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Form 10-Q for LAKES ENTERTAINMENT INC

19-May-2004

Quarterly Report

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS

OVERVIEW

Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")was established as a public corporation on December 31, 1998, via a distribution(the "Distribution") of its Common Stock, to the shareholders of Grand Casinos,Inc. ("Grand").

As a result of the Distribution, Lakes operates the Indian casino managementbusiness and holds various other assets previously owned by Grand. Lakes' mainbusiness is the development, construction and management of casinos and relatedhotel and entertainment facilities in emerging and established gamingjurisdictions. Lakes has entered into contracts for the development, managementand/or financing of new casino operations, all of which are subject to variousregulatory approvals before construction can begin. Lakes has contracts todevelop and manage Indian-owned gaming resorts for the following:

o Shingle Springs Band of Miwok Indians near Sacramento, California

o Pokagon Band of Potawatomi Indians near New Buffalo, Michigan

o Jamul Indian Village near San Diego, California

o Nipmuc Nation on the East Coast of the United States

In addition, Lakes owns options to purchase the patent rights for various newcasino games and is actively marketing these new games to the casino industry inan attempt to license the games for use in their operations.

World Poker Tour, a majority-owned subsidiary of Lakes, has created a circuit ofpreviously-established poker tournaments affiliated under the "World Poker Tour"name, and has produced the World Poker Tour television series. World Poker Toursigned an agreement for a second season with the Travel Channel, LLC ("TRV") forbroadcast of the World Poker Tour series on cable television which is currentlyairing. TRV was also granted options for five additional seasons. WPT receives aseries of fixed license payments from TRV.

During January of 2004, World Poker Tour announced that it will seek to raiseapproximately $20 million through a newly formed corporation pursuant to anunderwritten initial public offering of common stock at a price to bedetermined. It is expected that proceeds from the offering will be used toexpand World Poker Tour's entertainment production business and for its workingcapital. There will be no selling shareholders participating in the offering.Lakes does not expect to recognize a gain or loss on this transaction and theproceeds will be reflected as a minority interest.

Additionally, Lakes continually evaluates other opportunities to diversify theCompany's activities and bring in new revenue streams.

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                            AND RESULTS OF OPERATIONS

The significant accounting policies, which Lakes believes are the most criticalto aid in fully understanding and evaluating its reported financial results,include the following: revenue recognition and realizability of notesreceivable.

REVENUE RECOGNITION: Revenue from the management of Indian-owned casino gamingfacilities is recognized when earned according to the terms of the managementcontracts. Currently all of the Indian-owned casino projects that Lakes isinvolved with are in development stages and are not yet open. Therefore, until aproject is open and operating, Lakes will not recognize revenue related toIndian casino management. Interest income on notes receivable for Indian tribesrelated to casino development projects is deferred because realizability of theinterest is contingent upon the completion and generation of cash flow from theoperation of the casino. Interest deferred during the development period isrecognized over the remaining life of the note using the effective interestmethod. License revenue from the World Poker Tour series airing on TRV isrecognized upon delivery of completed episodes. WPT sponsorship and host casinorevenue is recognized upon airing of episodes. Any payments received in excessof WPT revenue earned are deferred and recoginized upon delivery or airing ofepisodes.

IMPAIRMENT OF LONG-TERM ASSETS: Currently, the Company's notes receivable fromIndian Tribes are generally for the pre-construction development of gamingproperties to be managed by the Company. The repayment terms are specific toeach tribe and are largely dependent upon the operating performance of eachgaming property. Repayments of the notes receivable are required to be made onlyif distributable profits are available from the operation of the relatedcasinos. Repayments are also subject to certain distribution prioritiesspecified in the management contracts. In addition, repayment of the notesreceivable and the manager's fees under the management contracts aresubordinated to certain other financial obligations of the respective tribes.Through April 4, 2004, no impairments have been recorded under these provisions.Management periodically evaluates the recoverability of such notes receivablebased on the current and projected operating results of the underlying facilityand an assessment of the underlying facility and an assessment as to theliklihood of project completion. If the Company determines an impairment hasoccurred, the notes receivable would be written down to their estimated fairvalue.

The Company currently holds land held for development and land held undercontract for sale. The Company periodically evaluates whether events andcircumstances have occurred that may affect the recoverability of the net bookvalue of these assets. If such events or circumstances indicate that thecarrying amount of an asset may not be recoverable, the Company estimates thefuture cash flows expected to result from the use of the asset. If the sum ofthe expected future undiscounted cash flows does not exceed the carrying valueof the asset, the Company will recognize an impairment loss.

