.8 million from the joint venture partnerships to Lakes and an agreement to make certain conditional payments to the individual KAR members from profits received under the respective management contracts. While these conditional payments could total up to $2 million per year for each project, Lakes believes these payments will be substantially less than KAR would have received under their original interest. The individual KAR members have options to repurchase their interest or obtain a comparable financial interest, in the event they are found suitable by relevant gaming regulatory authorities. A subsidiary of Lakes and Land Baron West, LLC are partners in a joint venture formed to develop or sell land purchased by the joint venture near San Diego, California. Land Baron West, LLC owed the joint venture $0.5 million, and $0.2 million, as of June 29, 2003 and December 29, 2002, respectively. These amounts are included in accounts receivable on the accompanying condensed consolidated balance sheets. During 2002, Lakes rented the use of Company equipment to another company that had a mutual Board member during a portion of 2001. The transaction was for full value of the associated use and all payments totaling $0.02 million for such use have been received. 8. SUBSEQUENT EVENT SHARK CLUB On July 1, 2003, Lakes completed the sale of its Shark Club property in Las Vegas, Nevada to an entity to be managed and operated by Marriott Ownership Resorts, Inc. As consideration for this sale, Lakes received $15.0 million in cash, plus $1.0 million as repayment of a loan previously made to Chateaux by Lakes. 18 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company") was established as a public corporation on December 31, 1998, via a distribution (the "Distribution") of its Common Stock, to the shareholders of Grand Casinos, Inc. ("Grand"). As a result of the Distribution, Lakes operates the Indian casino management business and holds various other assets previously owned by Grand. Lakes' main business is the development, construction and management of casinos and related hotel and entertainment facilities in emerging and established gaming jurisdictions. Lakes has entered into the following contracts for the development, management and/or financing of new casino operations, all of which are subject to various regulatory approvals before construction can begin: (1) Lakes has a contract to be the exclusive developer and manager of an Indian-owned gaming resort near New Buffalo, Michigan for the Pokagon Band of Potawatomi Indians. (2) Lakes has entered into contracts to develop and manage two casinos to be owned by Indian tribes in California, one near San Diego with the Jamul Indian Village and the other near Sacramento with the Shingle Springs Band of Miwok Indians. (3) Lakes and another company have formed a partnership with a contract to finance the construction of an Indian-owned casino 60 miles north of San Francisco, California. The Cloverdale Rancheria has notified the partnership that the Rancheria wishes to terminate the relationship between the two parties. The partnership has advised the Rancheria that the partnership believes the contract is enforceable. The Rancheria acknowledges that the partnership has loaned the Rancheria money and that the Rancheria will endeavor to repay the money in a timely manner. (4) Lakes has also signed contracts with the Nipmuc Nation, a Massachusetts Indian tribe, for development and management of a potential future gaming resort in the eastern United States; however, this tribe has received a negative finding regarding federal recognition from the Bureau of Indian Affairs (BIA). The tribe has submitted additional information to the BIA for reconsideration. In addition, Lakes owns options to purchase various new casino games and is actively marketing these new games to the casino industry in an attempt to have a casino accept the games for use in their operations. Lakes has also formed a joint venture with another company to develop approximately 2,000 acres owned by the joint venture in eastern San Diego County in California. It is possible the land will be sold in lieu of a development by the joint venture. Lakes has also formed a joint venture with a producer to launch the World Poker Tour ("WPT") and establish poker as the next significant televised mainstream sport. The joint venture signed an agreement with the Travel Channel ("TRV") in March 2003, for broadcast of the first season of the WPT series which has now been completed. During July of 2003, WPT reached an agreement with TRV for a second season with options for five additional seasons. Revenue is recognized ratably as production milestones and other conditions are met. During the first two quarters of 2003, Lakes recognized approximately $3.5 million in revenue related to the World Poker Tour. Revenues related to the second season will be recognized during 2004. 19 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Lakes' growth strategy contemplates the development of existing projects, the pursuit of opportunities to develop and manage additional gaming facilities and the pursuit of new business opportunities. The successful implementation of this growth strategy is contingent upon the satisfaction of various conditions, including obtaining governmental approvals, the impact of increased competition, and the occurrence of certain events, many of which are beyond the control of Lakes. SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies, which Lakes believes are the most critical to aid in fully understanding and evaluating its reported financial results, include the following: revenue recognition and realizability of notes receivable. REVENUE RECOGNITION: Revenue from the management of Indian-owned casino gaming facilities is recognized when earned according to the terms of the management contracts. Currently all of the Indian-owned casino projects that Lakes is involved with are in development stages and are not yet open. Therefore, until a project is open and operating, Lakes will not recognize revenue related to Indian casino management. Interest income on notes receivable for Indian tribes related to casino development projects is deferred because realizability of the interest is contingent upon the completion and generation of cash flow from the operation of the casino. Interest deferred during the development period is recognized over the remaining life of the note using the effective interest method. Revenue from the World Poker Tour series is recognized ratably as production milestones and other conditions are met. IMPAIRMENT OF LONG-TERM ASSETS: The Company's notes receivable from Indian Tribes are generally for the development of gaming properties to be managed by the Company. The repayment terms are specific to each tribe and are largely dependent upon the operating performance of each gaming property. Repayments of the notes receivable are required to be made only if distributable profits are available from the operation of the related casinos. Repayments are also the subject of certain distribution priorities specified in the management contracts. In addition, repayment of the notes receivable and the manager's fees under the management contracts may be subordinated to certain other financial obligations of the respective tribes. Through June 29, 2003, no impairments have been recorded under these provisions. Management periodically evaluates the recoverability of such notes receivable based on the current and projected operating results of the underlying facility and historical collection experience. The Company currently holds land held for development and land held under contract for sale. The Company periodically evaluates whether events and circumstances have occurred that may affect the recoverability of the net book value of these assets. If such events or circumstances indicate that the carrying amount of an asset may not be recoverable, the Company estimates the future cash flows expected to result from the use of the asset. If the sum of the expected future undiscounted cash flows does not exceed the carrying value of the asset, the Company will recognize an impairment loss. 20 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto and management's discussion and analysis included in the Company's Annual Report on Form 10-K for the year ended December 29, 2002. RECENT ACCOUNTING PRONOUNCEMENTS The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" in November 2002. This interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this interpretation are applicable to all guarantees and modification to guarantees made after December 31, 2002. The Company's disclosure of the indemnification and guarantee agreements of the Company is in compliance with the interpretation. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ended after December 15, 2002. The adoption of the interpretation did not have a material impact on the Company's results of operations, financial position and cash flows. The Company does have an indemnification agreement with Grand Casinos which is fully described in the Financial Condition section of this Management's Discussion and Analysis. In January 2003, the FASB issued Interpretation No. 46 (FIN46), "Consolidation of Variable Interest Entities", which addresses the consolidation of variable interest entities. The interpretation applicable immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which a Company obtains an interest after that date. For variable interests in variable interest entities acquired before February 1, 2003, the interpretation applicable applies in the first interim period beginning after June 15, 2003. The Company has determined that it has no investments or other interests in entities that may be deemed variable interest entities under the provisions of FIN 46, as the development projects subject to the management agreements with the Indian Tribes are not separate entities or legal structures. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123". SFAS No. 148 provides alternative transition methods for companies that make a voluntary change to the fair-value-based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the disclosure provisions of SFAS No. 148 and its adoption had no impact on the Company's consolidated financial position or results of operations. 