ITEM 1. BUSINESS
The following discussion contains trend information and other forward-looking statements that involve a number of risks and uncertainties. The actual results of Lakes Gaming, Inc., a Minnesota corporation (the "Company"), could differ materially from the Company's historical results of operations and those discussed in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those identified in "Risk Factors."
Lakes Gaming, Inc., a Minnesota corporation ("Lakes" or the "Company") was established as a public corporation on December 31, 1998, via a distribution (the "Distribution") of its common stock, par value $.01 per share (the "Common Stock") to the shareholders of Grand Casinos, Inc. ("Grand"). Pursuant to the terms of a Distribution Agreement entered into between Grand and Lakes and dated as of December 31, 1998 (the "Distribution Agreement"), Grand shareholders received .25 shares of Lakes Common Stock for each share held in Grand.
Immediately following the Distribution, Grand merged with a subsidiary of Park Place Entertainment Corporation, a Delaware corporation ("Park Place"), pursuant to which Grand became a wholly owned subsidiary of Park Place (the "Merger"). Grand shareholders received one share of Park Place common stock in the Merger for each share they held in Grand.
Lakes operates an Indian casino management business and holds various other assets previously owned by Grand. The Company's revenues are derived almost exclusively from management fees. Lakes currently manages two land-based, Indian-owned casinos in Louisiana: Grand Casino Avoyelles, in Marksville, Louisiana ("Grand Casino Avoyelles"), owned by the Tunica-Biloxi Tribe of Louisiana (the "Tunica-Biloxi Tribe") and Grand Casino Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta"), owned by the Coushatta Tribe of Louisiana (the "Coushatta Tribe").
Other assets previously owned by Grand that Lakes now owns through a subsidiary, include certain interests in four contiguous parcels of land in Las Vegas, Nevada, including the Polo Plaza Shopping Center. All or any combination of these interests may be sold, held for sale or held for future development. Lakes is currently evaluating the potential sale of these interests and in connection therewith has entered into a listing agreement with a real estate broker for the active marketing of these parcels.
For a portion of fiscal 1998, and prior to the Distribution, Grand also had management contracts for Indian-owned casinos located at Grand Casino Hinckley and Grand Casino Mille Lacs, both located in Minnesota. The management contract at Grand Casino Mille Lacs expired at the end of the first quarter of 1998, and the management contract at Grand Casino Hinckley ended November 30, 1998.
BUSINESS STRATEGY
Lakes' vision is to create a company with predictable long-term profitable growth that will be highly valued by its investors. The Company will implement three business strategies to accomplish its vision. The first of the three strategies is to grow the Company's assets. The more assets the Company has, the greater its potential for diversification and growth. The Company plans to increase its asset base by continuing to provide high quality comprehensive management services to Grand Casino Avoyelles and Grand Casino Coushatta. Lakes is dedicated to developing superior facilities and providing guest service that exceeds expectations. The facilities managed by Lakes are staffed with well-trained local casino employees and offer a casual environment designed to appeal to the family-oriented, middle income customer. Lakes strives to offer its casino customers creative gaming selections in a pleasant, festive, smoke and climate-controlled setting. Lakes' managed casinos also offer reasonably priced, high-quality food, first class hotel rooms, video arcades and Grand Casinos Kids Quest (SM), a professionally supervised entertainment and child care center.
Lakes 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 for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. The Coushatta Tribe and Lakes have agreed on a five-year contract renewal beginning January 17, 2002, subject to National Indian Gaming Commission ("NIGC") approval. Net distributable profits, if any, under the new agreement will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes. There can be no assurance that the Grand Casino Avoyelles management contract will be renewed upon expiration or the Grand Casino Coushatta extension will be approved by NIGC. The failure to renew
Lakes' management contracts would result in the loss of revenues to Lakes derived from such contracts, which would have a material, adverse effect on Lakes' results of operations. The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into tribal-state compacts with the State of Louisiana on September 29, 1992. These compacts were approved in November 1992 by the Secretary of the Interior. The compact for the Coushatta Tribe expired November 4, 1999, and the compact for the Tunica-Biloxi Tribe expired November 18, 1999, and the State of Louisiana has delivered a written notice of non-renewal. The Governor and each Tribe have agreed on a six-month extension which has been submitted to the Department of the Interior for approval. The Coushatta Tribe and the Tunica-Biloxi Tribe are actively negotiating with the State of Louisiana terms for a new compact. Lakes' management agreements with the Tunica-Biloxi Tribe and the Coushatta Tribe expire after November 1999. In the event the compacts are not renewed, gaming may not be permitted at Grand Casino Avoyelles or Grand Casino Coushatta. There can be no assurance that these compacts will be renewed on terms and conditions acceptable to either of the Tribes.
Another way the Company plans to grow its assets is to grow the Indian casino management business. Lakes enjoys a reputation as an experienced and successful casino management company for Native American owned casinos with available capital and experienced management. Lakes develops, constructs and manages Indian-owned casino properties that offer the opportunity for long-term development of related entertainment facilities, including hotels, theaters, recreational vehicle parks and other complimentary amenities designed to enhance the customers' total entertainment experience and to differentiate facilities managed by Lakes from its competitors. Lakes provides experienced corporate and casino management and develops and implements a wide scale of marketing programs. In conjunction with this part of Lakes' business strategy, Lakes entered into three new agreements in 1999, for the development, construction and management of three new Indian-owned casinos.
On May 12, 1999, the Company announced that it would form a partnership for the purpose of developing a gaming facility on Indian-owned land near San Diego, California. Under the agreement, Lakes has formed a limited liability company with Kean Argovitz Resorts, LLC ("KAR"), a limited liability company based in Houston, Texas. The partnership between Lakes and KAR holds a contract to develop and manage a casino resort facility with the Jamul Indian Village in California. The contract is subject to approval by NIGC. California voters recently approved an amendment to the State Constitution which allows for Nevada-style gaming on Indian land and ratifies the Tribal Compact. Development of the casino resort will begin once various regulatory approvals are received.
On June 22, 1999, the Company announced that it has been selected by the Pokagon Band of Potawatomi Indians (the "Band") to serve as the exclusive developer and manager of a proposed casino gaming resort facility to be owned by the Band in the state of Michigan. In connection with its selection, Lakes and the Band have executed a development and management agreement governing their relationship during the development, construction and management of the casino. Various regulatory approvals are needed prior to commencement of development activities. Casino construction is not planned to start until land is accepted into trust status by the Secretary of the Interior and the agreements are approved by the Chairman of NIGC.
On July 15, 1999, the Company announced that it would form a partnership for the purpose of developing a gaming facility on Indian-owned land near Sacramento, California. Pursuant to the agreement, Lakes has formed a limited liability company with KAR, a limited liability company based in Houston, Texas. The partnership between Lakes and KAR has been awarded a contract to develop and manage a casino resort facility with the Shingle Springs Band of Miwok Indians in California. The contract is subject to approval by NIGC and placement of the land where the gaming facility is to be located into trust with the Bureau of Indian Affairs ("BIA"). California voters recently approved an amendment to the State Constitution which allows for Nevada-style gaming on Indian land and ratifies the Tribal Compact. Development of the casino resort will begin once various regulatory approvals are received.
Each of the three new agreements require Lakes to loan each tribe various amounts to be used for preliminary development and start-up costs at each casino location. Total loan commitments, by Lakes, for the three projects are approximately $100 million.
The second business strategy is to remove a number of uncertainties surrounding the Company. To help accomplish this part of the Lakes strategy, the Company continues to evaluate the potential sale or development of its land in Las Vegas. The Company has the land listed for sale with a real estate broker and is currently reviewing alternative offers for the development or potential sale of the property. The Company also must win or settle the various lawsuits regarding Stratosphere. The Company is actively defending the suits and expects trial hearings to start in 2001 unless they are settled prior to that time. The other uncertainty
facing Lakes relates to the three proposed casino developments. In each such location, the Tribes need to have land accepted into trust on their behalf by the Bureau of Indian Affairs, and the National Indian Gaming Commission needs to approve the applicable Lakes management contracts. In addition, the Pokagon Band of Potawatomi Indians in Michigan needs to secure a valid contract with that state or a casino may not be built. Lakes is actively working with the Tribes to bring these issues to a successful conclusion.
Diversification is the key to Lakes' long-term success and it is the third of the business strategies. Lakes currently plans to buy or create new long-term business opportunities through the use of cash, stock or debt to complement its Indian casino management business. Substantial long-term growth and low multiple values to generate high returns are just a few of the attributes in companies or start-ups that Lakes is looking for in new opportunities to help enhance shareholder value. In addition to this approach, Lakes currently has investments in unconsolidated affiliates which include a 27 percent ownership interest in Fanball.com, Inc., a start-up internet provider of fantasy sports services, and a 23 percent ownership interest in Interactive Learning Group, Inc., a consumer product company. Lakes invested $3.4 million and $3 million in Fanball.com and Interactive Learning Group, respectively, at the end of the second quarter of 1999. Additionally, as a result of its spin-off from Grand, Lakes received a 49 percent ownership interest in Trak 21 Development, LLC, a developer of player tracking systems for the casino industry, and a 27 percent ownership interest in New Horizon Kids Quest, Inc., a publicly held provider of child care facilities.
MARKETING
Lakes targets its marketing strategy at its managed operations to attract and retain the repeat customer. Management believes that Lakes' emphasis on enhancing the entertainment value, coupled with marketing programs, contributes to attracting the repeat customer.
Lakes' operations strategy seeks to combine retail, gaming and entertainment marketing techniques. Lakes profiles its casino customers utilizing available demographic data, regularly conducted customer surveys and other sources. Based upon this data, Lakes uses a variety of initial special promotions to attract the first-time customer and, thereafter, seeks to leverage initial customer satisfaction through a mix of marketing programs dedicated to developing a repeat customer. A variety of other events, facilities and entertainment media provide the patron with a total entertainment experience. Lakes markets these programs through a variety of direct and media marketing techniques utilizing a significant customer database at each location.
GRAND CASINO AVOYELLES
Grand Casino Avoyelles opened in June 1994 and consists of a 218 room hotel and approximately 50,000 square feet of casino gaming space containing approximately 1,700 slot machines and 55 table games. The resort's other features include a 1,700 seat entertainment complex, three restaurants plus a night club featuring live entertainment, a full-service RV resort, a Kids Quest(SM) child care activity center, a video arcade, a gift shop and parking for approximately 2,250 vehicles.
Grand Casino Avoyelles is located approximately 50 miles west of Natchez, Mississippi, and within approximately 200 miles of the Louisiana cities of Baton Rouge, Lafayette, New Orleans, and Shreveport. Lakes purchased approximately 64 acres of land adjacent to the Tunica-Biloxi reservation and donated approximately 21 acres of this land to the Tunica-Biloxi Tribe. This land has been placed in trust, has been approved for gaming, and is the site upon which Grand Casino Avoyelles was constructed.
Lakes also leases land to the Tunica-Biloxi Tribe for a 220 room hotel which opened during 1996 and is located in close proximity to Grand Casino Avoyelles. The Tunica-Biloxi Tribe operates the hotel as a part of the Grand Casino Avoyelles enterprise. Lakes guaranteed $16.5 million of Tunica-Biloxi Tribal debt incurred in connection with the purchase of the hotel, and has subordinated payment of Lakes' management fee and any loan amounts owed by the Tunica-Biloxi Tribe to Lakes to the repayment of such debt. As of January 2, 2000, the amount outstanding was $2.0 million. The debt is scheduled to be fully repaid by April 2000.
The term of Lakes' development and management agreement with the Tunica-Biloxi Tribe (the "Tunica-Biloxi Agreement") expires on June 3, 2001. The net distributable profits, if any, as determined on a modified cash basis, are distributed each month 60% to the Tunica-Biloxi Tribe and 40% to Lakes.
Lakes loaned the Tunica-Biloxi Tribe an aggregate of approximately $23.5 million to construct and open Grand Casino Avoyelles, of which amount approximately $3.5 million was not, but may need to be, approved by the BIA and/or NIGC. Approximately $5.4 million of such loans remained outstanding at January 2, 2000.
The loans bear interest at 1% over the prime rate and are payable over the remaining term of the Tunica-Biloxi Agreement.
The Tunica-Biloxi Agreement was approved by the BIA on February 27, 1992. The Tunica-Biloxi Tribe and the State of Louisiana entered into a tribal-state compact on September 29, 1992, which was approved by the Secretary of the Interior on November 18, 1992. The compact expired on November 18, 1999 and the State of Louisiana has delivered a written notice of non-renewal. The Governor and the Tribe have agreed on a six-month extension which has been approved by the Department of the Interior.
In connection with the Distribution, Lakes and the appropriate subsidiaries made application to the Tribal gaming regulatory authority for a license and obtained certification and licensure by the Louisiana State Police.
GRAND CASINO COUSHATTA
Grand Casino Coushatta opened in January 1995 and currently consists of a 223 room hotel and approximately 98,000 square feet of casino gaming space containing approximately 3,100 slot machines and 90 table games. Three restaurants plus a food court, a full-service RV resort, a Kids Quest(SM) child care center, a video arcade, a gift shop and parking for approximately 1,600 vehicles are among the property's non-gaming amenities.
On February 25, 1992, Grand, as predecessor to Lakes, entered into a construction agreement and management contract (the "Coushatta Agreement") with the Coushatta Tribe for the development, construction, and management of a casino facility in Elton, Louisiana, on Highway 165. Grand Casino Coushatta is located approximately 60 miles south of Alexandria, Louisiana, and within 200 miles of Houston, Texas. Grand purchased approximately 688 acres of land adjacent to the Coushatta reservation. Grand has donated approximately 530 acres to the Coushatta Tribe. This land has been placed in trust for the Coushatta Tribe. The remaining land was sold to the Coushatta Tribe, and Lakes holds a promissory note to secure payment of the purchase price with an outstanding balance of $1.5 million at January 2, 2000.