The following discussion and analysis should be read in conjunction with thecondensed consolidated financial statements and notes thereto and management'sdiscussion and analysis included in the Company's Annual Report on Form 10-K forthe year ended December 28, 2003.

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                      AND RESULTS OF OPERATIONS (CONTINUED)

Revenues are calculated in accordance with accounting principles generallyaccepted in the United States of America and are presented in a mannerconsistent with industry practice.

THREE MONTHS ENDED APRIL 4, 2004 COMPARED TO THE THREE MONTHS ENDED MARCH 30,

Revenues

Total revenues were $4.1 million for the three months ended April 4, 2004,compared to $0.6 million in the prior year period. Revenues for the current andprior year periods were primarily derived from license fees related to the WPTseries. The increase in revenue is the result of a greater number of episodesdelivered to the Travel Channel in the current year period compared to the prioryear period.

Costs and Expenses

Total costs and expenses were $5.9 million for the three months ended April 4,2004, compared to $3.1 million for the same period in the prior year. Selling,general and administrative expenses increased from $2.1 million for the threemonths ended March 30, 2003 to $3.3 million for the three months ended April 4,2004. This increase is due to an increase in costs associated with World PokerTour and an increase in professional fees incurred by Lakes, related todevelopment projects. World Poker Tour production costs increased from $0.9million for the three months ended March 30, 2003 to $2.5 million for the threemonths ended April 4, 2004. Production costs consist of capitalizable directcosts, production overhead and development costs for each episode and aregenerally expensed as revenues are recognized upon delivery and acceptance ofthe completed episode. However, the $0.9 million in production costs recognizedin the 2003 period does not include an additional $1.0 million in productioncosts that were previously expensed in 2002 even though the episodes were notdelivered until 2003. These previous costs were not capitalized as of December29, 2002, because World Poker Tour did not have a contract for the sale ofepisodes at that time.

Other

A subsidiary of Lakes and Land Baron West, LLC are partners in a joint ventureformed to develop or sell land purchased by the joint venture near San Diego,California. During the first quarter of 2004, the joint venture sold this land.Lakes' share of the proceeds related to this sale was approximately $1.7 millionin cash after payment of closing costs. The sale resulted in a gain to Lakes ofapproximately $0.4 million which is included in the accompanying consolidatedstatement of earnings for the three months ended April 4, 2004.

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                      AND RESULTS OF OPERATIONS (CONTINUED)

For the three months ended April 4, 2004, basic and diluted losses per commonshare were $0.03, compared to basic and diluted losses of $0.06 per share, forthe same period in the prior year. Losses for the three months ended April 4,2004 were $0.8 million compared to losses of $1.3 million for the three monthsended March 30, 2003. This decrease in losses relates primarily to an increasein net World Poker Tour income during the current year period.

Outlook

It is currently contemplated that there will be no operating revenues for 2004from existing casino development projects. Revenue from the second season of theWorld Poker Tour series will be recognized along with associated productioncosts during 2004. The Company anticipates that most of the remaining revenuesfrom the second season will be recognized in the second quarter of 2004.Although none of the existing casino development projects are expected toproduce revenue in 2004, Lakes continues to evaluate potential newrevenue-generating business opportunities. Lakes continues to closely monitorits operating expenses.

After the anticipated initial public offering by World Poker Tour, Lakes willcontinue to own a majority of World Poker Tour's equity. Therefore, World PokerTour's operating results will continue to be consolidated with our results.

FINANCIAL CONDITION

At April 4, 2004, Lakes had $25.0 million in unrestricted cash and cashequivalents. Lakes' operating revenues have been minimal since the expiration ofthe management contract with the Coushatta Tribe in January 2002. In 2003, theoperating revenues derived from the World Poker Tour were offset almost entirelyby production costs. The Company's primary source of cash the past two years hasbeen from the planned sale of assets. We expect that proceeds from the sale ofassets will decrease in 2004. During the first quarter of 2004, the 2022 Ranchland, which was owned by Lakes and its joint venture partner Land Baron West,LLC, was sold. Lakes received cash in the amount of approximately $1.7 million.