21 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS Revenues are calculated in accordance with accounting principles generally accepted in the United States of America and are presented in a manner consistent with industry practice. Historically, net distributable profits by the Indian casinos were computed using a modified cash basis of accounting in accordance with the management contracts to calculate management fees. Under this modified cash basis of accounting prescribed by the management contracts, the write-off of capital equipment and leased assets for the casino operations was accelerated, which thereby impacted the timing of net distributable profits. SIX MONTHS ENDED JUNE 29, 2003 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2002 Revenues Total revenues were $3.5 million for the six months ended June 29, 2003 compared to $1.5 million for the same period in the prior year. Revenues for the current year period were derived entirely from license fees related to the WPT series, which has now completed its first full season. An agreement for a WPT second season was reached during July of 2003. Under the new agreement, WPT will receive a series of fixed license payments for the second season. These payments will commence in 2004 and are subject to satisfaction of production milestones and other conditions. WPT is also entitled to a portion of the revenues from other sources including international distribution, merchandising and certain sponsorships, and WPT is currently exploring these opportunities. Revenues for the prior year period were derived entirely from management fees from the management of Grand Casino Coushatta. The management contract with the Coushatta Tribe of Louisiana for Grand Casino Coushatta expired on January 16, 2002. The Company currently has no other management contracts from which it will derive revenues in 2003. Costs and Expenses Total costs and expenses were $5.0 million for the six months ended June 29, 2003, compared to $11.9 million for the same period in the prior year. Selling, general and administrative expenses decreased from $11.7 million for the six months ended June 30, 2002 to $7.9 million for the six months ended June 29, 2003. This decrease is the result of impairment charges taken in the prior year period of $4.0 million relating to a note receivable from Living Benefits, LLC, and $3.0 million relating to the Polo Plaza and Travelodge properties, which was partially offset by an increase in professional fees of approximately $1.4 million related to the property sales in Las Vegas, Nevada, as well as an increase in costs incurred associated with WPT in the amount of $2.2 million during the current year period. Also during the current year period, the Company reversed a reserve assessment related to Stratosphere litigation which exceeded the final judgment amount resulting in a reversal of litigation and claims accrual in the amount of $3.2 million. 22 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Other Interest income was $0.6 million for the six months ended June 29, 2003 compared to $1.2 million for the same period in the prior year. This decrease is primarily due to lower cash balances during the period. Losses Per Common Share and Net Losses For the six months ended June 29, 2003, basic and diluted losses per common share were $0.05, compared to basic and diluted losses of $0.68, for the same period in the prior year. Losses for the period ended June 29, 2003 were $0.5 million compared to $7.2 million for the six months ended June 30, 2002. This decrease in losses is primarily due to the impairment charges of $7.0 million taken in the prior year period discussed above. Also contributing to the decrease was the WPT revenue of $3.5 million recognized in 2003, compared to management fee income of $1.5 million related to the management of Grand Casino Coushatta, recognized in the prior year period. THREE MONTHS ENDED JUNE 29, 2003 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2002 Revenues Total revenues were $3.0 million for the three months ended June 29, 2003. There were no revenues in the same period in the prior year. Revenues for the current year period were derived entirely from license fees related to the WPT series, which has now completed its first full season. An agreement for a WPT second season was reached during July 2003. Revenue from the second season will be recognized in 2004 as production milestones and other conditions are met. Costs and Expenses Total costs and expenses were $1.9 million for the three months ended June 29, 2003, compared to $9.7 million for the same period in the prior year. Selling, general and administrative expenses decreased from $9.6 million for the three months ended June 30, 2002 to $5.0 million for the three months ended June 29, 2003. This decrease is primarily due to a second quarter 2002 impairment of $4.0 million relating to a note receivable from Living Benefits Financial Services, LLC, as well as a $3.0 million impairment charge taken on the Polo Plaza and Travelodge properties, which was partially offset by an increase in professional fees of approximately $1.4 million related to the property sales in Las Vegas, Nevada, as well as an increase in costs incurred associated with WPT in the amount of $1.2 million during the current year period. Also during the current year period, the Company reversed a reserve assessment related to Stratosphere litigation which exceeded the final judgment amount resulting in a reversal of litigation and claims accrual in the amount of $3.2 million. 23 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Other Interest income was $0.3 million for the three months ended June 29, 2003 compared to $0.4 million for the same period in the prior year. This decrease is primarily due to lower cash balances during the period. Earnings Per Common Share and Net Earnings For the three months ended June 29, 2003, basic and diluted earnings per common share were $0.07, compared to basic and diluted losses of $0.67, for the same period in the prior year. Earnings for the three months ended June 29, 2003 were $0.8 million compared to losses of $7.2 million for the three months ended June 30, 2002. This increase in earnings relates primarily to the impairment charges of $7.0 million taken in the prior year period discussed above. Also contributing to the increase was the WPT revenue recognized in the current year quarter. Outlook It is currently contemplated that there will be no operating revenues for the remainder of 2003 from existing casino development projects or from the World Poker Tour. Although none of the existing casino development projects are expected to produce revenue in 2003, Lakes continues to evaluate potential new revenue-generating business opportunities. The Company recently signed an agreement with TRV for a second season of the WPT series. Costs associated with WPT are expected to remain primarily consistent during the third and fourth quarters of 2003. However, revenues related to the second season will not be recognized until 2004, as production milestones and other conditions are met. Lakes anticipates that second season revenues from all sources will allow WPT to be profitable in 2004 and future years, thereby being incremental to Lakes' earnings and reducing financial risks associated with this venture. Lakes continues to closely monitor its operating expenses. FINANCIAL CONDITION At June 29, 2003, Lakes had $23.4 million in unrestricted cash and cash equivalents. Subsequent to June 29, 2003, Lakes has received $15.0 million in cash related to the sale of the Shark Club property and $1.0 million as repayment of a loan previously made to Chateaux by Lakes. Lakes considers its cash position, which includes the payments received upon the sale of the Shark Club property, adequate to cover expected remaining 2003 operating expenses. For the six months ended June 29, 2003, net cash used in operating activities totaled $4.0 million. For the six months ended June 30, 2002, net cash used in operating activities totaled $0.5 million. For the current year period, net cash provided by investing activities totaled $13.3 million. For the six months ended June 30, 2002, net cash used in investing activities totaled $15.6 million. Included in these investing activities for the periods ended June 29, 2003 and June 30, 2002 are advances on notes receivable of $6.6 million and $9.9 million, respectively. Net receipts from land held under contract for sale were $16.3 million during the six months ended June 29, 2003. Payments for land held under contract for sale were $0.7 million for the six months ended June 30, 2002. 24 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Unrestricted cash increased by $5.9 million during the 2003 period as a result of the reclassification of restricted cash as unrestricted. During the periods ended June 29, 2003 and June 30, 2002, payments for land held for development amounted to $1.6 million and $4.9 million, respectively. Lakes plans to use its cash for continuing operations, loans to current joint ventures and tribal partners to develop existing and anticipated Indian casino operations, the pursuit of additional business opportunities, and settlement of pending litigation matters. The amount and timing of Lakes' cash outlays for casino development loans will depend on the timing of the regulatory approval process and the availability of external financing. When approvals are received, additional financing will be needed to complete the projects. It is currently planned that this third-party financing will be obtained by each individual tribe. However, there can be no assurance that if third-party financing is not available, Lakes will not be required to finance these projects directly. If Lakes must provide this financing, Lakes expects to obtain debt or equity financing which it would loan to the respective tribes as necessary. In the alternative, Lakes may be required to guarantee the tribes' debt financing or otherwise provide support for the tribes' obligations. Any guarantees by Lakes or similar off-balance sheet liabilities will increase Lakes' potential exposure in the event of a default by any of these tribes. At June 29, 2003, Lakes had approximately $75.6 million in notes receivable from Indian tribes and other parties. Most of these amounts are advances made to the tribes for the development of gaming properties managed by Lakes. See Note 5 to the Consolidated Financial Statements included in Item 1. The joint venture entities that hold the management contracts for the San Diego and Sacramento area casino resorts were previously jointly owned with two LLC's owned by Kevin M. Kean and Jerry A. Argovitz, (the "KAR Entities"). On January 30, 2003, subsidiaries of Lakes purchased the respective joint venture interests of the KAR Entities for nominal consideration, at which time the joint venture entities became indirect wholly owned subsidiaries of Lakes. At the time of the purchase, Lakes or its subsidiaries had notes receivable from the KAR Entities and a long-term receivable from Kevin M. Kean that, as of December 29, 2002, were in the amounts of $1.8 million and $1.9 million, respectively. In connection with the purchase transactions, Lakes and certain of its subsidiaries entered into separate agreements with Kevin M. Kean and Jerry A. Argovitz, the two individual owners of the KAR Entities. Under these agreements, Lakes and its subsidiaries have forgiven the notes receivable from the KAR Entities, subject to the agreements of Messrs. Kean and/or Argovitz to assume the obligations under the notes in certain circumstances. Under the agreements with Kevin M. Kean, Mr. Kean may elect to serve as a consultant to Lakes' subsidiaries during the term of each subsidiary's casino management contract if he is found suitable by relevant gaming regulatory authorities. In such event, Mr. Kean will be entitled to receive annual consulting fees equal to 20% of the management fees from the San Diego area casino operations and 15% of the management fees from the Sacramento area casino operations, less certain costs of these operations. 