Grand loaned the Coushatta Tribe an aggregate of approximately $38.3 million to construct and open Grand Casino Coushatta, of which amount up to approximately $20.3 million was not, but may need to be, approved by the BIA and/or NIGC. The loans bear interest at 1% over the prime rate and are payable over the remaining term of the Coushatta Agreement. Approximately $10.0 million of such loans remained outstanding as of January 2, 2000.
The Coushatta Tribe constructed a hotel on trust land located adjacent to the casino. Pursuant to the Distribution, Lakes guaranteed $25.0 million of indebtedness incurred by the Tribe in connection therewith. Such indebtedness has a repayment term of approximately five years. Lakes subordinated payment of its management fee and repayment of any loans outstanding from the Coushatta Tribe to the repayment of such indebtedness. As of January 2, 2000, the amount outstanding was $19.3 million.
The Coushatta Agreement was approved by the BIA on February 27, 1992. The Coushatta Tribe and the State of Louisiana entered into a tribal-state compact on September 15, 1992, which was approved by the Secretary of the Interior on November 4, 1992.
The compact expired on November 4, 1999 and the State of Louisiana has delivered a written notice of non-renewal. The Governor and the Tribe have agreed on a six-month extension which has been approved by the Department of the Interior. In connection with the Distribution, Lakes was certified by the Louisiana State Police to manage the casino.
The current Coushatta Agreement expires on January 16, 2002. The net distributable profits, if any, as determined on a modified cash basis, are distributed each month 60% to the Coushatta Tribe and 40% to Lakes. The Coushatta Tribe and Lakes have agreed on a five year contract renewal beginning January 17, 2002, subject to NIGC approval. Net distributable profits, if any, under the new contract will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes.
FUNDING AGREEMENTS
Pursuant to the terms of the Distribution Agreement, Lakes assumed Grand's obligations under various agreements (the "Funding Agreements") with each of the Tunica-Biloxi and Coushatta Tribes to provide temporary funding, if necessary, for the construction of certain additional amenities on Grand Casino Avoyelles and Grand Casino Coushatta. The terms of the Funding Agreements require each party to advance
money for the payment of construction costs if and when the casino operating funds designated for such purpose are insufficient. Any funds advanced are to be repaid, together with interest at the prime rate plus 1 percent, over the remaining term of the respective management agreement.
Advances of $1.2 million and $13.9 million had been made to the Tunica-Biloxi and Coushatta Tribes, respectively, as of January 2, 2000. Amounts outstanding were $0.8 million and $11.0 million to the Tunica-Biloxi and Coushatta Tribes, respectively.
POLO PLAZA
On October 1, 1999, the Company purchased the shopping center and land owned by the Nevada Resort Properties Polo Plaza Limited Partnership (the "Partnership") in lieu of exercising its right to purchase the remaining 51% interest in the Partnership. Prior to the purchase, the Company held a 49% ownership interest in the Partnership. In consideration for the purchase, the Company paid approximately $3.3 million and paid off the outstanding partnership mortgage of approximately $6.3 million. A $6.2 million loan to the Partnership made by the Company during January 1999 was repaid and satisfied at the closing by offsetting an appropriate amount against the purchase price as agreed by the Company and the Partnership. Pursuant to the purchase agreement relating to this transaction, the Partnership is currently being dissolved. Lakes continues to operate the site as a commercial shopping center.
COMPETITION
The gaming industry is highly competitive. Gaming activities include traditional land-based casinos; river boat and dockside gaming; casino gaming on Indian land; state-sponsored video lottery and video poker in restaurants, bars and hotels; pari-mutuel betting on horse racing, dog racing, and jai-alai; sports bookmaking; and card rooms. The casinos managed by Lakes compete with all these forms of gaming, and will compete with any new forms of gaming that may be legalized in additional jurisdictions, as well as with other types of entertainment. Lakes also competes with other gaming companies for opportunities to acquire legal gaming sites in emerging gaming jurisdictions and for the opportunity to manage casinos on Indian land. Some of the competitors of Lakes have more personnel and greater financial and other resources than Lakes. Further expansion of gaming could also significantly affect Lakes' business.
The Louisiana markets are highly competitive and numerous Louisiana casinos, along with others in Mississippi, compete with Grand Casino Coushatta and Grand Casino Avoyelles. A single large land-based casino recently opened in downtown New Orleans and competes for customers with the casinos managed by Lakes. Louisiana has also legalized river boat gaming. There are presently 14 licensed river boats in operation in Louisiana, four of which are presently operating in the vicinity of Lake Charles, Louisiana, within approximately 50 miles of Grand Casino Coushatta, drawing players from the Houston market.
The river boats compete with Louisiana casinos managed by Lakes. Moreover, the legalization of casino gaming in Texas could have a material adverse effect on the casinos managed by Lakes. Louisiana has also enacted legislation allowing racetracks in certain parishes to install slot machines, which has been approved in local referenda. The slot machine operations could also have a material effect on the casinos managed by Lakes. Video poker machines may be located in facilities that serve liquor, at truck stops, and at pari-mutuel racetracks and off-track betting facilities.
REGULATION
The ownership, management, and operation of gaming facilities are subject to extensive federal, state, provincial, tribal and/or local laws, regulations and ordinances, which are administered by the relevant regulatory agency or agencies in each jurisdiction (the "Regulatory Authorities"). 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. Certain basic provisions that are currently applicable to Lakes are described below.
Neither Lakes nor any subsidiary may own, manage or operate a gaming facility unless proper licenses, permits and approvals are obtained. An application for a license, permit or approval may be denied for any cause that the Regulatory Authorities deem reasonable. Most Regulatory Authorities also have the right to license, investigate, and determine the suitability of any person who has a material relationship with Lakes or any of its subsidiaries, including officers, directors, employees, and security holders of Lakes or its subsidiaries. In the event a Regulatory Authority were to find a security holder to be unsuitable, Lakes may be sanctioned,
and may lose its licenses and approvals if Lakes recognizes any rights in such unsuitable person in connection with such securities. Lakes may be required to repurchase its securities at fair market value from security holders that the Regulatory Authorities deem unsuitable. Lakes' Articles of Incorporation authorize Lakes to redeem securities held by persons whose status as a security holder, in the opinion of the Lakes' Board, jeopardizes gaming licenses or approvals of Lakes or its subsidiaries.
Once obtained, licenses, permits, and approvals must be periodically renewed and generally are not transferable. The Regulatory Authorities may at any time revoke, suspend, condition, limit, or restrict a license for any cause they deem reasonable. Fines for violations may be levied against the holder of a license, and in certain jurisdictions, gaming operation revenues can be forfeited to the State under certain circumstances. No assurance can be given that any licenses, permits, or approvals will be obtained by Lakes or its subsidiaries, or if obtained, will be renewed or not revoked in the future. In addition, the rejection or termination of a license, permit, or approval of Lakes or any of its employees or security holders in any jurisdiction may have adverse consequences in other jurisdictions. Certain jurisdictions require gaming operators licensed therein to seek approval from the state before conducting gaming in other jurisdictions. Lakes and its subsidiaries may be required to submit detailed financial and operating reports to Regulatory Authorities.
The political and regulatory environment for gaming is dynamic and rapidly changing. The laws, regulations, and procedures pertaining to gaming are subject to the interpretation of the Regulatory Authorities and may be amended. Any changes in such laws, regulations, or their interpretations could have a material adverse effect on Lakes.
Certain specific provisions to which Lakes is currently subject are described below.
INDIAN GAMING
The terms and conditions of management contracts for the operation of Indian-owned casinos, and of all gaming on Indian land in the United States, are subject to the IGRA, which is administered by NIGC, and also are subject to the provisions of statutes relating to contracts with Indian tribes, which are administered by the Secretary of the Interior (the "Secretary") and the BIA. The regulations and guidelines under which NIGC will administer IGRA are evolving. The IGRA and those regulations and guidelines are subject to interpretation by the Secretary and NIGC and may be subject to judicial and legislative clarification or amendment.
Lakes may need to provide the BIA or NIGC with background information on each of its directors and each shareholder who holds five percent or more of Lakes' stock ("5% Shareholders"), including a complete financial statement, a description of such person's gaming experience, and a list of jurisdictions in which such person holds gaming licenses. Background investigations of key employees also may be required. Lakes' Articles of Incorporation contain provisions requiring directors and 5% Shareholders to provide such information.
IGRA currently requires NIGC to approve management contracts and certain collateral agreements for Indian-owned casinos. Prior to NIGC assuming its management contract approval responsibility, management contracts and other agreements were approved by the BIA. All of Lakes' current management contracts and collateral agreements were approved by the BIA; however, the NIGC may review such management contracts and collateral agreements for compliance with IGRA at any time in the future. The NIGC will not approve a management contract if a director or a 5% Shareholder of the management company (i) is an elected member of the Indian tribal government that owns the facility purchasing or leasing the games; (ii) has been or is convicted of a felony gaming offense; (iii) has knowingly and willfully provided materially false information to the NIGC or the tribe; (iv) has refused to respond to questions from the NIGC; or (v) is a person whose prior history, reputation and associations pose a threat to the public interest or to effective gaming regulation and control, or create or enhance the chance of unsuitable activities in gaming or the business and financial arrangements incidental thereto. In addition, the NIGC will not approve a management contract if the management company or any of its agents have attempted to unduly influence any decision or process of tribal government relating to gaming, or if the management company has materially breached the terms of the management contract or the tribe's gaming ordinance, or a trustee, exercising due diligence, would not approve such management contract.
A management contract can be approved only after NIGC determines that the contract provides, among other things, for (i) adequate accounting procedures and verifiable financial reports, which must be furnished to the tribe; (ii) tribal access to the daily operations of the gaming enterprise, including the right to verify daily
gross revenues and income; (iii) minimum guaranteed payments to the tribe, which must have priority over the retirement of development and construction costs; (iv) a ceiling on the repayment of such development and construction costs; and (v) a contract term not exceeding five years and a management fee not exceeding 30% of profits; provided that the NIGC may approve up to a seven year term and a management fee not to exceed 40% of profits if NIGC is satisfied that the capital investment required, and the income projections for the particular gaming activity justify the larger profit allocation and longer term. While Lakes believes that its management contracts meet all requirements of IGRA, there is a risk that the NIGC may reduce the term or the management fee provided for in any such contracts. Currently, the management contracts (i) have not been reviewed or approved by NIGC, and (ii) NIGC could call them for review at any time and may not approve the contracts at all or may require modification prior to granting approval.
Grand and Lakes have requested that the NIGC either approve the Grand Distribution, the Merger and the assignment of Grand's management contracts to Lakes or acknowledge that their approval is not required. While Lakes believes that the assignment is valid and has received the consent and support of both the Tunica-Biloxi Tribe and the Coushatta Tribe, there can be no assurance that the NIGC will respond favorably or will respond in a timely manner.
IGRA established three separate classes of tribal gaming -- Class I, Class II, and Class III. Class I includes all traditional or social games played by a tribe in connection with celebrations or ceremonies. Class II gaming includes games such as bingo, pulltabs, punch boards, instant bingo and card games that are not played against the house. Class III gaming includes casino-style gaming and includes table games such as blackjack, craps and roulette, as well as gaming machines such as slots, video poker, lotteries, and pari-mutuel wagering.
IGRA prohibits substantially all forms of Class III gaming unless the tribe has entered into a written agreement with the state in which the casino is located that specifically authorizes the types of commercial gaming the tribe may offer (a "tribal-state compact"). IGRA requires states to negotiate in good faith with tribes that seek tribal-state compacts, and grants Indian tribes the right to seek a federal court order to compel such negotiations. Many states have refused to enter into such negotiations. Tribes in several states have sought federal court orders to compel such negotiations under IGRA; however, the Supreme Court of the United States held in 1996 that the Eleventh Amendment to the United States Constitution immunizes states from suit by Indian tribes in federal court without the states' consent.
Because Indian tribes are currently unable to compel states to negotiate tribal-state compacts, Lakes may not be able to develop and manage casinos in states that refuse to enter into, or renew, tribal-state compacts.
The State of Louisiana has entered into tribal-state compacts with the Coushatta Tribe and the Tunica-Biloxi Tribe. Each of the Louisiana compacts expired in November 1999. The State of Louisiana has delivered a written notice of non-renewal. The Governor and each Tribe have agreed on a six-month extension which has been approved by the Department of the Interior. In the event either of the Louisiana compacts is not renewed, legal gaming possibly may not be permitted at the applicable casino location. There can be no assurance that either of the Louisiana compacts will be renewed.
In addition to IGRA, tribal-owned gaming facilities on Indian land are subject to a number of other federal statutes. The operation of gaming on Indian land is dependent upon whether the law of the state in which the casino is located permits gaming by non-Indian entities, which may change over time. Any such changes in state law may have a material adverse effect on the casinos managed by Lakes.
Title 25, Section 81 of the United States Code states that "no agreement shall be made by any person with any tribe of Indians, or individual Indians not citizens of the United States, for the payment or delivery of any money or other thing of value...in consideration of services for said Indians relative to their lands...unless such contract or agreement be executed and approved" by the Secretary or his or her designee. An agreement or contract for services relative to Indian lands that fails to conform with the requirements of Section 81 will be void and unenforceable. Any money or other thing of value paid to any person by any Indian or tribe for or on his or their behalf, on account of such services, in excess of any amount approved by the Secretary or his or her authorized representative will be subject to forfeiture. Lakes believes that it has complied with the requirements of Section 81 with respect to its management contracts for Grand Casino Avoyelles and Grand Casino Coushatta.
