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LACO > SEC Filings for LACO > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for LAKES ENTERTAINMENT INC


7-Nov-2013

Quarterly Report


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

Overview

Lakes Entertainment, Inc. and subsidiaries ("Lakes", "we", or "our") develops, finances, manages and owns casino properties with a historical emphasis on Indian-owned properties. An overview of our projects as of September 29, 2013 is as follows:

• We own and operate the Rocky Gap Casino Resort in Allegany County, Maryland ("Rocky Gap") which we acquired on August 3, 2012 for $6.8 million. In connection with the acquisition of Rocky Gap, we entered into a 40 year operating ground lease with the Maryland Department of Natural Resources ("Maryland DNR") for approximately 268 acres in the Rocky Gap State Park on which Rocky Gap is situated. The AAA Four Diamond Award® winning resort included a hotel, convention center, spa, two restaurants and the only Jack Nicklaus signature golf course in Maryland. We converted existing convention center space at Rocky Gap into a gaming facility which opened to the public on May 22, 2013 and features 558 video lottery terminals ("VLTs"), 10 table games, three poker tables, a casino bar and a new lobby food and beverage outlet. A new event and conference center is being constructed which will be able to accommodate large groups and will feature flexible use meeting rooms and is expected to be available for use in mid-November of 2013. The total cost of the Rocky Gap project is currently expected to be approximately $35.0 million, which includes the initial acquisition cost. We have a $17.5 million financing facility in place to finance a portion of the gaming facility project and new event and conference center construction costs. We have drawn $13.4 million on this financing facility and we do not currently plan to make further draws.

• We developed, and had a seven-year contract to manage the Red Hawk Casino that was built on the Rancheria of the Shingle Springs Band of Miwok Indians ("Shingle Springs Tribe") in El Dorado County, California, adjacent to U.S. Highway 50, approximately 30 miles east of Sacramento, California. We began managing the Red Hawk Casino when it opened to the public on December 17, 2008.

On July 17, 2013, we entered into a debt termination agreement with the Shingle Springs Tribe relating to amounts we had previously advanced to the Shingle Springs Tribe (the "Shingle Springs Notes") for the development of the Red Hawk Casino (the "Debt Termination Agreement"). The Debt Termination Agreement required certain conditions to be met, including a lump sum payment by the Shingle Springs Tribe to us of $57.1 million (the "Debt Payment"). The Debt Payment was made on August 29, 2013 (the "Payment Date") and constituted full and final payment of all debt owed to us as of that date. As a result of the receipt of the Debt Payment, during the third quarter of 2013, we recognized approximately $17.4 million in recovery of impairment on notes receivable because the Shingle Springs Notes had previously been impaired and were valued at $39.7 million. The face value of the Shingle Springs Notes including accrued interest was $69.7 million as of the Payment Date. The management agreement under which we were managing the Red Hawk Casino also terminated on the Payment Date.

• We have an investment in Rock Ohio Ventures, LLC ("Rock Ohio Ventures") that owns the Horseshoe Casino Cleveland in Cleveland, Ohio, the Horseshoe Casino Cincinnati in Cincinnati, Ohio, and the Thistledown Racino in North Randall, Ohio. As of September 29, 2013, we have contributed approximately $21.0 million to Rock Ohio Ventures. Lakes currently maintains a 10% interest in Rock Ohio Ventures' 80% ownership in its casino properties in Ohio. We currently plan to contribute additional capital as needed to maintain our equity position in Rock Ohio Ventures. If we choose not to fund any additional amounts, we will maintain an ownership position in Rock Ohio Ventures in a pro rata amount of what our $2.8 million initial payment is to the total amount of equity funded to develop casino operations, and all equity funded in excess of the initial $2.8 million is required to be repurchased at an amount equal to the price paid.

The Horseshoe Casino Cleveland opened in May 2012. The casino features approximately 2,100 slot machines, 89 table games, a 30-table poker room and multiple food and beverage outlets. The Horseshoe Casino Cincinnati opened in March 2013 and features approximately 2,000 slot machines, 118 table games (including poker), food and beverage outlets, and a parking structure with approximately 2,500 parking spaces. The Thistledown Racino added 1,100 VLTs to its existing racetrack in April 2013.