25 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) If Mr. Kean is found suitable by relevant gaming regulatory authorities and elects to serve as a consultant, he will be obligated to repay 50% of the notes receivable from the KAR Entities. If Mr. Kean is not found suitable by relevant gaming regulatory authorities or otherwise elects not to serve as a consultant, he will be entitled to receive annual payments of $1 million from each of the San Diego and Sacramento area casino projects during the term of the respective casino management contracts (but not during any renewal term of such management contracts). Regardless of whether Mr. Kean serves as a consultant, a Lakes subsidiary has agreed to loan up to $1.25 million to Mr. Kean, $1 million of which must be used to fund certain obligations of Mr. Kean related to a separate joint venture formed to acquire land in the San Diego area. Mr. Kean's personal indebtedness to Lakes remained outstanding. Mr. Kean has agreed that 50% of the consulting fees or other payments payable to him under the agreements with Lakes and its subsidiaries shall be applied toward repayment of his indebtedness to Lakes. In the event of a default under the agreements, 100% of the fees and payments will be applied toward repayment of his indebtedness to Lakes. Under the agreements with Jerry A. Argovitz, if Mr. Argovitz is found suitable by relevant gaming regulatory authorities, he will be entitled to purchase for nominal consideration a 20% equity interest in the Lakes subsidiary holding a management contract with the San Diego area casino and a 15% equity interest in the Lakes subsidiary holding a management contract with the Sacramento area casino. Upon such purchase, Mr. Argovitz will become obligated to repay 50% of the notes receivable from the KAR Entities. If he is not found suitable or does not elect to purchase equity interests in the Lakes subsidiaries, Mr. Argovitz may elect to receive annual payments of $1 million from each of the San Diego and Sacramento area casino projects from the date of election through the term of the respective casino management contracts (but not during any renewal term of such management contracts). As part of a joint venture which will televise poker tournaments, the Company invested $0.1 million for an approximately 78% ownership position in the joint venture during 2002. The Company is also required to loan up to $3.2 million to the joint venture as needed. As of June 29, 2003, the Company had made net loans totaling $1.8 million to the joint venture. On December 28, 2001, the Company transferred title and ownership obligations of the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and obligations of the adjacent Travelodge property consisting of a long-term land lease and a motel operation. This transaction was accounted for under the deposit method of accounting under the requirements of Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate rather than as a sale. Therefore, the fair value of the property was included as land held under contract for sale on the accompanying balance sheet as of December 29, 2002. The total price for this combined transaction was approximately $30.9 million. Terms of the transaction include a $1.0 million down payment, which was received in January 2002, a contractual commitment to pay to Lakes $23.3 million and a second contractual commitment to pay Lakes $7.5 million. 26 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) During 2002, Lakes and Metroflag restructured the terms of the Polo Plaza and Travelodge property transactions due to deteriorating economic conditions. The parties reduced the purchase price for the Polo Plaza property from $23.8 million to $21.8 million. On the payment date, which was scheduled to be no later than January 31, 2003, $16.8 million of the purchase price was to be payable to Lakes in cash and $4.0 million was to be payable through the issuance to Lakes of a preferred membership interest in Metroflag. During 2002, Lakes recorded a $3.0 million impairment charge for these properties relating to the adjustment in the purchase price and a negotiated potential discount on the return of Lakes' preferred interest. Lakes' collateral for the two contractual commitments is the property and lease rights described above which would revert back to Lakes in the event of default by Metroflag. During March of 2003, Lakes and Metroflag agreed to additional revisions to the terms of the Polo Plaza and Travelodge property transactions. The parties have increased the price of the Polo Plaza property from $21.8 million to $25.8 million. On the payment date, which was extended to May 15, 2003, $16.8 million of the purchase price was paid to Lakes in cash, $4.0 million was paid through the issuance to Lakes of a preferred membership interest in Metroflag and $4.0 million was paid through the issuance to Lakes of a subordinated membership interest in Metroflag. On or before April 30, 2004, Metroflag Polo may elect to distribute to Lakes $3.0 million plus interest in cash as full return of Lakes' preferred interest. If paid after April 30, 2004 and in no event later than December 24, 2006, the entire $4.0 million plus interest will be payable. The subordinated interest must be repurchased for $4.0 million at the time of repayment of an outstanding $3.5 million contractual commitment in connection with the Travelodge property, which is scheduled on or before December 28, 2004. If the Travelodge commitment is not repaid by December 28, 2004, ownership of the Travelodge lease rights would revert back to Lakes. If at any time the Polo Plaza property is sold and the Travelodge commitment has not been repaid, Metroflag is required to repurchase the subordinated interest for the lesser of $4.0 million or any portion of the net cash proceeds from such sale or refinancing that exceeds $60.0 million. In March of 2003, the parties decreased the sale price of the Travelodge property from $7.5 million to $3.5 million. The contractual commitment to pay Lakes was also decreased from $7.5 million to $3.5 million and is now payable no later than December 28, 2004. On July 1, 2003, Lakes completed the sale of its Shark Club property in Las Vegas, Nevada to an entity to be managed and operated by Marriott Ownership Resorts, Inc. As consideration for this sale, Lakes received $15.0 million in cash, plus $1.0 million as repayment of a loan previously made to Chateaux by Lakes. 27 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Pursuant to the terms of the Distribution Agreement, Grand Casinos assigned to Lakes, and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes' current corporate office space of approximately 65,000 square feet with a lease term of fifteen years. The lease commenced on October 14, 1996. During 2001, also pursuant to the terms of the Distribution Agreement, Lakes entered into a capital lease arrangement for the corporate office space at which time the operating lease was cancelled. Accordingly, Lakes recorded a capital leased asset and liability in the amount of approximately $5.8 million. On January 2, 2002, as per the agreement with Grand Casinos, Lakes purchased the building for $6.4 million, including transaction expenses. This transaction resulted in the extinguishment of the Company's capital lease obligation related to the building. The Company had two notes payable with third parties, which were repaid during 2002. The first was collateralized by certificates of deposit, in the amount of $1.0 million. The second was collateralized by property in the amount of $0.4 million. As a part of the agreements resulting from Lakes' spin-off from Grand Casinos and related transactions, Lakes has agreed to indemnify Grand Casinos against all costs, expenses and liabilities incurred in connection with or arising out of certain pending and threatened claims and legal proceedings to which Grand Casinos and certain of its subsidiaries are likely to be parties. The Company's indemnification obligations include the obligation to provide the defense of all claims made in proceedings against Grand Casinos and to pay all related settlements and judgments. See Part II Item 1. Legal Proceedings. As of December 29, 2002, Lakes had $7.5 million deposited in trust as security to support Lakes' indemnification obligations to Grand Casinos. In May 2003, $2.3 million was paid out of the trust to Stratosphere. Following such payment, the trust account was terminated and the remaining restricted funds of approximately $5.9 million, including interest, were released to Lakes and reclassified as unrestricted cash on Lakes' condensed consolidated balance sheet as of June 29, 2003. Notwithstanding termination of the trust account, Lakes' indemnification obligations to Grand remain in effect. Subsequent indemnification obligations to Grand Casinos, if any, would be paid directly by Lakes. SEASONALITY The Company believes that the operations of all casinos to be managed by the Company will be affected by seasonal factors, including holidays, weather and travel conditions. REGULATION AND TAXES The Company is subject to extensive regulation by state gaming authorities. The Company will also be subject to regulation, which may or may not be similar to current state regulations, by the appropriate authorities in any jurisdiction where it may conduct gaming activities in the future. Changes in applicable laws or regulations could have an adverse effect on the Company. 