The Indian Trader Licensing Act, Title 25, Section 261-64 of the United States Code ("ITLA") states that "any person other than an Indian of the full blood who shall attempt to reside in the Indian country, or on any Indian reservation, as a trader, or to introduce goods, or to trade therein, without such license, shall forfeit
all merchandise offered for sale to the Indians or found in his possession, and shall moreover be liable to a penalty of $500..." No such licenses have been issued to Lakes to date. The applicability of ITLA to Indian gaming management contracts is unclear. Lakes believes that ITLA is not applicable to its management contracts, under which Lakes provides services rather than goods to Indian tribes. Lakes further believes that ITLA has been superseded by IGRA.
Indian tribes are sovereign nations with their own governmental systems, which have primary regulatory authority over gaming on land within the tribe's jurisdiction. Because of their sovereign status, Indian tribes possess immunity from lawsuits to which the tribes have not otherwise consented or otherwise waived their sovereign immunity defense. Therefore, no contractual obligations undertaken by tribes to Lakes would be enforceable by Lakes unless the tribe has expressly waived its sovereign immunity as to such obligations. Courts strictly construe such waivers. Lakes has obtained immunity waivers from each of the tribes to enforce the terms of its management agreements, however, the scope of those waivers has never been tested in court, and may be subject to dispute. Additionally, persons engaged in gaming activities, including Lakes, are subject to the provisions of tribal ordinances and regulations on gaming. These ordinances are subject to review by NIGC under certain standards established by IGRA. The possession of valid licenses from the Coushatta Tribe and Tunica-Biloxi Tribe are conditions of the Coushatta Agreement and the Tunica-Biloxi Agreement, respectively.
NON-GAMING REGULATIONS
The Company and its subsidiaries are subject to certain federal, state and local, safety and health laws, regulations pertaining to operation of barges and other marine laws, and regulations and ordinances that apply to non-gaming businesses generally, such as the Clean Air Act, Clean Water Act, Occupational Safety and Health Act, Resource Conservation Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act. The Company believes that it is currently in material compliance with such regulations. The coverage and attendant compliance costs associated with such laws, regulations and ordinances may result in future additional cost to the Company's operations.
EMPLOYEES
At March 20, 2000, Lakes had approximately 25 employees. Lakes believes its relations with employees are positive.
RISK FACTORS
In addition to factors discussed elsewhere in this Annual Report on Form 10-K, the following are important factors that could cause actual results or events to differ materially from those contained in any forward-looking statement made by or on behalf of the Company.
INDEMNIFICATION OBLIGATIONS. Under the Distribution Agreement, Lakes and Grand agreed to indemnify each other for liabilities retained by them in the Distribution. Additionally, under the Agreement and Plan of Merger, dated as of June 30, 1998 (the "Merger Agreement") by and among Hilton Hotels Corporation, Park Place, Gaming Acquisition Corporation, Lakes and Grand, Lakes agreed to indemnify Grand for (i) Grand's ongoing indemnification obligations to current and former directors and officers of Grand and (ii) contingent liabilities related to Stratosphere Corporation ("Stratosphere"). The availability of such indemnities will be dependent upon the financial strength and creditworthiness of Grand and Lakes, respectively. No assurance can be given that such entities will be in a position to fund such indemnities should they be obligated to do so in the future.
LAKES' FUNDING OBLIGATION. As security to support Lakes' indemnification obligations to Grand under each of the Distribution Agreement and the Merger Agreement, Lakes agreed to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of Park Place, an aggregate of $30 million to cover various commitments and contingencies related to, or arising out of, Grand's Non-Mississippi business and assets (as defined in the Merger Agreement) (including by way of example, but not limitation, tribal loan guarantees, real property lease guarantees for Lakes' subsidiaries and director and executive officer indemnity obligations) consisting of four annual installments of $7.5 million, payable at the end of each year for a four year period subsequent to the effective date of the Merger if the indemnification obligation still exists. Lakes made the first deposit of $7.5 million on December 31, 1999 and such amount is included as restricted cash on the accompanying balance sheet as of January 2, 2000. Lakes' ability to satisfy this funding obligation is materially
dependent upon the continued success of its operations and the general risks inherent in its business. In the event Lakes is unable to satisfy its funding obligation, it would be in breach of its agreement with Grand, possibly subjecting itself to additional liability for contract damages, which could have a material adverse effect on Lakes' business and results of operations.
HIGHLY REGULATED INDUSTRY. The ownership, management and operation of gaming facilities are subject to extensive federal, state, provincial, tribal and/or local laws, regulations, 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. Grand and Lakes have requested that the NIGC either approve the Distribution or acknowledge that their approval is not required. There can be no assurance the NIGC approval or any other required approvals will be secured on a timely basis, if at all. See "Regulation."
STRATOSPHERE CORPORATION; PENDING LITIGATION. Grand and certain of its current and former directors and officers are defendants in several lawsuits related to Grand's former investment in Stratosphere. Stratosphere owns and operates the Stratosphere Tower, Casino & Hotel, a casino/hotel and entertainment complex in Las Vegas which filed for reorganization under Chapter 11 of the Bankruptcy Code on January 27, 1997. On November 7, 1997, Stratosphere filed a second amended proposed plan of reorganization with the Bankruptcy Court which became effective on October 14, 1998 (the "Second Amended Plan"). Under the Second Amended Plan, the secured portion of Stratosphere's outstanding first mortgage notes were converted into 100% of the equity of the reorganized Stratosphere and all of the common stock of Stratosphere outstanding prior to the effective date of the Second Amended Plan was canceled. Grand beneficially owned approximately 37% of the issued and outstanding common stock of Stratosphere prior to its cancellation as a result of the Second Amended Plan becoming effective.
Pursuant to the terms of the Distribution Agreement, any future liabilities arising out of the various Stratosphere-related lawsuits were assumed by Lakes. In addition other contingent liabilities related to or arising out of Grand's Non-Mississippi business (such as tribal loan guarantees, real property lease guarantees for Lakes' subsidiaries, and director and officer indemnity obligations (see below)) were also assumed by Lakes. Although potential costs associated with these various commitments and contingencies did not increase solely as a result of the Distribution, given the numerous uncertainties associated with litigation and the contingent nature of Lakes' various financial commitments, Lakes is unable to quantify, within any reasonable range, its total exposure if all or any of the pending litigation were to be resolved adversely to Lakes' interests. Nor is Lakes able to assess the likelihood that it will be required to perform on some or all of its contingent financial obligations.
Under Minnesota corporate law, Lakes is required, subject to certain limitations and exclusions, to indemnify its current and former officers and directors. Although Lakes has agreed to assume the liabilities related to Stratosphere and the Stratosphere lawsuits, Lakes agreed under the Merger Agreement to indemnify Grand for such liabilities and certain other pending litigation. Accordingly, Lakes will bear the cost of defending itself, its current and former directors and officers, and Grand and its current and former officers and directors for any settlement or judgment of such matters. Although these lawsuits are in their early stages and Lakes plans to defend itself vigorously, there can be no assurance that the costs of defense and any settlement or judgment will not have a material adverse effect on Lakes or, if Lakes does not satisfy its indemnification obligations to Grand, on Grand.
OPERATING COVENANTS; DIVIDEND RESTRICTIONS. So long as Lakes is required to indemnify Grand for certain specified liabilities, including (i) contingent liabilities assumed by Lakes under the Distribution Agreement, (ii) ongoing director and officer indemnification obligations and (iii) contingent liabilities related to Stratosphere, 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 interest in Lakes, without the written consent of Park Place, which consent can be given or withheld in Park Place's sole and absolute discretion.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. Lakes anticipates that the cash it received in the Distribution, interest expected to be earned thereon and its anticipated revenues will be sufficient to finance its operations. There can be no assurance, however, that Lakes will not seek or require additional capital at some point in the future through either public or private financings. Such financings may not be available when needed on terms acceptable to Lakes or at all. Moreover, any additional equity financings may be dilutive to Lakes shareholders, and any debt financing may involve additional restrictive covenants. An
inability to raise such funds when needed might require Lakes to delay, scale back or eliminate some of its expansion and development goals, and might require Lakes to cease its operations entirely. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of Lakes -- Capital Resources, Capital Spending and Liquidity."
COMPETITION. The gaming industry is highly competitive. Gaming activities include traditional land-based casinos; river boat and dockside gaming; casino gaming on Indian land; state-sponsored lotteries and video poker in restaurants, bars and hotels; pari-mutuel betting on horse racing, dog racing and jai alai; sports bookmaking; and card rooms. The Indian-owned casinos managed by Lakes compete, and will in the future compete, with all these forms of gaming, and will compete with any new forms of gaming that may be legalized in additional jurisdictions, as well as with other types of entertainment.
In Louisiana, there are presently 14 licensed river boats in operation that compete with Grand Casino Coushatta and Grand Casino Avoyelles, including "Casino America" and "Players Lake Charles" and, to a lesser extent, "Binion's Horseshoe Casino," "Casino Magic" and "Harrah's Shreveport."
Lakes also competes with other gaming companies for opportunities to acquire legal gaming sites in emerging and established gaming jurisdictions and for the opportunity to manage casinos on Indian land. Because the Distribution resulted in the unavailability of historical cash flows and assets represented by Grand's Mississippi business, Lakes' ability to compete for and develop future gaming or other business opportunities will be restricted, both in the size and number of development projects it can pursue. Many of Lakes' competitors have more personnel and most have greater financial and other resources than Lakes. Such competition in the gaming industry could adversely affect Lakes' ability to attract customers and thus, adversely affect its operating results. In addition, further expansion of gaming into new jurisdictions could also adversely affect Lakes' business by diverting customers from its managed casinos to competitors in such jurisdictions.
MANAGEMENT CONTRACTS OF LIMITED DURATION. Lakes is prohibited under the IGRA from having an ownership interest in any casino it manages for Indian tribes. The current management contracts for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. The Coushatta Tribe and Lakes have agreed on a five year contract renewal beginning January 17, 2002, subject to NIGC approval. Net distributable profits, if any, under the new agreement will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes. There can be no assurance that any of these management contracts will be renewed upon expiration or approved by the NIGC upon any such renewal. Lakes anticipates that any renewal of the Grand Casino Coushatta and Grand Casino Avoyelles management contracts will be upon terms less favorable to Lakes. The failure to renew Lakes' management contracts would result in the loss of revenues to Lakes derived from such contracts, which would have a material adverse effect on Lakes' results of operations.
The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into tribal-state compacts with the State of Louisiana on September 29, 1992. These compacts were approved in November, 1992 by the Secretary of the Interior. Each compact expired in November, 1999 and the State of Louisiana has delivered a written notice of non-renewal. The Governor and each Tribe have agreed on a six-month extension which has been approved by the Department of the Interior. In the event the compacts are not renewed, legal gaming may possibly not be permitted at Grand Casino Avoyelles or Grand Casino Coushatta. In the event that the compacts are renewed, but Lakes' management contracts are not, Lakes will not operate the casinos at those locations. The non-renewal of the management contracts would result in the loss of revenues to Lakes derived from such contracts, which would have a material adverse effect on Lakes' results of operations. Currently, the management contracts for Grand Casino Coushatta and Grand Casino Avoyelles generate all of Lakes' operating revenues. Without the renewal of either or both of the existing management contracts or the realization of new business opportunities or new management contracts, the non-renewal of the Louisiana management contracts would have a material adverse impact on Lakes' results of operations and financial condition. There can be no assurance that these compacts will be renewed on terms and conditions acceptable to either of the tribes.
MANAGEMENT CONTRACTS SUBJECT TO GOVERNMENTAL MODIFICATION. The NIGC has the power to require modifications to Indian management contracts under certain circumstances or to void such contracts or ancillary agreements including loan agreements if the management company fails to obtain requisite approvals or to comply with applicable laws and regulations. While Lakes believes that its management contracts meet the requirements of the IGRA, NIGC has the right to review each contract and has the authority to reduce the term of a management contract or the management fee or otherwise require modification of the contract,
which could have an adverse effect on Lakes. Currently, the management contracts (i) have not been reviewed or approved by NIGC and (ii) NIGC could call them for review at any time, in which case NIGC may not approve the contracts at all or may require modification prior to granting approval. In addition, Lakes has made loans to Indian tribes in excess of the loan ceilings set forth in each of the Indian management contracts. Under certain circumstances, these loans may not be enforceable by Lakes. As of January 2, 2000, loan balances outstanding to such tribes were approximately $33.1 million.
LIMITED RECOURSE AGAINST TRIBAL ASSETS. Lakes has made, and will make substantial loans to tribes for the construction, development, equipment and operations of casinos managed by Lakes. Lakes' only recourse for collection of indebtedness from a tribe or money damages for breach or wrongful termination of a management contract is from revenues, if any, from casino operations. Lakes has subordinated, and may in the future subordinate, the repayment of these loans to a tribe and other distributions due from a tribe (including management fees) in favor of other obligations of the tribe to other parties related to the casino operations. Accordingly, in the event of a default by a tribe under such obligations, Lakes' loans and other claims against the tribe will not be repaid until such default has been cured or the tribe's senior casino-related creditors have been repaid in full.
DEPENDENCE ON KEY PERSONNEL. Lakes' success will depend largely on the efforts and abilities of its senior corporate management, particularly Lyle Berman, its Chairman and Chief Executive Officer. The loss of the services of Mr. Berman or other members of senior corporate management could have a material adverse effect on Lakes. Lakes does not have an employment agreement with Mr. Berman.