Results of Operations

The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the three and nine months ended September 29, 2013.

Three months ended September 29, 2013 compared to the three months ended September 30, 2012

Net Revenues

Net revenues were $15.5 million for the third quarter of 2013 compared to $3.6 million for the third quarter of 2012. The increase in net revenues for the three months ended September 29, 2013 compared to the three months ended September 30, 2012 was due to additional net revenue of $12.3 million related to the operation of Rocky Gap, which Lakes acquired on August 3, 2012 and which commenced gaming operations on May 22, 2013. Also included in net revenues were $1.4 million in management fees earned related to the Red Hawk Casino during the third quarter of 2013 compared to $1.9 million earned during the third quarter of 2012. The decrease in management fees earned during the third quarter of 2013 compared to the third quarter of 2012 was due to the August 29, 2013 termination of the management agreement between Lakes and the Shingle Springs Tribe for the management of the Red Hawk Casino which resulted in only two months of management fees in the current year third quarter. Lakes' consolidated statement of operations will not include management fee revenues related to the Red Hawk Casino subsequent to August 29, 2013.


Property Operating Expenses

Property operating expenses were $8.2 million for the third quarter of 2013 compared to $0.8 million for the third quarter of 2012 which primarily related to gaming, rooms, food and beverage and golf operations of Rocky Gap. The increase in property operating expenses resulted primarily from the inclusion of gaming-related expenses in the current year quarter. Gaming commenced in May 2013, therefore there were no such expenses in the prior year third quarter. In addition, because Rocky Gap was acquired on August 3, 2012, the prior year third quarter included only a partial quarter of property operating expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $5.4 million in the third quarter of 2013 compared to $2.8 million for the third quarter of 2012. Included in these amounts were Lakes corporate selling, general and administrative expenses of $1.3 million and $2.0 million and Rocky Gap selling, general and administrative expenses of $4.1 million and $0.8 million for the third quarters of 2013 and 2012, respectively. For the third quarter of 2013, selling, general and administrative expenses consisted primarily of payroll and related expenses of $2.6 million (including share-based compensation), marketing and advertising expenses of $1.0 million, building and rent expenses of $0.8 million and professional fees of $0.4 million. For the third quarter of 2012, Lakes' selling, general and administrative expenses consisted primarily of payroll and related expenses of $1.3 million (including share-based compensation), building and rent expenses of $0.3 million and professional fees of $0.7 million.

Recovery of Impairment on Notes Receivable

On July 17, 2013, Lakes entered into the Debt Termination Agreement with the Shingle Springs Tribe relating to amounts Lakes had previously advanced to the Shingle Springs Tribe. Per the Debt Termination Agreement, the Shingle Springs Tribe paid Lakes $57.1 million on August 29, 2013 which constituted full and final payment of all debt owed to Lakes as of that date. As a result of the receipt of the Debt Payment and due to the fact that the Shingle Springs Notes had previously been impaired, Lakes recognized $17.4 million in recovery of impairment on notes receivable in the third quarter of 2013.

Gain on Extinguishment of Liabilities

During the third quarter of 2013, Lakes recognized a gain on extinguishment of liabilities of $3.8 million associated with contract acquisition costs related to the project with the Shingle Springs Tribe that were no longer owed upon the termination of the management agreement between Lakes and the Shingle Springs Tribe.

Impairments and Other Losses

Impairments and other losses were $3.4 million in the third quarter of 2013 compared to $2.0 million in the third quarter of 2012. During the third quarter of 2013, Lakes recognized impairment charges of $2.4 million related to the intangible assets associated with the development and management agreement with the Shingle Springs Tribe, which were considered fully impaired upon the termination of the management agreement on August 29, 2013 and were written down to zero. Lakes also recognized an impairment charge of $1.0 million related to receivables from related parties that are directly related to the development and opening of Lakes' Indian casino projects which were determined to be uncollectible during the third quarter of 2013. During the prior year period, Lakes recognized impairment charges of $0.7 million related to costs associated with development plans for the Rocky Gap project which were subsequently revised. In addition, as a result of agreeing to sell the majority of the land owned in Vicksburg, Mississippi during the third quarter of 2012 for an amount less than its recorded book value, Lakes recognized an impairment charge of $1.3 million.