28 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The gaming industry represents a significant source of tax revenues. From time to time, various federal legislators and officials have proposed changes in tax law, or in the administration of such law, affecting the gaming industry. It is not possible to determine the likelihood of possible changes in tax law or in the administration of such law. Such changes, if adopted, could have a material adverse effect on the Company's results of operations and financial results. RECENT ACCOUNTING PRONOUNCEMENTS The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" in November 2002. This interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this interpretation are applicable to all guarantees and modification to guarantees made after December 31, 2002. The Company's disclosure of the indemnification and guarantee agreements of the Company is in compliance with the interpretation. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ended after December 15, 2002. The adoption of the interpretation did not have a material impact on the Company's results of operations, financial position and cash flows. The Company does have an indemnification agreement with Grand Casinos which is fully described in the Financial Condition section of this Management's Discussion and Analysis. In January 2003, the FASB issued Interpretation No. 46 (FIN46), "Consolidation of Variable Interest Entities", which addresses the consolidation of variable interest entities. The interpretation applicable immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which a Company obtains an interest after that date. For variable interests in variable interest entities acquired before February 1, 2003, the interpretation applicable applies in the first interim period beginning after June 15, 2003. The Company has determined that it has no investments or other interests in entities that may be deemed variable interest entities under the provisions of FIN 46, as the development projects subject to the management agreements with the Indian Tribes are not separate entities or legal structures. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123". SFAS No. 148 provides alternative transition methods for companies that make a voluntary change to the fair-value-based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the disclosure provisions of SFAS No. 148 and its adoption had no impact on the Company's consolidated financial position or results of operations. 29 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) PRIVATE SECURITIES LITIGATION REFORM ACT The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in this Form 10-K and other materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) contain statements that are forward-looking, such as plans for future expansion and other business development activities as well as other statements regarding capital spending, financing sources and the effects of regulation (including gaming and tax regulation) and competition. Such forward looking information involves important risks and uncertainties that could significantly affect the anticipated results in the future and, accordingly, actual results may differ materially from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to possible delays in completion of Lakes' casino projects, including various regulatory approvals and numerous other conditions which must be satisfied before completion of these projects; possible termination or adverse modification of management contracts; continued indemnification obligations to Grand Casinos; highly competitive industry; possible changes in regulations; reliance on continued positive relationships with Indian tribes and repayment of amounts owed to Lakes by Indian tribes; possible need for future financing to meet Lakes' expansion goals; risks of entry into new businesses; and reliance on Lakes' management. For further information regarding the risks and uncertainties, see the "Business -- Risk Factors" section of the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2002. 30 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK; CONTROLS AND PROCEDURES ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's financial instruments include cash and cash equivalents, marketable securities and long-term debt. The Company's main investment objectives are the preservation of investment capital and the maximization of after-tax returns on its investment portfolio. Consequently, the Company invests with only high-credit-quality issuers and limits the amount of credit exposure to any one issuer. The Company does not use derivative instruments for speculative or investment purposes. The Company's cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. As of June 29, 2003, the carrying value of the Company's cash and cash equivalents approximates fair value. The Company has in the past and may in the future obtain marketable debt securities (principally consisting of commercial paper, corporate bonds, and government securities) having a weighted average duration of one year or less. Consequently, such securities would not be subject to significant interest rate risk. The Company's primary exposure to market risk associated with changes in interest rates involves the Company's notes receivable related to loans for the development and construction of Native American owned casinos. The loans and related note balances earn various interest rates based upon a defined reference rate. The floating rate receivables will generate more or less interest income if interest rates rise or fall. Interest income is deferred during development of the casinos because realizability of the interest is contingent upon the completion and positive cash flow from operation of the casino. As of June 29 2003, Lakes had $75.5 million of floating rate notes receivables. Based on the applicable current reference rates and assuming all other factors remain constant, deferred interest income for a twelve month period would be $4.1 million. A reference rate increase of 100 basis points would result in an increase in deferred interest income of $0.8 million. A 100 basis point decrease in the reference rate would result in a decrease of $0.8 million in deferred interest income over the same twelve month period. ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) or Rule 15d - 15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this quarterly report. Based on their evaluation, our chief executive officer and chief financial officer concluded that Lakes Entertainment, Inc.'s disclosure controls and procedures are effective. There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced above. 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. STRATOSPHERE PREFERENCE ACTION In April 1998, Stratosphere served on Grand and Grand Media & Electronics Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a complaint in the Stratosphere bankruptcy case seeking recovery of certain amounts paid by Stratosphere to (i) Grand Media for electronic equipment purchased by Stratosphere from Grand Media, and (ii) Grand as management fees and for costs and expenses under a management agreement between Stratosphere and Grand. Stratosphere claimed in its complaint that such amounts are recoverable by Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand responded to Stratosphere's complaint denying that Stratosphere is entitled to recover the amounts described in the complaint. Discovery was completed on December 31, 2001 and the case proceeded to trial before the United States Bankruptcy Court for the District of Nevada on June 20, 2002. On December 31, 2002, the Bankruptcy Court issued its final judgment holding that: (i) payments to Grand Media for electronic equipment totaling approximately $3.3 million are not recoverable by Stratosphere as avoidable preferences, and (ii) payment to Grand for management services in the approximate amount of $2.3 million is recoverable by Stratosphere and an avoidable preference. On May 8, 2003, this judgment was satisfied out of amounts held in trust as security to support Lakes' indemnification obligations to Grand. OTHER LITIGATION Lakes is involved in various other inquiries, administrative proceedings, and litigation relating to contracts and other matters arising in the normal course of business. While any proceeding or litigation has an element of uncertainty, management currently believes that the final outcome of these matters is not likely to have a material adverse effect upon the Company's consolidated financial position or results of operations. 32 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Annual Meeting of Shareholders was held on June 2, 2003. (b) At the Annual Meeting: (1) Management's nominees for directors as listed in the proxy statement were elected with the following vote:
Affirmative Votes Authority Withheld ----------------- ------------------ Lyle Berman 10,235,925 166,670 Timothy J. Cope 10,239,260 163,335 Morris Goldfarb 10,070,022 332,573 Ronald Kramer 10,348,604 53,991 Neil I. Sell 10,103,334 299,261
(2) The appointment of Deloitte & Touche, LLP as independent auditors of the Company was ratified with the following vote:
Affirmative Votes Negative Votes Abstentions - ----------------- -------------- ----------- 10,378,640 20,847 3,108
(3) The proposal to grant full voting rights to shares of the Company's common stock held by Mr. Lyle Berman, pursuant to the Minnesota Control Share Acquisition Act, was not approved, with the following vote:
Affirmative Votes Negative Votes Abstentions Broker Non-Votes - ----------------- -------------- ----------- ---------------- 4,766,478 1,282,130 9,618 4,344,369