LIMITED BASE OF OPERATIONS. Lakes' principal operations currently consist of the management of two Indian-owned casinos. The management contracts for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. The Coushatta Tribe and Lakes have agreed on a five-year contract renewal beginning January 17, 2002, subject to NIGC approval. The combination of the relatively small number of managed casinos and the potentially significant investment associated with any new managed casino may cause the operating results of Lakes to fluctuate significantly and adversely affect the profitability of Lakes. Due to this relatively small number of current locations, poor operating results at any one casino or a delay in the opening or non-opening of any future casinos could materially affect the profitability of Lakes. Future growth in revenues and profits will depend to a large extent on Lakes' ability to continue to increase the number of its managed casinos or develop new business opportunities.
RISKS ASSOCIATED WITH NEW DEVELOPMENT ACTIVITIES. Although Lakes and certain members of its management team have experience developing, operating and managing casinos owned by Indian tribes and located on Indian land, neither the Company nor any of these individuals has developed or operated a casino in either the State of California or the State of Michigan. In addition, the gaming industry in each of the three locations where Lakes plans to develop and operate casinos has no operating history as yet and faces several legal and procedural challenges which will need to be resolved prior to the commencement of Lakes' development activities and the opening and operation of the respective casinos.
The opening of each of the proposed Lakes' facilities, near San Diego, CA, Sacramento, CA, and in the State of Michigan, respectively, will be contingent upon, among other things, the completion of construction, hiring and training of sufficient personnel and receipt of all regulatory licenses, permits, allocations and authorizations. The scope of the approvals required to construct and open these facilities will be extensive, and the failure to obtain such approvals could prevent or delay the completion of construction or opening of all or part of such facilities or otherwise affect the design and features of the proposed casinos.
At this time, Lakes does not have a target date for the start of development and construction of these three projects, and no assurances can be given that even once a schedule for such construction and development activities has been established, such development activities will begin or will be completed on time, or any other time, or that the budget for these projects will not be exceeded. Major construction projects entail significant risks, including shortages of materials or skilled labor, unforeseen engineering, environmental and/or geological problems, work stoppages, weather interference, unanticipated cost increases and non-availability of construction equipment. Construction, equipment or stalling problems or difficulties in obtaining any of the requisite licenses, permits, allocations and authorizations from regulatory authorities could increase the total cost, delay or prevent the construction or opening or any of these planned casino developments or otherwise affect their design. In addition, once developed, no assurances can be given that the Company will be able to manage these casinos on a profitable basis or to attract a sufficient number of guests, gaming customers and other visitors to make the various operations profitable independently.
ITEM 2.
ITEM 2. PROPERTIES
CORPORATE OFFICE FACILITY
Pursuant to the terms of the Distribution Agreement, Grand has assigned to Lakes, and Lakes has 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 and the annual base rent is $768,300 plus building operating costs.
LAS VEGAS LAND
SHARK CLUB PARCEL
A subsidiary of Lakes is the tenant under a ground lease (the "Shark Club Lease") which has a term through July 31, 2046 unless sooner terminated in accordance with the provisions thereof. The Shark Club Lease provides for base rent in the initial amount of $65,000 per month, subject to adjustment each lease year based on a cost of living formula and additional rent in the amount of $6,500 per month if the parcel is used for a casino/hotel.
In addition to the base rent, Lakes must pay all taxes on and bear all costs of maintaining the property. Grand Casinos also executed a guarantee in connection with the execution of the Shark Club Lease by its former subsidiary.
In connection with the Merger, Lakes agreed with Park Place that Lakes will either exercise, or cause one of its subsidiaries to exercise, the Shark Club Lease purchase option of approximately $10.1 million prior to the earliest time when the landlord could require Lakes (or Grand as the guarantor) to purchase the subject real estate. Lakes is anticipating that date to be April 2000.
Under the Shark Club Lease, Lakes is required to maintain the leased property. Lakes executed an amendment to the Shark Club Lease that permitted it to raze the property without increasing its security deposit. In exchange. Lakes agreed to waive the payment and accrual of interest on such security deposit.
TRAVELODGE PARCEL
A Lakes subsidiary is tenant under a ground lease (the "Travelodge Lease") which commenced on June 17, 1996, and will (unless sooner terminated in accordance with the provisions thereof) remain in effect until June 16, 2095. The Travelodge Lease provides for a base rent (in the initial amount of $166,667 per month) that is adjusted each lease year based on a cost of living formula. In addition to the base rent, the tenant must pay all taxes on and costs of maintaining the leased property. Lakes has the option to purchase the leased property during the 20th lease year for the purchase price of $30 million. Lakes manages the hotel building located on the leased property. A third party had a sublease interest in the leased property. That claimed interest was terminated pursuant to an agreement between the third party and Lakes that provides for payments by Lakes in the amount of $150,000 per quarter for a period of ten years after such party surrendered possession of the property to Lakes. A portion of the building located on the leased property is subleased, which Lakes currently has the right to terminate by making certain prescribed payments, and complying with certain other conditions stated, in the sublease.
POLO PLAZA SHOPPING CENTER PARCEL
On October 1, 1999, the Company purchased the shopping center and land owned by the Nevada Resort Properties Polo Plaza Limited Partnership (the "Partnership") in lieu of exercising its right to purchase the remaining 51% interest in the Partnership. Prior to the purchase, the Company held a 49% ownership interest in the Partnership. In consideration for the purchase, the Company paid approximately $3.3 million and paid off the outstanding partnership mortgage of approximately $6.3 million. A $6.2 million loan to the Partnership made by the Company during January 1999 was repaid and satisfied at the closing by offsetting an appropriate amount against the purchase price as agreed by the Company and the Partnership. Pursuant to the purchase agreement relating to this transaction, the Partnership is currently being dissolved. Lakes continues to operate the site as a commercial shopping center.
CABLE PARCEL
Pursuant to a November 1, 1997 Option Agreement, Grand acquired an option to purchase approximately 4.5 acres of land located near the Polo Plaza Shopping Center anytime prior to October 31, 2000. As
consideration for the option, Lakes pays the landowner a non-refundable monthly option payment of $80,000. The option agreement states that the purchase price for the land is $18 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The following summaries describe certain known legal proceedings to which Grand is a party which Lakes has assumed, or with respect to which Lakes has agreed to indemnify Grand, in connection with the Distribution.
STRATOSPHERE SHAREHOLDERS LITIGATION -- FEDERAL COURT
In August 1996, a complaint was filed in the U.S. District Court for the District of Nevada -- Michael Ceasar, et al v. Stratosphere Corporation, et al -- against Stratosphere and others, including Grand. The complaint was filed as a class action, and sought relief on behalf of Stratosphere shareholders who purchased their stock between December 19, 1995 and July 22, 1996. The complaint included allegations of misrepresentations, federal securities law violations and various state law claims.
In August through October 1996, several other nearly identical complaints were filed by various plaintiffs in the U.S. District Court for the District of Nevada.
The defendants in the actions submitted motions requesting that all of the actions be consolidated. Those motions were granted in January 1997, and the consolidated action is entitled In re: Stratosphere Corporation Securities Litigation -- Master File No. CV-S-96-00708 PMP (RLH).
In February 1997, the plaintiffs filed a consolidated and amended complaint naming various defendants, including Grand and certain current and former officers and directors of Grand. The amended complaint includes claims under federal securities laws and Nevada laws based on acts alleged to have occurred between December 19, 1995 and July 22, 1996.
The Court has recently signed a scheduling order, which cuts off fact discovery as of April 30, 2000 and expert discovery as of September 30, 2000. The parties have submitted preliminary pretrial statements, which may be amended after the completion of discovery.
In February 1997, various defendants, including Grand and Grand's officers and directors named as defendants, submitted motions to dismiss the amended complaint. Those motions were made on various grounds, including Grand's claim that the amended complaint failed to state a valid cause of action against Grand and Grand's officers and directors.
In May 1997, the court dismissed the amended complaint. The dismissal order did not allow the plaintiffs to further amend their complaint in an attempt to state a valid cause of action.
In June 1997, the plaintiffs asked the court to reconsider its dismissal order, and to allow the plaintiffs to submit a second amended complaint in an attempt to state a valid cause of action. In July 1997, the court allowed the plaintiffs to submit a second amended complaint.
In August 1997, the plaintiffs filed a second amended complaint. In September 1997, certain of the defendants, including Grand and Grand's officers and directors named as defendants, submitted a motion to dismiss the second amended complaint. The motion was based on various grounds, including Grand's claim that the second amended complaint failed to state a valid cause of action against Grand and Grand's officers and directors.
In April 1998, the Court granted Grand's motion to dismiss, in part, and denied the motion in part. Thus, the plaintiffs are pursuing the claims in the second amended complaint that survived the motion to dismiss.
In June 1998, certain of the defendants, including Grand and Grand's officers and directors named as defendants, submitted a motion for summary judgment seeking an order that such defendants are entitled to judgment as a matter of law. In December 1998, the plaintiffs completed fact discovery related to the issues raised by the summary judgment motion. Expert discovery was completed in March of 1999. All papers relating to this matter were filed on June 1, 1999.
On October 6, 1999, the District Court entered its Order, granting in part and denying in part, defendants' Motion for Summary Judgment and Summary Adjudication. The Court dismissed all allegations in reference to (1) Phase II funding levels; (2) "over-allotments uses", as stated in the December 19, 1995 Prospectus; (3) the purpose and use of the Grand Casino Completion Guaranty, as stated in the June 6, 1996 Press
Statement; (4) the vague expressions of general optimism (issued within the December 19, 1995 Prospectus, the 10-Q and 10-K Filings, press releases and other public statements) referred to in this Order; (5) the adoption of statements in securities analysts reports; (6) the alleged utterance of misleading statements before the Nevada Gaming Commission; and (7) the temporary diversion of Phase II proceeds to fund Phase I. The remaining claims relate to the accuracy of defendants' budgetary estimates issued in Stratosphere's December 1995 Prospectus and SEC 10-Q and 10-K Reports. The Court concluded that there were triable issues as to whether defendants misstated anticipated construction costs or omitted to disclose material cost overruns.
The court recently added the Company as an additional defendant because of its indemnity obligation and stipulation. Park Place has opposed being added to the litigation and plaintiffs' motion to add Park Place as a defendant is pending.
STRATOSPHERE SHAREHOLDERS LITIGATION -- NEVADA STATE COURT
In August 1996, a complaint was filed in the District Court for Clark County, Nevada -- Victor M. Opitz, et al v. Robert E. Stupak, et al -- Case No. A363019 -- against various defendants, including Grand. The complaint seeks relief on behalf of Stratosphere Corporation shareholders who purchased stock between December 19, 1995 and July 22, 1996. The complaint alleges misrepresentations, state securities law violations and other state claims.
Grand and certain defendants submitted motions to dismiss or stay the state court action pending resolution of the federal court action described above. The court has stayed further proceedings pending the resolution of In re: Stratosphere Securities Litigation.
GRAND CASINOS, INC. SHAREHOLDERS LITIGATION
In September and October 1996, two actions were filed by Grand shareholders in the U.S. District Court for the District of Minnesota against Grand and certain of Grand's current and former directors and officers.
The complaints allege misrepresentations, federal securities law violations and other claims in connection with the Stratosphere project.
The actions have been consolidated as In re: Grand Casinos, Inc. Securities Litigation -- Master File No. 4-96-890 -- and the plaintiffs filed a consolidated complaint. The defendants submitted a motion to dismiss the consolidated complaint, based in part on Grand's claim that the consolidated complaint failed to properly state a cause of action.
In December 1997, the court granted Grand's motion to dismiss in part, and denied the motion in part. Thus, the plaintiffs are pursuing the claims in the consolidated complaint that survived Grand's motion to dismiss. Discovery in the action has begun.
The defendants have submitted a motion for summary judgment seeking an order that the defendants are entitled to judgment as a matter of law. In December 1998, the plaintiffs completed fact discovery related to the issues raised by the summary judgement motion. Expert discovery was completed in March of 1999. The parties have completed follow-up discovery pertaining to the summary judgment motion. The court heard the motion on September 2, 1999. The court has not yet ruled on the motion.
In early February 1999, the plaintiffs filed a motion for leave to amend the complaint in this action to include, as defendants in the case, both the Company and Park Place. The motion for leave to amend the complaint has been granted and Lakes has filed its answer. Lakes will defend this action vigorously.
SLOT MACHINE LITIGATION
In April 1994, William H. Poulos brought an action in the U.S. District Court for the Middle District of Florida, Orlando Division -- William H. Poulos, et al v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various parties (including Grand) alleged to operate casinos or be slot machine manufacturers were named as defendants. The plaintiff sought to have the action certified as a class action.
A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was consolidated with the Poulos action.
Both actions included claims under the federal Racketeering-Influenced and Corrupt Organizations Act and under state law, and sought compensatory and punitive damages. The plaintiffs claimed that the
defendants are involved in a scheme to induce people to play electronic video poker and slot machines based on false beliefs regarding how such machines operate and the extent to which a player is likely to win on any given play.
In December 1994, the consolidated actions were transferred to the U.S. District Court for the District of Nevada.
In September 1995, Larry Schreier brought an action in the U.S. District Court for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al -- Case No. CV-95-00923-DWH(RJJ).
The plaintiffs' allegations in the Schreier action were similar to those made by the plaintiffs in the Poulos and Ahearn actions, except that Schreier claimed to represent a more precisely defined class of plaintiffs than Poulos or Ahearn.
In December 1996, the court ordered the Poulos, Ahearn and Schreier actions consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the plaintiffs to file a consolidated and amended complaint. In February 1997, the plaintiffs filed a consolidated and amended complaint.