Amortization of Intangible Assets Related to Indian Casino Projects

Amortization of intangible assets related to Indian casino projects was $0.2 million for the third quarter of 2013 compared to $0.3 million for the third quarter of 2012 and were associated with the project with the Shingle Springs Tribe. In connection with the Debt Termination Agreement entered into with the Shingle Springs Tribe during the third quarter of 2013, the remaining intangible assets associated with that project were fully impaired as of August 29, 2013.

Other Income (Expense), net

Other income (expense), net was $0.8 million for the third quarter of 2013 compared to $1.4 million for the third quarter of 2012, a significant portion of which relates to non-cash interest income associated with accretion on notes receivable from the Shingle Springs Tribe.

Income Taxes

There was no income tax provision for the third quarter of 2013 because the Company released valuation allowance against deferred tax assets available to offset current income. The income tax benefit for the third quarter of 2012 was $0.1 million and was primarily due to the third quarter of 2012 income tax benefit. Our effective tax rates were 0% and (8)% for the third quarter of 2013 and 2012, respectively. For the three months ended September 29, 2013, the effective tax rate differs from the federal tax rate of 35% primarily due to the release of valuation allowance against deferred tax assets which were available to offset current income. For the three months ended September 30, 2012, the effective tax rate differs from the federal tax rate of 35% due to state income taxes and discrete items recognized.

Nine months ended September 29, 2013 compared to the nine months ended September 30, 2012

Net Revenues

Net revenues were $27.3 million for the nine months ended September 29, 2013 compared to $8.1 million for the nine months ended September 30, 2012. The increase in net revenues for the nine months ended September 29, 2013 compared to the nine months ended September 30, 2012 was due primarily to additional net revenue of $17.8 million related to the operation of Rocky Gap. Also contributing to the increase in net revenues was an additional $1.4 million in management fees earned related to the Red Hawk Casino during the nine months ended September 29, 2013 compared to the prior year period. Lakes' consolidated statement of operations will not include management fee revenues related to the Red Hawk Casino subsequent to August 29, 2013.

Property Operating Expenses

Property operating expenses were $12.2 million for the nine months ended September 29, 2013 compared to $0.8 million for the nine months ended September 30, 2012 which primarily related to gaming, rooms, food and beverage and golf operations of Rocky Gap. The increase in property operating expenses was primarily due to the inclusion of gaming-related expenses in the current year period. Gaming commenced in May 2013, therefore there were no such expenses in the prior year period. In addition, because Rocky Gap was acquired on August 3, 2012, the prior year period included property operating expenses beginning on the date of acquisition.


Selling, General and Administrative Expenses

Selling, general and administrative expenses were $13.8 million for the nine months ended September 29, 2013 compared to $7.1 million for the nine months ended September 30, 2012. Included in these amounts were Lakes corporate selling, general and administrative expenses of $5.3 million and $5.9 million and Rocky Gap selling, general and administrative expenses of $8.5 million and $1.2 million during the nine months ended 2013 and 2012, respectively. For the nine months ended September 29, 2013, selling, general and administrative expenses consisted primarily of payroll and related expenses of $6.7 million (including share-based compensation), marketing and advertising expenses of $1.5 million, building and rent expense of $1.7 million and professional fees of $2.2 million. For the nine months ended September 30, 2012, Lakes' selling, general and administrative expenses consisted primarily of payroll and related expenses of $3.5 million (including share-based compensation), building and rent expenses of $0.4 million, and professional fees of $1.8 million.

Recovery of Impairment on Notes Receivable

On July 17, 2013, Lakes entered into the Debt Termination Agreement with the Shingle Springs Tribe relating to amounts Lakes had previously advanced to the Shingle Springs Tribe. Per the Debt Termination Agreement, the Shingle Springs Tribe paid Lakes $57.1 million on August 29, 2013 which constituted full and final payment of all debt owed to Lakes as of that date. As a result of the receipt of the Debt Payment and due to the fact that the Shingle Springs Notes had previously been impaired, Lakes recognized $17.4 million in recovery of impairment on notes receivable for the nine months ended September 29, 2013.