33 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) ITEM 5. OTHER INFORMATION The Lakes Board of Directors previously has determined that each of the three Audit Committee members is an "independent director" under Nasdaq listing standards. The Board has been advised of an informal interpretation of the Nasdaq rules that might cause Neil I. Sell, a member of the Audit Committee, not to be considered independent. Mr. Sell is a partner in the law firm of Maslon Edelman Borman & Brand, LLP, which performs legal services for Lakes, and the fees paid by Lakes to the Maslon law firm have exceeded $60,000 per year. Under the informal interpretation, all of these fees are imputed to Mr. Sell personally, and he is not considered independent. However, under Nasdaq guidelines, he can still serve as a member of the Audit Committee if the Board of Directors determines that membership on the Audit Committee by Mr. Sell is required by the best interests of Lakes and its shareholders. The Board has made this determination considering all relevant factors, principally Mr. Sell's membership on the Audit Committee since Lakes commenced its business, resulting in his understanding of Lakes' financial statements and accounting issues; his dedication and thoroughness as a member of the Audit Committee; his previous background as a member of the Board of Directors and Audit Committee of Grand Casinos, Inc.; and his background as a certified public accountant. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Purchase Agreement dated as of June 26, 2003, by and between Grand Casinos Nevada I, Inc. and Diamond Resorts, LLC 31.1 Certification of CEO pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of CFO pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 34 LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES PART II OTHER INFORMATION (CONTINUED) (b) Reports on Form 8-K (i) A Form 8-K, Item 5. Other Events, and Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, was filed on April 7, 2003 (ii) A Form 8-K, Item 5. Other Events, and Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, was filed on April 14, 2003 (iii) A Form 8-K, Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, and Item 12. Results of Operations and Financial Condition, was filed on April 28, 2003 (iv) A Form 8-K, Item 5. Other Events, and Item 7. Financial Statements, Pro Forma Financial Information and Exhibits, was filed on May 16, 2003 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: August 13, 2003 LAKES ENTERTAINMENT, INC. ------------------------- Registrant /s/ Lyle Berman -------------------------- Lyle Berman Chairman of the Board and Chief Executive Officer /s/ Timothy J. Cope -------------------------- Timothy J. Cope President and Chief Financial Officer 36 EX-10.1 3 c78855exv10w1.txt PURCHASE AGREEMENT DATED AS OF JUNE 26, 2003 EXHIBIT 10.1 PURCHASE AGREEMENT BY AND BETWEEN GRAND CASINOS NEVADA I, INC. ("SELLER") AND DIAMOND RESORTS, LLC ("PURCHASER") PURCHASE AGREEMENT This Purchase Agreement ("Contract") is entered into this 26th day of June, 2003 by and among GRAND CASINOS NEVADA I, INC., ("Seller"), a Minnesota corporation, and DIAMOND RESORTS, LLC., ("Diamond" or "Purchaser"), a Nevada limited liability company. RECITALS A. Seller is the owner in fee simple of those certain two parcels of land containing approximately 3.245 acres fronting on Harmon Avenue in Las Vegas, Clark County, Nevada, and more particularly described on EXHIBIT A attached hereto, including all entitlements and appurtenances of record (the "Property"), and the intangible property rights, if any, in the name "The Chateaux" when used in connection with the improvements to be constructed on the Property (the "Intangible Property"). B. Seller desires to sell, and Purchaser desires to purchase, the Property. C. Seller is entitled to occupy certain premises located in the Polo Towers Resort, which premises presently are being used as a sales gallery (lobby level) and sales offices (18th & 19th floors), hereinafter collectively referred to as the "Towers Sales Center." D. Seller desires to assign, and Purchaser desires to assume, Seller's rights and obligations in and to the Towers Sales Center. E. The parties desire to confirm the agreement between them by the execution of this Contract. AGREEMENT NOW, THEREFORE, in consideration of the foregoing premises and the respective representations, agreements, covenants and conditions herein contained, and other good and valuable consideration, the sufficiency and receipt of which are hereby acknowledged, Seller and Purchaser agree as follows: -1- ARTICLE I DEFINITIONS 1.1 DEFINITIONS. See EXHIBIT B attached hereto and incorporated herein by reference. ARTICLE II PURCHASE AND SALE OF PROPERTY; ASSIGNMENT OF RIGHTS TO TOWERS SALES CENTER 2.1 PURCHASE AND SALE. Subject to the conditions and on the terms contained in this Contract, on the Closing Date, Seller shall convey and transfer to Purchaser fee simple title to the Property, subject to the Permitted Exceptions as defined in Section 4.1. Conveyance and transfer of the Property at the Closing shall be by recordable grant, bargain, sale deed, substantially in the form of EXHIBIT C attached hereto and subject only to the Permitted Exceptions. Assignment of Seller's interest in the Towers Sales Center shall be by instrument substantially in the form of EXHIBIT D attached hereto (the "Assignment"). Seller shall convey the Intangible Property by Quit Claim Bill of Sale substantially in the form of EXHIBIT E attached hereto. 2.2 PURCHASE PRICE. The total purchase price (the "Purchase Price") to be paid to Seller by Purchaser for the Assets shall be Fifteen Million Dollars ($15,000,000), and shall be paid by Purchaser to Seller (as set forth in Section 2.4.2 herein). 2.3 EARNEST MONEY DEPOSIT. Purchaser shall immediately deliver to Escrow Agent its check or Immediately Available Funds in the amount of One Hundred Thousand Dollars ($100,000) (such amount with interest shall be referred to as the "Deposit"), which shall be held by Escrow Agent in an interest-bearing trust account. The Deposit shall be, except as specifically set forth herein, deemed earned by Seller and nonrefundable to Purchaser. 2.4 PAYMENT OF PURCHASE PRICE. The Purchase Price shall be paid by Purchaser to Seller at Closing as follows: 2.4.1 DEPOSIT. The Deposit shall be paid to Seller by Escrow Agent on behalf of Purchaser. -2- 2.4.2 PURCHASE NOTE. The amount of the Purchase Price, less the Deposit, shall be paid by delivery to Seller at the Closing of a note ("Purchase Note") and deed of trust ("Deed of Trust") in the forms of EXHIBITS G AND H respectively attached hereto. ARTICLE III SURVEY Purchaser has reviewed and approved a survey ("Survey") of the Property prepared by a surveyor licensed in Nevada. Purchaser shall have paid all costs related to the Survey at or prior to Closing. ARTICLE IV TITLE 4.1 TITLE COMMITMENT. Purchaser has approved the title exceptions set forth on EXHIBIT J attached hereto and which shall be deemed permitted exceptions hereunder (the "Permitted Exceptions"). Notwithstanding anything herein to the contrary, Seller shall cure or pay off any financial title objection (such as liens, judgments, mortgages) at or prior to Closing ("Financial Title Objection"). The parties hereby agree that notwithstanding anything else contained herein, that certain Amended and Restated Grant of Reciprocal Easements and Declaration of Covenants, Conditions and Restrictions made as of June 19, 2002, as amended March 25, 2003, and June 26, 2003 ("Master CC&Rs") shall also be deemed a Permitted Exception. 4.2 TITLE POLICY. This sale is subject to Purchaser being able to obtain an ALTA extended owner's policy of title insurance (Form B, Rev. 10-17-70) from Title Insurer at Closing in the amount of the Purchase Price insuring that Purchaser has fee title to the Property, subject only to Permitted Exceptions ("Title Policy"). -3- ARTICLE V POSSESSION, PRORATIONS AND CLOSING EXPENSES 5.1 POSSESSION. Sole and exclusive possession of the Assets shall be delivered to Purchaser on the Closing Date, subject only to rights of others as may be unknown to Seller (as in the case of the Intangible Property) or which are set forth in EXHIBIT J entitled Permitted Exceptions. 5.2 REAL ESTATE TAXES. General and special real estate and other ad valorem taxes or fees in lieu thereof, affecting the Property for the year of Closing shall be prorated as of the Closing Date based upon the most recent ascertainable amounts of each such item. Any such taxes prorated on an estimated basis on the Closing Date shall be adjusted by the parties when and as the actual amount of such item becomes known. Any such adjustment shall be effected not later than fifteen (15) days following final determination of the amount of such item, receipt of an invoice or bill therefor, and demand by the party to whom credit is due. The provisions of this Section 5.2 shall survive Closing. 5.3 CLOSING EXPENSES. Seller shall pay and be responsible for the following costs associated with the transfer of the Property: (i) transfer or documentary stamp taxes on the transfer of the Property, (ii) the cost of preparing and recording any corrective instruments, (iii) the cost of curing Financial Title Objections and any other title objections Seller elects or is required to make, and (iv) the cost of the Title Policy. Purchaser shall be responsible for the payment of the cost of endorsements to the Title Policy and the Survey. Each party shall pay one-half of the escrow fee charged by Escrow Agent. Except as otherwise specifically set forth herein, each party shall be responsible for the fees and expenses of their respective designated representatives, accountants and attorneys. ARTICLE VI AFFIRMATIVE COVENANTS 6.1 TRANSACTIONS AND ENCUMBRANCES AFFECTING THE PROPERTY. From the date hereof to the Closing Date, and without Purchaser's written consent, Seller shall not do, suffer, permit or agree to do any of the following: 6.1.1 Enter into any transaction affecting the Assets, or any portion thereof, inconsistent with, or in violation of, this Contract or out of the ordinary course of business; or -4- 6.1.2 Sell, lease, encumber or grant any interest in the Assets, or any part thereof, in any form or manner whatsoever, or otherwise perform or permit any act which will diminish or otherwise affect Purchaser's interest under this Contract or which will prevent Seller's full performance of its obligations hereunder. 6.1.3 Modify, amend or supplement the Master CC&Rs in such a manner that would adversely affect the Property in any material respect, except that Purchaser acknowledges and approves that certain Amendment to Article Four (only) of Amended and Restated Grant of Reciprocal Easements and Declaration of Covenants, Conditions and Restrictions ("Article 4 Amendment"). 6.1.4 Do or permit any other act which might reasonably be anticipated to adversely affect the Assets or Seller's ability to perform hereunder. 6.2 PURCHASER'S ACCESS. From the date hereof to the Closing Date, Seller shall permit representatives, agents, employees, contractors, appraisers, architects and/or engineers designated by Purchaser ("Purchaser's Agents") reasonable access to, and entry upon, the Property to examine, inspect, measure and test the Property for all reasonable purposes. Purchaser shall indemnify and hold Seller harmless from and against any and all claims, actions or demands arising from or related to any incident, occurrence, personal injury or property damage resulting from Purchaser or Purchaser's Agents, or anyone on Purchaser's behalf performing the Purchaser's examinations, inspections, measurements and testing of and on the Property. Purchaser also agrees that upon the completion of any such examinations, inspections, measurements or tests that the Property will remain in or be restored to substantially the same condition as before. This indemnification shall survive the Closing or termination of this Contract, and is not limited by the measure of liquidated damages set forth in Section 11.5. Purchaser or Purchaser's Agents shall, prior to accessing the Property, provide Seller an insurance certificate evidencing public liability naming Seller as an additional insured (from Purchaser and/or Purchaser's Agent) in form reasonably satisfactory to Seller. 