In March 1997, various defendants (including Grand) filed motions to dismiss or stay the consolidated action until the plaintiffs submitted their claims to gaming authorities and those authorities considered the claims submitted by the plaintiffs.
In December 1997, the court denied all of the motions submitted by the defendants, and ordered the plaintiffs to file a new consolidated and amended complaint. That complaint has been filed. Grand has filed its answer to the new complaint.
The plaintiffs have filed a motion seeking an order certifying the action as a class action. Grand and certain of the defendants have opposed the motion. The Court has not ruled on the motion.
STANDBY EQUITY COMMITMENT LITIGATION
In September 1997, the Stratosphere Trustee under the indenture pursuant to which Stratosphere issued its first mortgage notes filed a complaint in the U.S. District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company, Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand as defendant.
The complaint alleges that Grand failed to perform under the Standby Equity Commitment entered into between Stratosphere and Grand in connection with Stratosphere's issuance of such first mortgage notes in March 1995. The complaint seeks an order compelling specific performance of what the Trustee claims are Grand's obligations under the Standby Equity Commitment.
The Stratosphere Trustee filed the complaint in its alleged capacity as a third party beneficiary under the Standby Equity Commitment. Pursuant to the Second Amended Plan, a new limited liability company (the "Stratosphere LLC") was formed to pursue certain alleged claims and causes of action that Stratosphere and other parties may have against numerous third parties, including Grand and/or officers and/or directors of Grand. The Stratosphere LLC has been substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding.
In October of 1999, Motions for Summary Judgment by both parties were denied. Grand's request for appellate court review of the denial as to its motion for summary judgment was denied. The trial court is expected to hold a pretrial conference to address discovery and scheduling issues. Lakes will continue to defend the lawsuit diligently.
STRATOSPHERE PREFERENCE ACTION
In April 1998, Stratosphere served on Grand and Grand Media & Electronics Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a complaint in the Stratosphere bankruptcy case seeking recovery of certain amounts paid by Stratosphere to (i) Grand as management fees and for costs and expenses under a management agreement between Stratosphere and Grand, and (ii) Grand Media for electronic equipment purchased by Stratosphere from Grand Media.
Stratosphere claims in its complaint that such amounts are recoverable by Stratosphere as preferential payments under bankruptcy law.
In May 1998, Grand responded to Stratosphere's complaint. That response denies that Stratosphere is entitled to recover the amounts described in the complaint. The matter is pending.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Lakes became a stand-alone, publicly held and publicly traded company as a result of the Grand Distribution which was effected on December 31, 1998. The fourth quarter of Lakes' fiscal year ended on Sunday, January 3, 1999 and the Common Stock did not begin trading on the Nasdaq National Market under the symbol LACO until Monday, January 4, 1999.
For the period from January 4, 1999 through January 2, 2000, the high and low sales prices per share of the Company's Common Stock are indicated below, as reported on the Nasdaq National Market:
On March 20, 2000, the last reported sale price for the Common Stock was $7.9375 per share. As of March 20, 2000, the Company had approximately 10,630,453 shareholders of record.
The Company has never paid any cash dividends with respect to its Common Stock and the current policy of the Board of Directors is to retain any earnings to provide for the growth of the Company. So long as Lakes is required to indemnify Grand, as a subsidiary of Park Place, for certain specified liabilities, 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 interest in Lakes without the written consent of Park Place which consent can be given or withheld in Park Place's sole and absolute discretion. Subject to the foregoing dividend restrictions, the payment of cash dividends in the future, if any, will be at the discretion of the Board of Directors and will depend upon such factors as earnings levels, capital requirements, the Company's overall financial condition and any other factors deemed relevant by the Board of Directors. See "Risk Factors -- Operating Covenants -- Dividend Restrictions."
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data presented below should be read in conjunction with the Financial Statements and notes thereto included elsewhere in this Form 10-K, and in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K.
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(1) 1998 results include $36.8 million in revenues from the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley that concluded during 1998. The Company's revenues and earnings will not include contributions from these operations going forward. EBITDA is earnings before interest, taxes, depreciation and amortization, which can be computed by adding depreciation and amortization to operating income. EBITDA also excludes the $161 million write off of Grand's investment in Stratosphere Corporation. EBITDA is presented supplementally because management believes it allows for a more complete analysis of results of operations. This information should not be considered as an alternative to any measure of performance as promulgated under generally accepted accounting principles (such as operating income or income from continuing operations) nor should it be considered as an indicator of the overall financial performance of Lakes. The calculations of EBITDA may be different from the calculations used by other companies and therefore comparability may be limited. Historical depreciation and amortization for Lakes for the fiscal years ended January 2, 2000, January 3, 1999, December 28, 1997, December 29, 1996 and December 31, 1995 totaled $2 million, $2 million, $1 million, $1 million and $2 million, respectively.
(2) Includes a non-recurring, non-cash $161 million charge related to the write-off of Lakes' investment in Stratosphere Corporation.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Lakes was established as a public corporation on December 31, 1998, via a distribution of its Common Stock, to the shareholders of Grand. Pursuant to the terms of the Distribution Agreement entered into between Grand and Lakes and dated as of December 31, 1998, Grand shareholders received .25 shares of Lakes Common Stock for each share held in Grand. Historical references to the Company, which preclude the distribution give pro forma effect to the distribution as if it had already occurred.
Immediately following the Distribution, Grand merged with a subsidiary of Park Place, pursuant to which Grand became a wholly owned subsidiary of Park Place. Grand shareholders received one share of Park Place common stock in the Merger for each share they held in Grand.
As a result of the Distribution, Lakes operates the Indian casino management business and holds various other assets previously owned by Grand. The Company's revenues are derived almost exclusively from management fees. Lakes manages two land-based, Indian-owned casinos in Louisiana: Grand Casino Avoyelles, in Marksville, Louisiana, owned by the Tunica-Biloxi Tribe and Grand Casino Coushatta, in Kinder, Louisiana, owned by the Coushatta Tribe. Both management contracts expire seven years from the dates the casinos opened.
For a portion of fiscal 1998, and prior to the Distribution, Grand also had management contracts for Indian-owned casinos located at Grand Casino Hinckley and Grand Casino Mille Lacs in Minnesota. The management contract at Grand Casino Mille Lacs expired at the end of the first quarter of 1998, and the management of Grand Casino Hinckley ended November 30, 1998, with the buyout of the remaining contract term.
Lakes develops, constructs and manages casinos and related hotel and entertainment facilities in emerging and established gaming jurisdictions. Lakes' revenues are derived from management fee income from Grand Casino Avoyelles and Grand Casino Coushatta. Grand commenced operations in September 1990, and opened its first casino, Grand Casino Mille Lacs, in April 1991. Grand Casino Hinckley commenced operations in May 1992, Grand Casino Avoyelles commenced operations in June 1994 and Grand Casino Coushatta commenced operations in January 1995.
Pursuant to the Avoyelles and Coushatta management contracts, Lakes receives a fee based on the net distributable profits (as defined in the contracts) generated by Grand Casino Avoyelles and Grand Casino Coushatta.
On May 12, 1999, the Company announced that it would form a partnership for the purpose of developing a gaming facility on Indian-owned land near San Diego, California. Under the agreement, Lakes has formed a limited liability company with KAR, a limited liability company based in Houston, Texas. The partnership between Lakes and KAR holds a contract to develop and manage a casino resort facility with the
Jamul Indian Village in California. The contract is subject to approval by NIGC. California voters recently approved an amendment to the State Constitution which allows for Nevada-style gaming on Indian land and ratifies the Tribal Compact. Development of the casino resort will begin once various regulatory approvals are received.
On June 22, 1999, the Company announced that it has been selected by the Pokagon Band to serve as the exclusive developer and manager of a proposed casino gaming resort facility to be owned by the Pokagon Band in the State of Michigan. In connection with its selection, Lakes and the Band have executed a development and management agreement governing their relationship during the development, construction and management of the casino. Various regulatory approvals are needed prior to commencement of development activities. Casino construction is not planned to start until land is accepted into trust status by the Secretary of the Interior and the agreements are approved by the Chairman of NIGC.
On July 15, 1999, the Company announced that it would form a partnership for the purpose of developing a gaming facility on Indian-owned land near Sacramento, California. Pursuant to the agreement, Lakes has formed a limited liability company with KAR, a limited liability company based in Houston, Texas. The partnership between Lakes and KAR has been awarded a contract to develop and manage a casino resort facility with the Shingle Springs Band of Miwok Indians in California. The contract is subject to approval by NIGC and placement of the land where the gaming facility is to be located into trust with the BIA. California voters recently approved an amendment to the State Constitution which allows for Nevada-style gaming on Indian land and ratifies the Tribal Compact. Development of the casino resort will begin once various regulatory approvals are received.
On October 1, 1999, the Company purchased the shopping center and land owned by the Nevada Resort Properties Polo Plaza Limited Partnership in lieu of exercising its right to purchase the remaining 51% interest in the Partnership. Prior to the purchase, the Company held a 49% ownership interest in the Partnership. In consideration for the purchase, the Company paid approximately $3.3 million and paid off the outstanding partnership mortgage of approximately $6.3 million. A $6.2 million loan to the Partnership made by the Company during January 1999 was repaid and satisfied at the closing by offsetting an appropriate amount against the purchase price as agreed by the Company and the Partnership. Pursuant to the purchase agreement relating to this transaction, the Partnership is currently being dissolved.
On December 22, 1999, the Company and Rainforest Cafe, Inc. announced plans to merge. Under the terms of the agreement, Rainforest Cafe shareholders would have received .55 of one share of Lakes Common Stock for every share owned in Rainforest Cafe. The transaction was terminated by mutual agreement on January 24, 2000 after Rainforest Cafe, Inc. received an unsolicited offer to purchase Rainforest Cafe, Inc. Lakes will be entitled to a $2 million termination fee in the event Rainforest Cafe, Inc. consummates a competing proposal prior to July 24, 2000.
Lakes' investments in unconsolidated affiliates include a 27 percent ownership interest in Fanball.com, Inc., a start-up internet provider of fantasy sports services, and a 23 percent ownership interest in Interactive Learning Group, Inc., a consumer product company. Lakes invested $3.4 million and $3 million in Fanball.com and Interactive Learning Group, respectively, at the end of the second quarter of 1999. Additionally, as a result of its spin-off from Grand, Lakes received a 49 percent ownership interest in Trak 21 Development, LLC, a developer of player tracking systems for the casino industry, and a 27 percent ownership interest in New Horizon Kids Quest, Inc., a publicly held provider of child care facilities.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto for the years ended January 2, 2000, January 3, 1999, and December 28, 1997.
RESULTS OF OPERATIONS
Revenues are calculated in accordance with generally accepted accounting principles and are presented in a manner consistent with industry practice. Net distributable profits from Grand Casino Avoyelles and Grand Casino Coushatta are computed using a modified cash basis of accounting in accordance with the management contracts. The effect of the use of the modified cash basis of accounting is to accelerate the write-off of capital equipment and leased assets, which thereby impacts the timing of net distributable profits.
Lakes is prohibited by IGRA from having an ownership interest in any casino it manages for Indian tribes. The management contracts for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. The Coushatta Tribe and Lakes have agreed on a five-year contract renewal beginning January 17, 2002, subject to NIGC approval. Net distributable profits, if any, under the
new agreement will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes. There can be no assurance that any of these management contracts will be renewed upon expiration or approved by NIGC upon any such renewal. The failure to renew the Lakes' management contracts would result in the loss of revenues to Lakes derived from such contracts, which would have a material adverse effect on Lakes' results of operations. The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into tribal-state compacts with the State of Louisiana on September 29, 1992.
These compacts were approved in November 1992 by the Secretary of the Interior. The compact for the Coushatta Tribe expired November 4, 1999, and the compact for the Tunica-Biloxi Tribe expired November 18, 1999, and the State of Louisiana has delivered a written notice of non-renewal. The Governor and each Tribe have agreed on a six-month extension which has been approved by the Department of the Interior. The Coushatta Tribe and the Tunica-Biloxi Tribe are actively negotiating with the State of Louisiana terms for a new compact. In the event the compacts are not renewed, gaming may not be permitted at Grand Casino Avoyelles or Grand Casino Coushatta. There can be no assurance that these compacts will be renewed on terms and conditions acceptable to either of the Tribes.
FISCAL YEAR ENDED JANUARY 2, 2000 COMPARED TO FISCAL YEAR ENDED JANUARY 3, 1999
Revenues. Grand Casino Avoyelles and Grand Casino Coushatta generated $54.7 million in management fee income during the fiscal year ended January 2, 2000. Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles and Grand Casino Coushatta generated $92.3 million in management fee income during the fiscal year ended January 3, 1999. Gross revenue increases at Grand Casino Avoyelles and Grand Casino Coushatta partially offset the fact that the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley ended during 1998. Contributing to the increases were a 223-room hotel at Grand Casino Coushatta, which opened in November of 1998 along with a 28,000 square foot casino expansion at Coushatta which opened in December of 1998. Also contributing to the increases were a special events center and RV resort at Grand Casino Avoyelles, which opened during the first quarter of 1998, and the addition of approximately 180 slot machines at Avoyelles from January 3, 1999 to January 2, 2000.
Costs and Expenses. Total costs and expenses decreased $6.7 million from $16.4 million for the fiscal year ended January 3, 1999 to $9.7 million for the fiscal year ended January 2, 2000. Selling, general, and administrative expenses decreased $6.8 million from $14.6 million for the fiscal year ended January 3, 1999 to $7.8 million for the fiscal year ended January 2, 2000 due primarily to legal, professional and other costs associated with separating Lakes from Grand incurred during 1998.