Our management contracts with our tribal partners require that we providefinancial support in the form of notes receivable prior to the beginning ofconstruction (the 'Pre-construction Financing'). We also have commitments toprovide additional financing to our tribal partners to fund the construction ofthe casinos ('the Construction Financing') if it is not available from othersources. These notes are interest bearing; however, the interest is deferreduntil the casino is built and has established profitable operations. In theevent that the casinos are not built, our only recourse is to liquidate theassets of the development. We currently believe that our existing casinodevelopment projects included in the table below will be constructed and achieveprofitable operation; however, no assurance can be made that this will occur. Ifthis does not occur, it is likely that Lakes would incur substantial losses inthe liquidation of the collateral.

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                      AND RESULTS OF OPERATIONS (CONTINUED)

                                                       Casino Development Advances/Commitments                                               ----------------------------------------------------                                                                    (in millions)                                               Pre-construction    Land Held for        Remaining                                                   Advances        Development          Commitment                                                 as of 4/4/04      as of 4/4/04        as of 4/4/04                                               ----------------    -------------       ------------    Jamul Indian Village                           $   13.0          $    6.6          $   10.4    Shingle Springs Band of Miwok Indians              27.4               7.4               0.2    Pokagon Band of Potawatomi Indians                 42.8                --              25.7    Nipmuc Nation                                       5.1                --               1.0

Lakes may be required to provide a guarantee of tribal debt financing orotherwise provide support for the tribal obligations related to any of theprojects. Any guarantees by Lakes or similar off-balance sheet liabilities willincrease Lakes' potential exposure in the event of a default by any of thesetribes.

Our major use of cash over the past three years has been Pre-constructionFinancing provided to our tribal partners. At April 4, 2004, Lakes hadapproximately $89.9 million in notes receivable from Indian tribes. See Note 5to the Consolidated Financial Statements.

We believe that our cash and cash equivalents, along with expected cashreceipts, will be adequate to fund operating expenses and Pre-constructionFinancing in 2004. If the Pokagon casino project begins construction during2004, it is anticipated that we will require additional capital through eitherpublic or private financings.

Lakes loaned $0.3 million to a former non-tribal partner in one of its Indiancasino development projects. Repayment is expected to be received from thisformer partner's future consulting fees related to certain Indian casinodevelopment projects. At April 4, 2004, $0.3 million is outstanding under thisagreement.

As a part of the transaction establishing Lakes as a separate public company onDecember 31, 1998, the Company agreed to indemnify Grand through December 28,2004 against all costs, expenses and liabilities incurred in connection with orarising out of certain pending and threatened claims and legal proceedingsagainst Grand and to pay all related settlements and judgments. The Company'sindemnification obligations include the obligation to provide the defense of allclaims made in proceedings against Grand and to pay all related settlements andjudgments.

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                      AND RESULTS OF OPERATIONS (CONTINUED)

SEASONALITY

The Company believes that the operations of all casinos to be managed by theCompany will be affected by seasonal factors, including holidays, weather andtravel conditions.

REGULATION AND TAXES

The Company is subject to extensive regulation by state gaming authorities. TheCompany will also be subject to regulation, which may or may not be similar tocurrent state regulations, by the appropriate authorities in any jurisdictionwhere it may conduct gaming activities in the future. Changes in applicable lawsor regulations could have an adverse effect on the Company.

The gaming industry represents a significant source of tax revenues. From timeto time, various federal legislators and officials have proposed changes in taxlaw, or in the administration of such law, affecting the gaming industry. It isnot possible to determine the likelihood of possible changes in tax law or inthe administration of such law. Such changes, if adopted, could have a materialadverse effect on the Company's results of operations and financial results.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements that have or are reasonablylikely to have a current or future effect on its financial condition, changes infinancial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources that is material to investors, exceptfor the financing commitments previously discussed, and except for Lakes'investments in unconsolidated affiliates (see Note 2).

PRIVATE SECURITIES LITIGATION REFORM ACT

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"for forward-looking statements. Certain information included in this Form 10-Kand other materials filed or to be filed by the Company with the Securities andExchange Commission (as well as information included in oral statements or otherwritten statements made or to be made by the Company) contain statements thatare forward-looking, such as plans for future expansion and other businessdevelopment activities as well as other statements regarding capital spending,financing sources and the effects of regulation (including gaming and taxregulation) and competition.

Such forward looking information involves important risks and uncertainties thatcould significantly affect the anticipated results in the future and,accordingly, actual results may differ materially from those expressed in anyforward-looking statements made by or on behalf of the Company.

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                      AND RESULTS OF OPERATIONS (CONTINUED)

                   LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK;                             CONTROLS AND PROCEDURES

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