6.3 OTHER AGREEMENTS. Until the Closing, Seller shall comply with all agreements affecting the Property which will survive the transfer of title, and shall deliver to Purchaser -5- immediately upon receipt copies of all notices of default under any of the foregoing served upon Seller. 6.4 TAXES. Seller shall pay when due all real estate and other ad valorem taxes or fees in lieu thereof (collectively the "taxes") relating to the Property and due and payable prior to Closing, provided, however, to the extent permitted by law, Seller may postpone the payment of such taxes which may be the subject of a good faith contest or appeal by Seller. Seller shall promptly pay any such taxes determined to be due at the end of any such contest or appeal. ARTICLE VII REPRESENTATIONS OF SELLER 7.1 REPRESENTATIONS OF SELLER. Seller hereby represents and warrants the following as of the Effective Date and as of the Closing Date: 7.1.1 TITLE TO PROPERTY. Seller has good and marketable title to the Property, which as of the Closing will be subject only to Permitted Exceptions. 7.1.2 AUTHORIZATION. Seller has full capacity, right, power and authority to execute, deliver and perform under this Contract and all documents to be executed by Seller pursuant hereto, and all required corporate action and approvals therefor, have been duly and previously taken and obtained. The individuals signing this Contract and all other documents executed or to be executed pursuant hereto on behalf of Seller are and shall be duly authorized to sign the same on Seller's behalf and to bind Seller thereto. This Contract and all documents to be executed pursuant hereto by Seller are and shall be binding upon and enforceable against Seller in accordance with their respective terms. 7.1.3 LITIGATION. To the best of Seller's knowledge, Seller has not been served with notice of any claims, causes of action or other litigation or proceedings pending or threatened in respect to the ownership, operation or environmental condition of the Property or any part thereof. 7.1.4 FIRPTA WITHHOLDINGS. Purchaser will have no duty to collect withholding taxes from Seller pursuant to the Foreign Investors Real Property Tax Act of 1980, as amended ("FIRPTA"). -6- 7.1.5 MATERIAL FACTS. To the best of Seller's knowledge, except as disclosed to Purchaser in writing, there are no facts or circumstances which have or would have a material adverse effect upon the Assets or Purchaser's use thereof or which would materially increase the cost of developing the Property. 7.1.6 NO BANKRUPTCY/DISSOLUTION EVENT. No Bankruptcy/Dissolution Event has occurred with respect to Seller. 7.1.7 SELLER'S COVENANT. Seller shall notify Purchaser promptly in writing if Seller becomes aware of any transaction or occurrence prior to the Closing Date which would make any of the representations of Seller contained in this Article and/or Article VIII below untrue in any material respect. Such notice shall not relieve Seller of any liability for such untruth or impair any right of Purchaser as a result thereof. ARTICLE VIII ENVIRONMENTAL MATTERS 8.1 ENVIRONMENTAL REPRESENTATIONS. Except as may be revealed by an Environmental Assessment, on and as of the Effective Date and on and as of the Closing Date, Seller represents, to the actual knowledge of Lyle Berman, without any inquiry, investigation or duty of inquiry or investigation by him (and excluding any constructive, imputed or implied knowledge), that with regard to the Property: 8.1.1 No part of the Property is in breach of any Environmental Laws; 8.1.2 During Seller's ownership of the Property, the Property has not been used as a sanitary landfill, waste dump site or for the treatment, storage or disposal of Hazardous Materials. 8.2 SPECIAL FLOOR HAZARD AREA. Seller represents and warrants that Seller has not received any notice that all or a part of the Property is located within an area that has been designated by the Federal Emergency Management Agency, the Army Corps of Engineers or any other governmental body as being subject to special flood hazards. -7- ARTICLE IX "AS-IS" CONDITION 9.1 PROPERTY CONVEYED "AS-IS". Even though Seller and Persons related to Seller may provide Purchaser with information regarding the Property, Purchaser expressly acknowledges and agrees that Purchaser and Purchaser Agents shall have had ample time and opportunity to inspect the Property and to perform its due diligence and that if Purchaser elects to close on the Property, except for the specific representations and warranties contained herein, the Property will be sold "as is" "where is" with all faults and Purchaser agrees to accept the Property in its "as is" condition on the Effective Date. Purchaser further acknowledges that neither Seller nor Seller's agents have made, and that Seller expressly disclaims making, any representation or warranty of any nature, whether expressed or implied, to Purchaser with respect to the condition of the Property, except as expressly provided herein. ARTICLE X REPRESENTATIONS OF PURCHASER 10.1 REPRESENTATIONS OF PURCHASER. To induce Seller to execute, deliver and perform under this Contract, Purchaser hereby represents to Seller on and as of the Effective Date and on and as of the Closing Date as follows: 10.1.1 AUTHORIZATION. Purchaser has full capacity, right, power and authority to execute, deliver and perform under this Contract and all documents to be executed by Purchaser pursuant hereto, and all required limited liability company actions and approvals therefor have been duly taken and obtained. The individuals signing this Contract and all other documents executed or to be executed pursuant hereto on behalf of Purchaser are and shall be duly authorized to sign the same on Purchaser's behalf and to bind Purchaser thereto. This Contract and all documents to be executed pursuant hereto by Purchaser are and shall be binding upon and enforceable against Purchaser in accordance with their respective terms. 10.1.2 LEGAL MATTERS. To the best of Purchaser's knowledge, there is no pending litigation or dispute, judgment or execution of any nature whatsoever pending or threatened against Purchaser which could adversely affect Purchaser's ability to enter into this Contract and perform its obligations to consummate the transactions contemplated hereby. 10.1.3 NO BANKRUPTCY/DISSOLUTION EVENT. No Bankruptcy/Dissolution Event has occurred with respect to Purchaser. -8- 10.1.4 OBLIGATIONS OF CHATEAUX. Upon delivery of the Repayment Note (as hereinafter defined) and Unwind Documents neither Purchaser, Chateaux, or any affiliate of either of them shall have any further liability to Seller or any affiliate of Seller with respect to Chateaux or the Property other than pursuant to this Agreement. ARTICLE XI CONDITIONS PRECEDENT, DEFAULT AND TERMINATION 11.1 CONDITIONS PRECEDENT TO CLOSING. The obligation of Purchaser to purchase the Assets, and close the transaction contemplated hereby is subject to satisfaction of each of the following conditions precedent, the satisfaction of which shall be determined solely by Purchaser in the exercise of its reasonable judgment (unless a different standard is stated). Any of these conditions precedent may be waived in Purchaser's sole discretion. 11.1.1 OLD NOTE. Seller shall have delivered to Purchaser at Closing the duly endorsed Old Note (as hereinafter defined). 11.1.2 STATUS QUO OF MASTER CC&RS. Prior to the Closing, none of the provisions of the Master CC&Rs which affect either the "Shark Parcel" or "Diamond" (both as defined therein) shall be amended without the prior written consent of Purchaser which will not be unreasonably withheld or delayed (except that Purchaser approves the Article 4 Amendment). Seller, as of the Effective Date and again as of the Closing Date, shall acknowledge and confirm its guaranty in its capacity as "Grand" (as distinct from "Shark Owner") pursuant to Article 4 of the Master CC&R's as amended. Purchaser acknowledges that upon a successful Closing, it becomes the Shark Owner and agrees to perform all the obligations of the Shark Owner (but not of "Grand") under the Master CC&R's for so long as it owns the Property. The foregoing obligations of Seller and Purchaser shall survive the Closing and delivery of the deed. 11.1.3 UNWIND DOCUMENTS. Seller shall have executed and delivered to Purchaser the documents described in clauses (i), (iii) and (iv) of the definition of Unwind Documents. 11.1.4 CLOSING DELIVERIES. Seller shall have delivered at Closing all documents required from Seller under this Contract, including the Assignment. -9- 11.2 SELLER'S CONDITIONS PRECEDENT TO CLOSING. The obligation of Seller to sell the Assets and close the transactions contemplated hereby is subject to satisfaction of each of the following conditions precedent, the satisfaction of which shall be determined solely by Seller in the exercise of its reasonable judgment (unless a different standard is stated). Any of these conditions precedent may be waived by Seller in Seller's sole discretion. 11.2.1 REPRESENTATIONS AND WARRANTIES. All of the representations and warranties of Purchaser set forth herein shall be true in all material respects as of the Closing Date. 11.2.2 CLOSING DELIVERIES. Purchaser shall have paid the Purchase Price as provided in Section 2.4 and shall have delivered at Closing all documents required from Purchaser under this Contract and the document described in clauses (ii), (iii) and (iv) of the definition of Unwind Documents. 11.2.3 CHATEAUX LOAN. At the Closing Diamond shall purchase from Seller, without recourse or representation or warranty whatsoever by Seller, the loan made by Seller to The Chateaux, LLC ("Chateaux") pursuant to that certain Loan Agreement dated September 25, 2002 by and between Seller and Chateaux, and evidenced by a note ("Old Note") of even date, for the outstanding amount thereof, not to exceed One Million Dollars ($1,000,000) of principal plus interest. Such payment shall be made by delivery to Seller of a note in the form of EXHIBIT I attached hereto ("Repayment Note"), which shall be secured by the Deed of Trust. 11.2.4 MARRIOTT TRANSACTION. Seller shall have satisfied itself, in its sole discretion, that Purchaser shall have entered into a non-contingent agreement with Marriott Ownership Resorts, Inc. with respect to the development of the Property as a timeshare project ("Marriott Agreement"). 