Other. Interest income increased $2 million to $7.6 million for the fiscal year ended January 2, 2000 from $5.6 million for the fiscal year ended January 3, 1999 due primarily to interest earned on increased cash balances and additional notes receivable. Interest expense was $0.1 million for both periods. Equity in loss of unconsolidated affiliates increased from $.4 million for the fiscal year ended January 3, 1999 to $2.9 million for the fiscal year ended January 2, 2000 due primarily to investments in Interactive Learning Group, Inc. and Fanball.com.
Taxes. A deferred tax asset was recorded in 1996 when the Company set up a reserve allowance due to uncertainty related to the collectibility of the note receivable from Stratosphere. However, a full valuation allowance was created for the deferred tax asset and no income tax benefit was recognized at that time. Upon writing off the receivable and realizing the tax deduction in 1998, the Company reversed the deferred tax asset valuation allowance, resulting in the recognition of a $17.3 million income tax benefit. Under the terms of its tax sharing agreement with Grand, any further tax benefits relating to capital losses resulting from the Company's write-off of its investment in Stratosphere will be shared equally by Lakes and Park Place, up to a benefit of approximately $12 million to Lakes.
Earnings per Common Share and Net Earnings. For the fiscal year ended January 2, 2000 basic and diluted earnings per common share were $2.72 and $2.67, respectively. This compares to basic and diluted earnings per common share of $5.80 and $5.71, respectively, for the fiscal year ended January 3, 1999. Earnings decreased $32.3 million to $28.8 million for the fiscal year ended January 2, 2000 compared to the same period in the prior year.
FISCAL YEAR ENDED JANUARY 3, 1999 COMPARED TO FISCAL YEAR ENDED DECEMBER 28,
Revenues. Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles and Grand Casino Coushatta generated $92.3 million in management fee income during the fiscal year ended January 3,
1999 as compared to $78.5 million for the prior year's comparable period. Gross revenue increases at Grand Casino Hinckley, Grand Casino Avoyelles and Grand Casino Coushatta offset the fact that the management contract for Grand Casino Mille Lacs expired at the end of the first quarter. Contributing to the increases was the early buyout of the Management Agreement for Grand Casino Hinckley by the Mille Lacs Band of Ojibwe in December, 1998. Under the early buyout agreement, the Company was compensated for the management fees it would have received had it managed Grand Casino Hinckley through the original contract expiration date which was May, 1999. Also contributing to the increases were a 378-room hotel at Grand Casino Hinckley, which opened in November of 1997, and a special events center and RV resort at Grand Casino Avoyelles, which opened during the first quarter of 1998.
1998 results include $36.8 million in revenues from the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley that concluded during 1998. The Company's revenues and earnings will not include contributions from these operations going forward.
Costs and Expenses. Total costs and expenses were $16.4 million for the fiscal year ended January 3, 1999 compared to $8.8 million for the same period in the prior year. Selling, general, and administrative expenses increased in the amount of $6.7 million from $7.9 million for the fiscal year ended December 28, 1997 to $14.6 million for the fiscal year ended January 3, 1999 due to legal, professional and other costs associated with separating Lakes from Grand.
Other. Interest income was $5.6 million and $5.9 million for the fiscal years ended January 3, 1999 and December 28, 1997, respectively. Interest expense was $0.1 million for both periods.
Taxes. A deferred tax asset was recorded in 1996, when the Company set up a reserve allowance due to uncertainty related to the collectibility of the note receivable from Stratosphere. However, a full valuation allowance was created for the deferred tax asset and no income tax benefit was recognized at that time. Upon writing off the receivable and realizing the tax deduction in 1998, the Company reversed the deferred tax asset valuation allowance, resulting in the recognition of a $17.3 million income tax benefit. Under the terms of its tax sharing agreement with Grand, any further tax benefits relating to capital losses resulting from the Company's write-off of its investment in Stratosphere will be shared equally by Lakes and Park Place, up to a benefit of approximately $12 million to Lakes.
Earnings per Common Share and Net Earnings. For the fiscal year ended January 3, 1999 basic and diluted earnings per common share were $5.80 and $5.71, respectively. This compares to basic and diluted earnings of $4.32 and $4.20 per share for the fiscal year ended December 28, 1997. Earnings increased $16 million to $61.2 million for the fiscal year ended January 3, 1999 compared to the same period in the prior year, primarily due to increased management fee income from each of the casino operations.
CAPITAL RESOURCES, CAPITAL SPENDING, AND LIQUIDITY
At January 2, 2000 Lakes had $36.5 million in restricted and unrestricted cash and cash equivalents. At January 2, 2000, the Company also had $27.4 million in short-term, available-for-sale investments, consisting primarily of a fixed income portfolio made up of various types of bonds which are rated A1 or better. The cash and short-term investment balances are planned to be used for loans to current tribal partners to help develop existing operations, the pursuit of additional gaming and non-gaming opportunities, and settlement of pending litigation matters.
For the years ended January 2, 2000, January 3, 1999, and December 28, 1997, net cash provided by operating activities totaled $8.1 million, $85.8 million, and $35.8 million, respectively. During 1999, $27.4 million of cash and cash equivalents were reclassified as short-term investments. For the years ended January 2, 2000, January 3, 1999, and December 28, 1997, proceeds from repayment of notes receivable amounted to $12.0 million, $6.6 million, and $6.1 million, respectively. Also during these periods, payments for land held for development amounted to $22.9 million, $11.2 million, and $13.2 million, respectively.
As security to support Lakes' indemnification obligations to Grand under each of the Distribution Agreement and the Merger Agreement, and as a condition to the consummation of the Merger, Lakes agreed to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of Park Place, an aggregate of $30 million, consisting of four annual installments of $7.5 million, on each annual anniversary of the Distribution and Merger. Lakes' ability to satisfy this funding obligation is materially dependent upon the continued success of its operations and the general risks inherent in its business. In the event Lakes is unable to satisfy its funding obligation, it would be in breach of its agreement with Grand, possibly subjecting itself to additional liability for contract damages, which could have a material adverse effect on Lakes' business and
results of operations. The Company made the first deposit of $7.5 million on December 31, 1999, and such amount is included as restricted cash on the accompanying consolidated balance sheet as of January 2, 2000.
THE YEAR 2000 ISSUE
The Year 2000 issue was the result of computer programs being written using two digits rather than four digits to define the applicable year. Any programs that have time-sensitive software may have recognized a date using "00" as the year 1900 rather than the year 2000. If not remedied, this could have resulted in system failure or miscalculations.
The Company assessed the impact of the Year 2000 on its computer systems, both hardware and software, and developed a plan to timely address the Year 2000 issue. The Company and its currently managed properties spent approximately $1.1 million in the execution of the Year 2000 plan. These expenditures were charged to expense or capitalized in accordance with appropriate accounting policies. To date there have been no material adverse consequences, nor does the Company believe that there will be any future material adverse consequences to the Company's business, operations, or financial condition from the Year 2000 issue. However, there can be no assurances that failure to address the Year 2000 issue by a third party on whom the Company's systems rely, will not have a material adverse effect on the Company.
SEASONALITY
The Company believes that the operations of all casinos managed by the Company are affected by seasonal factors, including holidays, weather and travel conditions.
REGULATION AND TAXES
The Company is subject to extensive regulation by state gaming authorities. The Company will also be subject to regulation, which may or may not be similar to current state regulations, by the appropriate authorities in any other jurisdiction where it may conduct gaming activities in the future. Changes in applicable laws or regulations could have an adverse effect on the Company.
The gaming industry represents a significant source of tax revenues. From time to time, various federal legislators and officials have proposed changes in tax law, or in the administration of such law, affecting the gaming industry. It is not possible to determine the likelihood of possible changes in tax law or in the administration of such law. Such changes, if adopted, could have a material adverse effect on the Company's results of operations and financial results.
PRIVATE SECURITIES LITIGATION REFORM ACT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in this integrated Form 10-K/Annual Report and other materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) contain statements that are forward-looking, such as plans for future expansion and other business development activities as well as other statements regarding capital spending, financing sources and the effects of regulation (including gaming and tax regulation) and competition.
Such forward looking information involves important risks and uncertainties that could significantly affect the anticipated results in the future and, accordingly, actual results may differ materially from those expressed in any forward-looking statements made by or on behalf of the Company.
These risks and uncertainties include, but are not limited to, those relating to development and construction activities, dependence upon existing management, pending litigation, domestic or global economic conditions and changes in federal or state tax laws or the administration of such laws and changes in gaming laws or regulations (including the legalization of gaming in certain jurisdictions). For further information regarding the risks and uncertainties, see the "Business -- Risk Factors" section of this Annual Report on Form 10-K for the fiscal year ended January 2, 2000.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
LAKES GAMING, INC.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Lakes Gaming, Inc.
We have audited the accompanying consolidated balance sheets of Lakes Gaming, Inc. (a Minnesota corporation) and Subsidiaries as of January 2, 2000 and January 3, 1999 and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity and cash flows for each of the three years in the period ended January 2, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lakes Gaming, Inc. and Subsidiaries as of January 2, 2000 and January 3, 1999, and the results of their operations and their cash flows for each of the three years in the period ended January 2, 2000, in conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota January 28, 2000
LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated balance sheets.
LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED JANUARY 2, 2000, JANUARY 3, 1999 AND DECEMBER 28, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of these consolidated financial statements.
LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS YEARS ENDED JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
LAKES GAMING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JANUARY 2, 2000, JANUARY 3, 1999 AND DECEMBER 28, 1997 (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Lakes Gaming, Inc., a Minnesota corporation ("Lakes" or the "Company") was established as a public corporation on December 31, 1998, via a distribution (the "Distribution") of its common stock, par value $.01 per share (the "Common Stock") to the shareholders of Grand Casinos, Inc. ("Grand"). Pursuant to the terms of a Distribution Agreement entered into between Grand and Lakes and dated as of December 31, 1998 (the "Distribution Agreement"), Grand shareholders received .25 shares of Lakes Common Stock for each share held in Grand. Historical references to the Company which predate the Distribution give pro forma effect to the Distribution as if it had already occurred.
Immediately following the Distribution, Grand merged with a subsidiary of Park Place Entertainment Corporation, a Delaware corporation ("Park Place"), pursuant to which Grand became a wholly owned subsidiary of Park Place (the "Merger"), Grand shareholders received one share of Park Place common stock in the Merger for each share they held in Grand. Both transactions are hereinafter referred to as the Transaction. The Transaction received shareholder and regulatory approvals and was completed on December 31, 1998. Grand obtained a ruling from the Internal Revenue Service (IRS) that the Distribution qualified as a tax-free transaction, solely with respect to Grand shareholders except to the extent that Grand shareholders received cash in lieu of fractional shares.
Lakes manages Indian-owned casinos and owns certain other assets related to potential gaming-related development. The Company manages two Indian-owned casinos in Louisiana and previously managed two Minnesota casinos through April 4, 1998 and November 30, 1998. The Company had written off or reserved for its investments and other related costs in Stratosphere Corporation (Stratosphere), which owns the Stratosphere Tower, Casino and Hotel in Las Vegas, Nevada, as of December 29, 1996 in the amount of $161 million. The Company has not recorded any results of Stratosphere's operations in 1997, 1998 or 1999. Stratosphere is the subject of Chapter 11 bankruptcy proceedings. See Note 8 for further discussion. The Second Amended Plan has been approved by the Bankruptcy Court and was declared effective on October 14, 1998. As such, all Stratosphere stock owned by Lakes has been canceled.
MANAGEMENT CONTRACTS OF LIMITED DURATION
The ownership, management and operation of gaming facilities are subject to extensive federal, state, provincial, tribal and/or local laws, regulation, and ordinances, which are administered by the relevant regulatory agency or agencies in each jurisdiction. These laws, regulations and ordinances vary from jurisdiction to jurisdiction, but generally concern the responsibility, financial stability and character of the owners and managers of gaming operations as well as persons financially interested or involved in gaming operations. The Company is prohibited by the Indian Gaming Regulatory Act from having an ownership interest in any casino it manages for Indian tribes.
Management contracts for the two previously managed Minnesota casinos, Grand Casino Mille Lacs and Grand Casino Hinckley concluded during 1998. The current management contracts for Grand Casino Avoyelles and Grand Casino Coushatta expire June 3, 2001 and January 16, 2002, respectively. The Coushatta Tribe and Lakes have agreed on a five-year contract renewal beginning January 17, 2002, subject to NIGC approval. Net distributable profits, if any, under the new agreement will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes. There can be no assurance that the Louisiana management contracts will be renewed upon expiration or approved by NIGC upon any such renewal. The failure to renew the Company's management contracts would result in the loss of revenues to the Company derived from such contracts, which would have a material adverse effect on the Company's results of operations. The Coushatta Tribe and the Tunica-Biloxi Tribe each entered into tribal-state compacts with the State of Louisiana on September 29, 1992. These compacts were approved in November 1992 by the Secretary of the Interior. The compact for the Coushatta Tribe expired November 4, 1999, and the compact for the Tunica-Biloxi Tribe expired November 18, 1999, and the State of Louisiana has delivered a written notice of non-renewal. The Governor and each Tribe have agreed on a six-month extension which has been approved by the Department of the Interior.
The Coushatta Tribe and the Tunica-Biloxi Tribe are actively negotiating with the State of Louisiana terms for a new compact. In the event the compacts are not renewed, gaming may not be permitted at Grand
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
Casino Avoyelles or Grand Casino Coushatta. There can be no assurance that these compacts will be renewed on acceptable terms and conditions.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Ultimate results could differ from those estimates.