11.3 PURCHASER'S RIGHTS AND REMEDIES IN EVENT OF NON-SATISFACTION OF CONDITIONS PRECEDENT. If Purchaser, in its reasonable discretion, determines that any of the conditions precedent set forth in Section 11.1 shall be unsatisfied by the date stated or, if no date is stated, the Closing Date, Purchaser may, at its option, elect either (i) to terminate this Contract by written notice to Seller, in which event the Deposit shall forthwith be returned to Purchaser and thereupon this Contract shall be terminated and of no further force or effect, or (ii) to waive the condition precedent. -10- 11.4 PURCHASER'S REMEDIES. The obligation of Purchaser to close the transaction contemplated hereby is, at Purchaser's option, further subject to all representations of Seller contained in this Contract being true and correct in all material respects on and as of the Effective Date and the Closing Date and all obligations of Seller to have been performed on or before the Closing Date having been timely and duly performed. Upon default by Seller in its obligation to convey the Assets, Purchaser's may, by notice to Seller, elect either (i) to terminate this Contract, or (ii) to seek specific performance of Seller's obligation to convey the Assets. If this Contract is terminated by Purchaser pursuant to this Section 11.4, the Deposit shall be returned to Purchaser and thereupon this Contract shall be terminated. The failure of a condition precedent caused by the action or inaction of a third party not in the control of Seller shall not be deemed a default by Seller in the fulfillment of an obligation. 11.5 SELLER'S SOLE REMEDY. Prior to entering into this Contract, Purchaser and Seller have considered the damages that would be suffered by Seller in the event of a default by Purchaser of its obligation to purchase the Assets. Given all the factors which directly affect the value and marketability of the Assets, the parties realize that it would be extremely difficult and impracticable, if not impossible, to ascertain with any degree of certainty the amount of damages which would be suffered by Seller in the event of Purchaser's failure to perform its obligations under this Contract to purchase the Assets. The parties hereby agree that a reasonable amount of liquidated damages is the Deposit, and in the event of Purchaser's failure to perform its obligations under this Contract to purchase the Assets, Seller shall, as its sole and exclusive remedy, be entitled to retain the Deposit as liquidated damages. Failure of Purchaser to deliver to Escrow Agent any of the documents required under this Contract because any party to such document other than Purchaser or any affiliate of Purchaser refuses to execute the same shall not be deemed a default by Purchaser in its obligations under this Contract, but shall be deemed a failure of a condition precedent, whereupon the Deposit shall be returned to Purchaser and this Contract shall be terminated. ARTICLE XII BROKERAGE 12.1 BROKERAGE. Each party hereby represents and warrants to the other party they have not dealt with any broker or finder regarding the transaction contemplated hereby. Each party shall indemnify, defend and hold the other party harmless from any claim for brokerage commission or -11- finder's fee asserted by any broker or finder or any other Person claiming to have been engaged by the applicable party. This indemnity of the parties shall survive the Closing or termination of this Contract. The indemnity given by Purchaser in this Article XII is not limited by the measure of liquidated damages set forth in Section 11.5 ARTICLE XIII CASUALTY AND CONDEMNATION 13.1 CASUALTY AND CONDEMNATION. If, after the Effective Date and prior to the Closing Date, a material portion of the Property is damaged by a natural disaster or other casualty or is taken by exercise of the power of eminent domain or any proceedings are threatened or instituted to effect such a taking, Seller shall immediately give Purchaser notice of such occurrence, and if in the sole but reasonable judgment of Purchaser such casualty or condemnation would have a material adverse impact on Purchaser's Contemplated Use of the Property, Purchaser may, within fifteen (15) days after receipt of such notice elect either (i) to terminate this Contract, in which event the Deposit, together with all interest earned thereon, shall forthwith be returned to Purchaser, and all obligations of the parties hereunder shall cease and this Contract shall have no further force and effect, or (ii) to close the transaction contemplated hereby as scheduled (except that if the Closing Date is sooner than fifteen (15) days following Purchaser's receipt of such notice, the Closing shall be delayed until Purchaser makes such election), in which event Seller shall assign and/or pay to Purchaser at the Closing all insurance proceeds or condemnation awards or other damages collected or claimed with respect to such casualty or taking to the extent that such awards or damages apply to the Property or portion thereof, or, if such sums are paid to a mortgagee, the Purchase Price shall be reduced by the amount so paid. In the event the Property is only partially damaged or taken, and Purchaser can utilize the remainder for its Contemplated Use, Purchaser in its election of (ii) above may elect to purchase only that portion of the Property not damaged or taken, with such reduction in the Purchase Price as the parties may agree. In the case of a casualty loss, the Purchase Price shall be reduced by the amount of any deductible or co-insurance amount applicable to the unrestored loss. 13.2 LOSS. This Article XIII is intended as an express provision with respect to destruction and condemnation which supersedes the provisions of the Nevada Uniform Vendor and Purchaser Risk Act. -12- ARTICLE XIV CLOSING 14.1 DATE AND PLACE. Closing of the transaction contemplated hereby for the Assets shall be held at 10:00 A.M. (local time) at the offices of the Escrow Agent in Las Vegas, at such date, place and time as the parties may mutually agree ("Closing Date") but no later than July 3, 2003. 14.2 SELLER'S DELIVERIES. On the Closing Date, Seller shall deliver to the Escrow Agent the following closing documents, all duly executed by the proper parties: 14.2.1 Seller's deed in a form substantially the same as EXHIBIT C attached hereto, conveying to Purchaser good and marketable fee simple title to the Property, subject only to the Permitted Exceptions. 14.2.2 Seller's FIRPTA Affidavit, substantially in the form attached as EXHIBIT F, dated as of the Closing Date. 14.2.3 The Assignment. 14.2.4 All additional documents required by the provisions of this Contract to be executed or delivered by Seller on or prior to Closing. 14.2.5 Documents evidencing the legal status, good standing and authority of Seller and such other documents, instruments, affidavits, certifications and confirmations as may reasonably be required and designated by Purchaser, Purchaser's attorney, or the Escrow Agent to fully effect and consummate the transactions contemplated hereby, so long as they do not require Seller to expend any material amount of additional money not contemplated in this Contract. 14.2.6 Original documents relating to the purchase of the Chateaux Loan including but not limited to the Old Note. 14.2.7 The Quit Claim Bill of Sale covering the Intangible Property. 14.2.8 The Unwind Documents described in clauses (i), (iii) and (iv) of the definition thereof. -13- 14.3 PURCHASER'S DELIVERIES. On the Closing Date, Purchaser shall deliver to the Escrow Agent the following documents, all duly executed by the proper parties: 14.3.1 All documents evidencing the legal status, standing and authority of Purchaser and such other documents, instruments, certifications and confirmation as may reasonably be required and designated by Seller, Seller's attorney, or the Escrow Agent to fully effect and consummate the transaction contemplated hereby, so long as they do not require Purchaser to expend any material amount of additional money not contemplated in this Contract. 14.3.2 The Unwind Documents described in clauses (ii), (iii) and (iv) of the definition thereof, the Purchase Note, the Deed of Trust, the Repayment Note and evidence that the Marriott Agreement has been executed. 14.3.3 All additional documents required by the provisions of this Contract to be executed or delivered by Purchaser on or prior to Closing. 14.3.4 APPROVAL OF CLOSING DOCUMENTS. All Closing documents to be furnished by Seller or Purchaser pursuant hereto shall be in form and substance reasonably satisfactory to both Seller and Purchaser. ARTICLE XV CONTEMPLATED USE OF THE PROPERTY 15.1 CONTEMPLATED USE OF THE PROPERTY. The parties hereto acknowledge that Purchaser contemplates (i) developing and constructing, in phases, a residential condominium resort on the Property, totaling approximately eight hundred sixty-eight (868) units; (ii) submitting the Property in phases to an interval ownership plan; and (iii) selling timeshare interests pursuant thereto under its Marriott Vacation Club International brand. 15.2 DEFINITIONS. Any use in this Contract of the phrases "Purchaser's Contemplated Use", "contemplated use of the Property," or similar phrases shall mean Purchaser's development, use and enjoyment of the Property as described in Section 15.1. ARTICLE XVI NOTICES -14- 16.1 NOTICES. Any notice, request, demand, instruction or other document to be given or served hereunder or under any document or instrument executed pursuant hereto shall be in writing and shall be delivered personally with a receipt requested therefor or by telex or telephone facsimile or sent by a recognized overnight courier service or by United States registered or certified mail, return receipt requested, postage prepaid and addressed to the parties at their respective addresses set forth below, and the same shall be effective (i) upon receipt or refusal if delivered personally or by telex or by telephone facsimile, (ii) one business day after depositing with such an overnight courier service, or (iii) three business days after deposit in the mails if mailed. A party may change its address for receipt of notices by service of a notice of such change in accordance herewith. All notices by telex or telephone facsimile shall be subsequently confirmed by U.S. certified or registered mail or by recognized overnight courier service. If to Purchaser: Diamond Resorts International Attn: President 3745 Las Vegas Blvd. South Las Vegas, Nevada 89109 with copies to: Lionel Sawyer & Collins Attn: Jeffrey P. Zucker, Esq. 1700 Bank of America Plaza 300 South Fourth Street Las Vegas, Nevada 89101 If to Seller: Grand Casinos Nevada I, Inc. 130 Cheshire Lane Minnetonka, Minnesota 55305 Attention: President Fax: (952) 449-7064 with a copy to: Maslon Edelman Borman & Brand, LLP 3300 Wells Fargo Center 90 South Seventh Street Minneapolis, Minnesota 55402 Attention: Neil I. Sell, Esq. Fax: (612) 672-8397 ARTICLE XVII ENTIRE AGREEMENT, AMENDMENTS AND WAIVERS 17.1 ENTIRE AGREEMENT, AMENDMENTS AND WAIVERS. This Contract, inclusive of the recital paragraphs above, which by this reference are made a part of this Contract, contains the entire -15- agreement and understanding of the parties with respect to the subject matter hereof, and the same may not be amended, modified or discharged nor may any of its terms be waived except by an instrument in writing signed by the party to be bound thereby. ARTICLE XVIII CONTEMPLATED USE OF THE PROPERTY 18.1 NO THIRD PARTY BENEFITS. This Contract is for the sole and exclusive benefit of the parties hereto and their respective successors and assigns, and no third party other than a permitted assignee of Purchaser or Seller is contemplated to or shall have any rights hereunder. 18.2 ASSIGNMENT. Neither party may assign any of its rights or obligations hereunder without the prior written consent of the other party, which consent shall not be unreasonably withheld or delayed, except (i) Purchaser may assign its rights and obligations under this Contract to NEWCO without Seller's consent (which assignment will not release Purchaser of its obligations hereunder) and (ii) to a subsidiary or affiliated company of either party or pursuant to a merger of Seller or Purchaser provided that in each instance the assigning party remains liable hereunder. ARTICLE XIX MISCELLANEOUS 19.1 FURTHER ASSURANCES. The parties each agree to do, execute, acknowledge and deliver all such further acts, instruments and assurances and to take all such further action before or after the Closing as shall be reasonably necessary or desirable to fully carry out this Contract and to fully consummate and effect the transactions contemplated hereby. 19.2 SURVIVAL AND BENEFIT. All representations, agreements, indemnifications and obligations of the parties shall survive the Closing, and the same shall inure to the benefit of, and be binding upon, the respective successors and assigns of the parties. 19.3 INTERPRETATION. 19.3.1 The headings and captions herein are inserted for convenient reference only and the same shall not limit nor construe the Sections or Articles to which they apply nor otherwise affect the interpretation hereof. -16- 19.3.2 The terms "hereby", "hereof", "hereto", "herein", "hereunder", and any similar terms shall refer to this Contract, and the term "hereafter" shall mean after, and the term "heretofore" shall mean before, the Effective Date. 19.3.3 Words of the masculine, feminine or neuter gender shall mean and include the correlative words of other genders, and words importing the singular number shall mean and include the plural number and vice versa. 19.3.4 Words importing persons shall include firms, associations, partnerships, limited liability companies, trusts, corporations and other legal entities, including public bodies, as well as natural persons. No reference herein to Seller or Purchaser shall, in and of itself, be deemed to refer to its shareholders or members as such. 19.3.5 The terms "include," "including," and similar terms shall be construed as if followed by the phrase "without being limited to". 19.3.6 This Contract and any document or instrument executed pursuant hereto may be executed in any number of counterparts each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 19.3.7 All references herein to "days" shall mean calendar days. 19.3.8 This Contract shall be governed by and construed in accordance with the laws of the State of Nevada. 19.3.9 Time is of the essence of this Contract. 19.3.10 Except as otherwise specifically set forth in this Contract, neither Seller nor Purchaser shall avail itself of any remedy granted to it hereunder based upon an alleged default of the other party hereunder unless and until written notice of the alleged default, in reasonable detail, has been delivered to the defaulting party by the non-defaulting party and the alleged default has not been cured on or before 5:00 p.m. (local time) on the fifth (5th) day next following delivery of the notice of default. -17- 19.3.11 This Contract shall not be construed more strictly against one party than against the other merely by virtue of the fact that it may have been prepared primarily by counsel for one of the parties, it being recognized that both Purchaser and Seller have contributed substantially and materially to the preparation of this Contract. 19.3.12 Any condition precedent imposed as a contingency under this Contract may be waived by the party entitled to satisfaction of the condition as a pre-requisite to that party's performance. Any condition precedent which remains unsatisfied upon Closing shall be deemed to be waived by the party entitled to satisfaction. 19.4 DISCREPANCY IN DESCRIPTIONS. If prior to the delivery of the deed, it appears that the legal description of the real property to be purchased does not include or correctly describe Seller's fee simple title therein or appurtenances thereto, the legal description shall be modified to correctly describe the same at Purchaser's request. 19.5 PUBLICITY. All notice to third parties and all other publicity concerning the transaction contemplated hereby prior to the Closing Date shall be jointly planned and coordinated by and between Purchaser and Seller. None of the parties shall act unilaterally in this regard without the prior written approval of the other, except as required by law; however, this approval shall not be unreasonably withheld or delayed. 19.6 RELATION OF PARTIES. This Contract shall not be deemed, held or construed as creating a partnership or joint venture between any of the parties hereto. Breach of this Contract due to the action or inaction of only one of the parties constituting Purchaser shall not give rise to liability on the part of the other party. 19.7 HEADINGS. The captions and headings used in this Contract are for convenience only and do not in any way limit, amplify, or otherwise modify the provisions of this Contract. 19.8 INVALID PROVISIONS. If any provision of this Contract is held to be illegal, invalid or unenforceable under present or future laws, such provision shall be fully severable; this Contract shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Contract; and the remaining provisions of this Contract shall remain in full -18- force and effect and shall not be affected by such illegal, invalid, or unenforceable provision or by its severance from this Contract. 19.9 ATTORNEY'S FEES. In the event it becomes necessary for either party hereto to file suit to enforce this Contract or any provision contained herein, the prevailing party shall be entitled to recover reasonable attorney's fees at both the trial and appellate stages. ARTICLE XX OFFER AND ACCEPTANCE 20.1 OFFER AND ACCEPTANCE. Delivery by either party to the other of a copy of this Contract executed by such party shall constitute an offer by such party to sell or purchase, as the case may be, the Assets upon the terms and conditions herein set forth and subject to the provisions herein contained, which offer shall be effective for a period of ten (10) days after receipt by the other party (unless otherwise previously revoked). If the other party fails to deliver a fully executed counterpart of this Contract to the offeror prior to expiration of the offer period, then the offer shall automatically be revoked and rescinded in its entirety, and upon such revocation and rescission, the offer and this Contract shall have no further force or effect. [The remainder of this page has been left blank intentionally.] -19- IN WITNESS WHEREOF, this Contract has been executed and delivered by Seller and Purchaser on the respective dates set forth next to each of their signatures. SELLER: GRAND CASINOS NEVADA I, INC. Dated: June 26, 2003 By: /s/ Timothy J. Cope ------------------- Title: CFO PURCHASER: DIAMOND RESORTS, LLC Dated: June 26, 2003 By: /s/ Stephen J. Cloobeck ------------------------ Title: President -20- EX-31.1 4 c78855exv31w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 302 Exhibit 31.1 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. Lakes Entertainment, Inc.'s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for Lakes Entertainment, Inc., and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. disclosed in this report any change in Lakes Entertainment, Inc.'s internal control over financial reporting that occurred during Lakes Entertainment, Inc.'s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Lakes Entertainment, Inc.'s internal control over financial reporting; 5. Lakes Entertainment, Inc.'s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to Lakes Entertainment, Inc.'s auditors and the audit committee of Lakes Entertainment, Inc.'s board of directors or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect Lakes Entertainment, Inc.'s ability to record, process, summarize and report financial information; 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 control over financial reporting. Date: August 13, 2003 /s/Lyle Berman -------------------------- Lyle Berman Chief Executive Officer 37 EX-31.2 5 c78855exv31w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 302 Exhibit 31.2 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. Lakes Entertainment, Inc.'s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for Lakes Entertainment, Inc., and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. disclosed in this report any change in Lakes Entertainment, Inc.'s internal control over financial reporting that occurred during Lakes Entertainment, Inc.'s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Lakes Entertainment, Inc.'s internal control over financial reporting; 5. Lakes Entertainment, Inc.'s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to Lakes Entertainment, Inc.'s auditors and the audit committee of Lakes Entertainment, Inc.'s board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect Lakes Entertainment, Inc.'s ability to record, process, summarize and report financial information; 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 control over financial reporting. Date: August 13, 2003 /s/ Timothy J. Cope -------------------------- Timothy J. Cope Chief Financial Officer 38 EX-32.1 6 c78855exv32w1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Lakes Entertainment, Inc. (the "Company") on Form 10-Q for the period ended June 29, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Lyle Berman, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Lyle Berman ----------------------- Lyle Berman Chief Executive Officer August 13, 2003 EX-32.2 7 c78855exv32w2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Lakes Entertainment, Inc. (the "Company") on Form 10-Q for the period ended June 29, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Timothy J. Cope, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Timothy J. Cope ----------------------------------- Timothy J. Cope Chief Financial Officer August 13, 2003 -----END PRIVACY-ENHANCED MESSAGE-----