YEAR END
The Company has a 52- or 53-week accounting period ending on the Sunday closest to December 31 of each year. The Company's fiscal years for the periods shown on the accompanying consolidated statements of earnings ended on January 2, 2000 (1999), January 3, 1999 (1998), and December 28, 1997 (1997). The activity from the date of the Transaction to January 3, 1999 was not segregated from the full year's results as it was not material.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Lakes and its wholly-owned and majority-owned subsidiaries. Investments in unconsolidated affiliates representing between 20% and 50% of voting interests are accounted for on the equity method. All material intercompany balances and transactions have been eliminated in consolidation.
Lakes' investments in unconsolidated affiliates include a 27 percent ownership interest in Fanball.com, Inc., a start-up internet provider of fantasy sports services, and a 23 percent ownership interest in Interactive Learning Group, Inc., a consumer product company. Lakes invested $3.4 million and $3 million in Fanball.com and Interactive Learning Group, respectively, at the end of the second quarter of 1999. Additionally, as a result of its spin-off from Grand, Lakes received a 49 percent ownership interest in Trak 21 Development, LLC, a developer of player tracking systems for the casino industry, and a 27 percent ownership interest in New Horizon Kids Quest, Inc., a publicly held provider of child care facilities.
REVENUE AND EXPENSES
Revenue from the management of Indian-owned casino gaming facilities is recognized when earned according to the terms of the management contracts.
The operating expenses of the Company include the costs associated with the management of all gaming operations for which the Company has a management contract. Such amounts represent the direct cost of providing assistance in the areas of casino operations, marketing and promotion, customer service, accounting, legal and other functions.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand and in banks, interest-bearing deposits, money market funds and other instruments with original maturities of three months or less. Restricted cash and cash equivalents consist primarily of funds deposited as security to support Lakes' indemnification obligations to Grand under each of the Distribution Agreement and the Merger Agreement, and funds designated as collateral relating to land held for development. Cash and cash equivalents are stated at cost which approximates fair value.
SHORT-TERM INVESTMENTS
Investment securities are classified as available-for-sale and stated at market value. Unrealized gains and losses, net of income tax effects, are excluded from income and reported as a component of accumulated other comprehensive income. Market value is determined by the most recently traded price of the security at the balance sheet date. Net realized gains or losses are determined on the specific identification cost method. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation. Expenditures for additions, renewals, and improvements are capitalized. Costs of repairs and maintenance are expensed when incurred. Depreciation and amortization of property and equipment is computed using the straight-line method over the following estimated useful lives:
Property and Equipment consist of the following (in thousands):
The Company periodically evaluates whether events and circumstances have occurred that may affect the recoverability of the net book value of its long-lived 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.
LAND HELD FOR DEVELOPMENT
Land held for development consists of amounts related to an approximately 15-acre site in Las Vegas, Nevada, which the Company controls. All or any portion of this site may be sold, held for sale or held for future development. The Company is currently evaluating the potential sale of all or any portion of this site and in connection therewith has entered into a listing agreement with a real estate broker for the active marketing of this site.
SECURITIES AVAILABLE FOR SALE
The Company follows the provisions of Statement on Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and has classified all of its investments (except restricted cash reserves) as available for sale, whereby investments are reported at fair value, with unrealized gains and losses reported as accumulated other comprehensive earnings (loss), net of income taxes, in the accompanying consolidated statements of shareholders' equity.
On October 15, 1998, Hollywood Park and Casino Magic completed a merger agreement under which Hollywood Park purchased each outstanding share of Casino Magic common stock for $2.27 of cash per share. As a result of this transaction, the Company realized a loss of approximately $2.9 million, net of tax, on the 2,126,000 shares of Casino Magic common stock it owned at the time of the Merger.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company classifies deferred tax liabilities and assets into current and non-current amounts based on the classification of the related assets and liabilities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
INTEREST INCOME
Interest income represents interest on the notes receivable from Indian tribes and interest on cash, cash equivalents and short-term investments. Interest on the notes receivable is recorded as earned based on contractual rates of interest. Interest on cash, cash equivalents and short-term investments reflects interest income realized from investments in savings and money market accounts and other short-term liquid investments.
EARNINGS PER SHARE
Earnings per share (EPS) is calculated for the periods ended January 3, 1999 and December 28, 1997 based on the exchange of one Lakes share for every four owned Grand shares. For all periods, basic EPS is calculated by dividing earnings by the weighted average common shares outstanding. Diluted EPS reflects the potential dilutive effect of all common stock equivalents outstanding by dividing net income by the weighted average of all common and dilutive shares outstanding.
CONCENTRATIONS OF CREDIT RISK
The financial instruments that subject the Company to concentrations of credit risk consist principally of accounts and notes receivable. Notes receivable are due primarily from the Tunica-Biloxi Tribe of Louisiana and the Coushatta Tribe of Louisiana.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement on Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 137 deferred the effective date of SFAS No. 133 to fiscal quarters of all fiscal years beginning after June 15, 2000. The Company believes that the adoption of SFAS No. 133 will not have a material impact on the Company financial statements.
2. MANAGEMENT CONTRACTS FOR INDIAN-OWNED CASINOS:
The Company had contracts with the Mille Lacs Band for the management of two gaming facilities in Onamia and Hinckley, Minnesota. The management contract for the gaming facility in Onamia expired on April 2, 1998. The Company reached an agreement with the Mille Lacs Band of Ojibwe, effective December 1, 1998, for the early buyout of the management contract for the facility in Hinckley. The Mille Lacs Band elected to exercise its option for the early buyout of the contract that was scheduled to expire on May 15, 1999.
The early buyout of the contract was provided in the original seven-year management agreement and the Company received full value for all contracted obligations by the Mille Lacs Band. Under the early buyout agreement, the Company was compensated for the management fees the company would have received had it managed Grand Casino Hinckley through the original contract expiration date.
1998 results include $36.8 million in revenues from the management contracts for Grand Casino Mille Lacs and Grand Casino Hinckley that concluded during 1998. The Company's revenues and earnings will not include contributions from these operations going forward.
In addition, the Company holds a management contract with the Tunica-Biloxi Tribe of Louisiana for a gaming facility in Marksville, Louisiana, that expires on June 3, 2001 and a management contract with the Coushatta Tribe of Louisiana for a gaming facility in Kinder, Louisiana, that expires on January 16, 2002. The Coushatta Tribe and Lakes have agreed on a five-year contract renewal beginning January 17, 2002, subject to NIGC approval. Net distributable profits, if any, under the new agreement will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes.
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 of seven years. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
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.
In the event the management contracts are not renewed upon expiration of their initial term, the Company will be entitled to payments equal to a percentage of the fair value of certain leased gaming equipment.
The management contracts for the Tunica-Biloxi Tribe of Louisiana and the Coushatta Tribe of Louisiana have been approved by the Bureau of Indian Affairs (BIA). While the Company believes that all of its management contracts meet all requirements of the Indian Gaming Regulatory Act of 1988, the BIA or the NIGC may attempt to reduce the terms or the management fees payable under the management contracts or require other changes to the contracts.
3. NOTES RECEIVABLE:
Notes receivable consist of the following (in thousands):
The notes receivable are generally advances made to Indian Tribes for the development of gaming properties managed by the Company. The repayment terms are specific to each tribe and are largely dependent upon the operating performance of each gaming property. Repayments of the aforementioned notes receivable from the Coushatta Tribe and the Tunica-Biloxi Tribe is 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 January 2, 2000, no amounts have been withheld under these provisions.
Management periodically evaluates the recoverability of such notes receivable based on the current and projected operating results of the underlying facility and historical collection experience. No impairment losses on such notes receivable have been recognized through January 2, 2000.
The Company believes the costs and complexities of assembling the relevant facts and comparables needed to appraise the fair market values of these notes based on estimates of net present value of discounted cash flows or using other valuation techniques are excessive and the process exceedingly time consuming. It further believes that the determined results would not reasonably differ from the carrying values, which are believed to be reasonable estimates of fair market value based on past experience with similar receivables.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
4. INCOME TAXES:
The provisions for income taxes attributable to earnings for 1999, 1998, and 1997 consisted of the following (in thousands):
Reconciliations of the statutory federal income tax rate to the Company's actual rate based on earnings before income taxes for 1999, 1998, and 1997 are summarized as follows:
The Company's deferred income tax liabilities and assets are as follows (in thousands):
A deferred tax asset was recorded in 1996 when the Company set up a reserve allowance due to uncertainty related to the collectability of a note receivable from Stratosphere. However, a full valuation allowance was created for the deferred tax asset and no income tax benefit was recognized at that time.
Upon writing off the receivable and realizing the tax deduction in 1998, the Company reversed the deferred tax asset valuation allowance resulting in the recognition of a $17.3 million income tax benefit. Under the terms of its tax sharing agreement with Grand, any further tax benefits relating to capital losses resulting from the Company's write-off of its investment in Stratosphere will be shared equally by Lakes and Park Place up to a benefit of approximately $12.0 million to Lakes.
5. LONG-TERM DEBT:
The Company has two notes payable with third parties. The first is collateralized by certificates of deposit, with $1.0 million outstanding at January 2, 2000 and January 3, 1999. Interest is compounded and paid on a quarterly basis at 10%. The principal and any unpaid interest are due December 22, 2002. The
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
second is collateralized by property with $0.5 million outstanding at January 2, 2000. Interest is compounded and paid on a quarterly basis at 8.5%. The principal and any unpaid interest are due November 5, 2001.
6. STOCK OPTIONS:
Grand had a Stock Option and Compensation Plan and a Director Stock Option Plan whereby incentive and nonqualified stock options and other awards to acquire shares of Grand's common stock were granted to officers, directors, and employees.
Upon the consummation of the Transaction, the holders of outstanding Grand stock options received one new option to purchase one share of Lakes common stock for each four options previously held, and one new option to purchase one share of Park Place common stock for each option previously held. The exercise price of the new options was apportioned between Lakes and Park Place to preserve option value as it existed on December 31, 1998 as measured by the difference between the option exercise price and the fair market value of Grand on that date. This value was calculated by reference to the closing price of Lakes on January 4, 1999 and the closing price of Grand on December 31, 1998. Additionally, Lakes has a 1998 Stock Option and Compensation Plan and a 1998 Director Stock Option Plan which are approved to grant up to an aggregate of 2.5 million shares and .2 million shares, respectively, of incentive and non-qualified stock options to officers, directors, and employees.
Information with respect to the stock option plans is summarized as follows:
The Company accounts for these plans under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS No. 123, the Company's net earnings (loss) would have been as follows (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
The SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, thus the resulting pro forma compensation cost may not be representative of that to be expected in future years. The fair value of each award under the option plans is estimated on the date of grant using the Black-Scholes option-pricing model. The fair value of the options issued in 1999 range from $8.38 per share to $10.81 per share. The following assumptions were used to estimate the fair value of options:
7. EMPLOYEE RETIREMENT PLAN:
Grand had a section 401(k) employee savings plan for all full-time employees which upon consummation of the Transaction became Lakes' Plan. The savings plan allows participants to defer, on a pretax basis, a portion of their salary and accumulate tax-deferred earnings as a retirement fund. Eligibility is based on years of service and minimum age requirements. Contributions are invested, at the direction of the employee, in one or more available funds. Lakes matches employee contributions up to a maximum of 4% of participating employees' gross wages. The Company contributed $.03 million, $.03 million, and $.02 million during 1999, 1998, and 1997, respectively. Company contributions are vested over a period of five years.
8. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company leases certain property and equipment under non-cancelable operating leases. Rent expense, under non-cancelable operating leases, exclusive of real estate taxes, insurance, and maintenance expense was $1.3 million, $0.2 million, and $0.2 million for 1999, 1998, and 1997, respectively. Future minimum lease payments, excluding contingent rentals, due under non-cancelable operating leases as of January 2, 2000 are as follows (in thousands):
PURCHASE OPTIONS
As a condition to the Merger, the Company has agreed to exercise its call option to purchase the Shark Club property in Las Vegas, Nevada, not prior to April 9, 2000 and not later than January 10, 2001. The option purchase price would be approximately $10.1 million.
The Company also has an option to purchase the Travelodge property in Las Vegas, Nevada for the purchase price of $30 million on October 31, 2017 and an option to purchase the Cable property in Las Vegas, Nevada for the purchase price of $18 million anytime prior to October 31, 2000.
LOAN GUARANTY AGREEMENTS
The Company has guaranteed a loan and security agreement entered into by the Tunica-Biloxi Tribe of Louisiana for $16.5 million for the purpose of purchasing a hotel and additional casino equipment. The agreement extends through 2000, and as of January 2, 2000 and January 3, 1999, the amounts outstanding were $2.0 million and $7.3 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
On May 1, 1997, the Company entered into a guaranty agreement related to a loan agreement entered into by the Coushatta Tribe of Louisiana in the amount of $25.0 million, for the purpose of constructing a hotel and acquiring additional casino equipment. The guaranty will remain in effect until the loan is paid. The loan term is approximately five years. As of January 2, 2000 and January 3, 1999, the amounts outstanding were $19.3 million and $19.6 million, respectively.
INDEMNIFICATION AGREEMENT
As a part of the Transaction, the Company has agreed to indemnify Grand against all costs, expenses and liabilities incurred in connection with or arising out of certain pending and threatened claims and legal proceedings to which Grand and certain of its subsidiaries are likely to be parties. The Company's indemnification obligations include the obligation to provide the defense of all claims made in proceedings against Grand and to pay all related settlements and judgments.
As security to support Lakes' indemnification obligations to Grand under each of the Grand Distribution Agreement and the Park Place Merger Agreement, and as a condition to the consummation of the Merger, Lakes has agreed to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of Park Place, an aggregate of $30 million, to cover various commitments and contingencies related to or arising out of, Grand's non-Mississippi business and assets (including by way of example, but not limitation, tribal loan guarantees, real property lease guarantees for Lakes' subsidiaries and director and executive officer indemnity obligations) consisting of four annual installments of $7.5 million, during the four-year period subsequent to the Effective Date of the Transaction. Any surplus proceeds remaining after all the secured obligations are indefeasibly paid in full and discharged shall be paid over to Lakes. Lakes made the first deposit of $7.5 million on December 31, 1999 and such amount is included as restricted cash on the accompanying balance sheet as of January 2, 2000.
As part of the indemnification agreement, Lakes has agreed that it will not declare or pay any dividends, make any distribution of Lakes' equity interests, or otherwise purchase, redeem, defease or retire for value any equity interests in Lakes without the written consent of Park Place.
The following summaries describe certain known legal proceedings to which Grand is a party which Lakes has assumed, or with respect to which Lakes has agreed to indemnify Grand, in connection with the Distribution.
STRATOSPHERE SHAREHOLDERS LITIGATION -- FEDERAL COURT
In August 1996, a complaint was filed in the U.S. District Court for the District of Nevada -- Michael Ceasar, et al v. Stratosphere Corporation, et al -- against Stratosphere and others, including Grand. The complaint was filed as a class action, and sought relief on behalf of Stratosphere shareholders who purchased their stock between December 19, 1995 and July 22, 1996. The complaint included allegations of misrepresentations, federal securities law violations and various state law claims.
In August through October 1996, several other nearly identical complaints were filed by various plaintiffs in the U.S. District Court for the District of Nevada.
The defendants in the actions submitted motions requesting that all of the actions be consolidated. Those motions were granted in January 1997, and the consolidated action is entitled In re: Stratosphere Corporation Securities Litigation -- Master File No. CV-S-96-00708 PMP (RLH).
In February 1997, the plaintiffs filed a consolidated and amended complaint naming various defendants, including Grand and certain current and former officers and directors of Grand. The amended complaint includes claims under federal securities laws and Nevada laws based on acts alleged to have occurred between December 19, 1995 and July 22, 1996.
The Court has recently signed a scheduling order, which cuts off fact discovery as of April 30, 2000 and expert discovery as of September 30, 2000. The parties have submitted preliminary pretrial statements, which may be amended after the completion of discovery.
In February 1997, various defendants, including Grand and Grand's officers and directors named as defendants, submitted motions to dismiss the amended complaint. Those motions were made on various NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
grounds, including Grand's claim that the amended complaint failed to state a valid cause of action against Grand and Grand's officers and directors.
In May 1997, the court dismissed the amended complaint. The dismissal order did not allow the plaintiffs to further amend their complaint in an attempt to state a valid cause of action.
In June 1997, the plaintiffs asked the court to reconsider its dismissal order, and to allow the plaintiffs to submit a second amended complaint in an attempt to state a valid cause of action. In July 1997, the court allowed the plaintiffs to submit a second amended complaint.
In August 1997, the plaintiffs filed a second amended complaint. In September 1997, certain of the defendants, including Grand and Grand's officers and directors named as defendants, submitted a motion to dismiss the second amended complaint. The motion was based on various grounds, including Grand's claim that the second amended complaint failed to state a valid cause of action against Grand and Grand's officers and directors.
In April 1998, the Court granted Grand's motion to dismiss, in part, and denied the motion in part. Thus, the plaintiffs are pursuing the claims in the second amended complaint that survived the motion to dismiss.
In June 1998, certain of the defendants, including Grand and Grand's officers and directors named as defendants, submitted a motion for summary judgment seeking an order that such defendants are entitled to judgment as a matter of law. In December 1998, the plaintiffs completed fact discovery related to the issues raised by the summary judgment motion. Expert discovery was completed in March of 1999. All papers relating to this matter were filed on June 1, 1999.
On October 6, 1999, the District Court entered its Order, granting in part and denying in part, defendants' Motion for Summary Judgment and Summary Adjudication. The Court dismissed all allegations in reference to (1) Phase II funding levels; (2) "over-allotments uses", as stated in the December 19, 1995 Prospectus; (3) the purpose and use of the Grand Casino Completion Guaranty, as stated in the June 6, 1996 Press Statement; (4) the vague expressions of general optimism (issued within the December 19, 1995 Prospectus, the 10-Q and 10-K Filings, press releases and other public statements) referred to in this Order; (5) the adoption of statements in securities analysts reports; (6) the alleged utterance of misleading statements before the Nevada Gaming Commission; and (7) the temporary diversion of Phase II proceeds to fund Phase I. The remaining claims relate to the accuracy of defendants' budgetary estimates issued in Stratosphere's December 1995 Prospectus and SEC 10-Q and 10-K Reports. The Court concluded that there were triable issues as to whether defendants misstated anticipated construction costs or omitted to disclose material cost overruns.
The Court recently added the Company as an additional defendant because of its indemnity obligation and stipulation. Park Place has opposed being added to the litigation and plaintiffs' motion to add Park Place as a defendant is pending.
STRATOSPHERE SHAREHOLDERS LITIGATION -- NEVADA STATE COURT
In August 1996, a complaint was filed in the District Court for Clark County, Nevada -- Victor M. Opitz, et al v. Robert E. Stupak, et al -- Case No. A363019 -- against various defendants, including Grand. The complaint seeks relief on behalf of Stratosphere Corporation shareholders who purchased stock between December 19, 1995 and July 22, 1996. The complaint alleges misrepresentations, state securities law violations and other state claims.
Grand and certain defendants submitted motions to dismiss or stay the state court action pending resolution of the federal court action described above. The court has stayed further proceedings pending the resolution of In re: Stratosphere Securities Litigation.
GRAND CASINOS, INC. SHAREHOLDERS LITIGATION
In September and October 1996, two actions were filed by Grand shareholders in the U.S. District Court for the District of Minnesota against Grand and certain of Grand's current and former directors and officers. The complaints allege misrepresentations, federal securities law violations and other claims in connection with the Stratosphere project.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
The actions have been consolidated as In re: Grand Casinos, Inc. Securities Litigation -- Master File No. 4-96-890 -- and the plaintiffs filed a consolidated complaint. The defendants submitted a motion to dismiss the consolidated complaint, based in part on Grand's claim that the consolidated complaint failed to properly state a cause of action.
In December 1997, the court granted Grand's motion to dismiss in part, and denied the motion in part. Thus, the plaintiffs are pursuing the claims in the consolidated complaint that survived Grand's motion to dismiss. Discovery in the action has begun.
The defendants have submitted a motion for summary judgment seeking an order that the defendants are entitled to judgment as a matter of law. In December 1998, the plaintiffs completed fact discovery related to the issues raised by the summary judgement motion. Expert discovery was completed in March of 1999. The parties have completed follow-up discovery pertaining to the summary judgment motion. The court heard the motion on September 2, 1999. The court has not yet ruled on the motion.
In early February 1999, the plaintiffs filed a motion for leave to amend the complaint in this action to include, as defendants in the case, both the Company and Park Place. The motion for leave to amend the complaint has been granted and Lakes has filed its answer. Lakes will defend this action vigorously.
SLOT MACHINE LITIGATION
In April 1994, William H. Poulos brought an action in the U.S. District Court for the Middle District of Florida, Orlando Division -- William H. Poulos, et al v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various parties (including Grand) alleged to operate casinos or be slot machine manufacturers were named as defendants. The plaintiff sought to have the action certified as a class action.
A subsequently filed Action - William Ahearn, et al v. Caesars World, Inc. et al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was consolidated with the Poulos action.
Both actions included claims under the federal Racketeering-Influenced and Corrupt Organizations Act and under state law, and sought compensatory and punitive damages. The plaintiffs claimed that the defendants are involved in a scheme to induce people to play electronic video poker and slot machines based on false beliefs regarding how such machines operate and the extent to which a player is likely to win on any given play.
In December 1994, the consolidated actions were transferred to the U.S. District Court for the District of Nevada.
In September 1995, Larry Schreier brought an action in the U.S. District Court for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier action were similar to those made by the plaintiffs in the Poulos and Ahearn actions, except that Schreier claimed to represent a more precisely defined class of plaintiffs than Poulos or Ahearn.
In December 1996, the court ordered the Poulos, Ahearn and Schreier actions consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the plaintiffs to file a consolidated and amended complaint. In February 1997, the plaintiffs filed a consolidated and amended complaint.
In March 1997, various defendants (including Grand) filed motions to dismiss or stay the consolidated action until the plaintiffs submitted their claims to gaming authorities and those authorities considered the claims submitted by the plaintiffs.
In December 1997, the court denied all of the motions submitted by the defendants, and ordered the plaintiffs to file a new consolidated and amended complaint. That complaint has been filed. Grand has filed its answer to the new complaint.
The plaintiffs have filed a motion seeking an order certifying the action as a class action. Grand and certain of the defendants have opposed the motion. The Court has not ruled on the motion.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
STANDBY EQUITY COMMITMENT LITIGATION
In September 1997, the Stratosphere Trustee under the indenture pursuant to which Stratosphere issued its first mortgage notes filed a complaint in the U.S. District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company, Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand as defendant.
The complaint alleges that Grand failed to perform under the Standby Equity Commitment entered into between Stratosphere and Grand in connection with Stratosphere's issuance of such first mortgage notes in March 1995. The complaint seeks an order compelling specific performance of what the Trustee claims are Grand's obligations under the Standby Equity Commitment.
The Stratosphere Trustee filed the complaint in its alleged capacity as a third party beneficiary under the Standby Equity Commitment. Pursuant to the Second Amended Plan, a new limited liability company (the "Stratosphere LLC") was formed to pursue certain alleged claims and causes of action that Stratosphere and other parties may have against numerous third parties, including Grand and/or officers and/or directors of Grand. The Stratosphere LLC has been substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding.
In October of 1999, Motions for Summary Judgment by both parties were denied. Grand's request for expedited appellate court review of the denial as to its motion for summary judgment was denied. The trial court is expected to hold a pretrial conference to address discovery and scheduling issues. Lakes will continue to defend the lawsuit diligently.
STRATOSPHERE PREFERENCE ACTION
In April 1998, Stratosphere served on Grand and Grand Media & Electronics Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a complaint in the Stratosphere bankruptcy case seeking recovery of certain amounts paid by Stratosphere to (i) Grand as management fees and for costs and expenses under a management agreement between Stratosphere and Grand, and (ii) Grand Media for electronic equipment purchased by Stratosphere from Grand Media.
Stratosphere claims in its complaint that such amounts are recoverable by Stratosphere as preferential payments under bankruptcy law.
In May 1998, Grand responded to Stratosphere's complaint. That response denies that Stratosphere is entitled to recover the amounts described in the complaint. The matter is pending.
OTHER LITIGATION
The Company has recorded a reserve assessment related to various of the above items. The reserve is reflected as a litigation and claims accrual on the accompanying consolidated balance sheet as of January 2, 2000.
Grand and Lakes are involved in various other inquiries, administrative proceedings, and litigation relating to contracts and other matters arising in the normal course of business. While any proceeding or litigation has an element of uncertainty, management currently believes that the final outcome of these matters is not likely to have a material adverse effect upon Grand's or the Company's consolidated financial position or results of operations.
9. SUBSEQUENT EVENTS:
On January 18, 2000, a Michigan Ingham County Circuit Judge ruled that the Michigan State Legislature acted improperly in 1998 when it approved casino compacts by joint resolution. The Governor of the State of Michigan has indicated that he will appeal the ruling. The ruling directly affects four tribes in Michigan, one of which is the Pokagon Band of Potawatomi Indians with whom Lakes has development and management contracts. Lakes is continuing to work with the Band to have land accepted into Trust by the Secretary of Interior and to have the management agreement approved by the NIGC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 2, 2000, JANUARY 3, 1999, AND DECEMBER 28, 1997 -- (CONTINUED)
On February 7, 2000, Lakes announced that it reached an agreement with the Coushatta Tribe of Louisiana for a five year renewal of its management agreement. The new contract is subject to NIGC approval. Net distributable profits, if any, under the new agreement will be determined in accordance with IGRA and distributed each month 90% to the Coushatta Tribe and 10% to Lakes.
10. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Year ended January 2, 2000 (in thousands, except per share amounts):
Year ended January 3, 1999 (in thousands, except per share amounts):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information beginning immediately following the caption "Election of Directors" to, but not including, the caption "Compensation Committee Interlocks and Insider Participation" in the Company's 1999 Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after the close of the Company's year ended January 2, 2000 and forwarded to shareholders prior to the Company's 1999 Annual Meeting of Shareholders (the "1999 Proxy Statement"), is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information in the 1999 Proxy Statement beginning immediately following the caption "Executive Compensation" to, but not including, the caption "Director Compensation", is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the 1999 Proxy Statement beginning immediately following the caption "Voting Securities and Principal Holders Thereof" to, but not including, the caption "Election of Directors", is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the 1999 Proxy Statement under the caption "Certain Transactions" is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Consolidated Financial Statements:
(a)(2) None.
(a)(3)
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* Management Compensatory Plan or Arrangement. (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 December 23, 1999. (c) See Part IV, Item 14 (a)(3) and the exhibit list immediately above. (d) None.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LAKES GAMING, INC. Registrant
By: /s/ LYLE BERMAN ------------------------------------ Name: Lyle Berman Title: Chairman of the Board and Chief Executive Officer Dated as of March 28, 2000
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 28, 2000.