Gain on Extinguishment of Liabilities

During the nine months ended September 29, 2013, Lakes recognized a gain on extinguishment of liabilities of $3.8 million associated with contract acquisition costs related to the project with the Shingle Springs Tribe that were no longer owed upon the termination of the management agreement between Lakes and the Shingle Springs Tribe.

Impairments and Other Losses

Impairments and other losses were $3.4 million for the nine months ended September 29, 2013 compared to $4.3 million for the nine months ended September 30, 2012. During the current year period, Lakes recognized impairment charges of $2.4 million related to the intangible assets associated with the development and management agreement with the Shingle Springs Tribe, which were considered fully impaired upon the termination of the management agreement on August 29, 2013 and were written down to zero. Lakes also recognized an impairment charge of $1.0 million related to receivables from related parties that are directly related to the development and opening of Lakes' Indian casino projects which were determined to be uncollectible for the nine months ended September 29, 2013. During the prior year period, Lakes recognized impairment charges of $1.8 million due to Lakes determining that it would not continue to move forward with the project with the Jamul Tribe. Also included in impairments and other losses for the nine months ended September 30, 2012 were $1.2 million related to costs associated with development plans for the Rocky Gap project which were subsequently revised and an impairment charge of $1.3 million as a result of agreeing to sell the majority of the land owned in Vicksburg, Mississippi during the third quarter of 2012 for an amount less than its recorded book value.

Preopening Expenses

Lakes expenses certain project preopening costs as incurred. During the nine months ended September 29, 2013, Lakes recognized preopening expenses of $1.2 million related to the Rocky Gap project. There were no preopening expenses during the nine months ended September 30, 2012.

Amortization of Intangible Assets Related to Indian Casino Projects

Amortization of intangible assets related to Indian casino projects was $0.7 million for the nine months ended September 29, 2013 compared to $0.8 million for the nine months ended September 30, 2012 and were associated with the project with the Shingle Springs Tribe. In connection with the Debt Termination Agreement entered into with the Shingle Springs Tribe during the third quarter of 2013, the remaining intangible assets associated with that project were fully impaired as of August 29, 2013.

Other Income (Expense), net

Other income (expense), net was $3.9 million for the nine months ended September 29, 2013 compared to $4.2 million for the nine months ended September 30, 2012, a significant portion of which relates to non-cash interest income associated with accretion on notes receivable from the Shingle Springs Tribe.

Income Taxes

There was no income tax provision for the nine months ended September 29, 2013 because the Company released valuation allowance against deferred tax assets available to offset current income. The income tax benefit for the nine months ended September 30, 2012 was $2.2 million and resulted from Lakes' ability to carry back its taxable losses to a prior year and receive a refund of taxes previously paid. Our effective tax rates were 0% and (227)% for the nine months ended September 29, 2013 and September 30, 2012, respectively. For the nine months ended September 29, 2013, the effective tax rate differs from the federal tax rate of 35% primarily due to the release of valuation allowance against deferred tax assets which were available to offset current income. For the nine months ended September 30, 2012, the effective tax rate differs from the federal tax rate of 35% due to state income taxes and discrete items recognized.

Outlook

Historically, Lakes' revenues have primarily come from the management of Indian casino properties. As a result of the August 29, 2013 termination of the management agreement between Lakes and the Shingle Springs Tribe for the management of the Red Hawk Casino, Lakes' subsequent consolidated statement of operations will not include revenues from the management of Indian casino properties. During the next twelve months, Lakes currently expects the majority of its revenue to come from the operation of Rocky Gap. However, due to the relatively short operating history of Rocky Gap, we do not plan to provide guidance on future results of operations.

Liquidity and Capital Resources

As of September 29, 2013, we had $41.9 million in cash and cash equivalents and $49.0 million in short-term investments. We currently believe that our cash and cash equivalents, short-term investments, and our cash flows from operations will be sufficient to meet our working capital and Rocky Gap project cost requirements during the next 12 months.

Our operating results and performance depend significantly on economic conditions and their effect on consumer spending in the property we own. Declines in consumer spending would cause our revenues generated from the ownership of Rocky Gap to be adversely affected.


On July 17, 2013, we entered into a Debt Termination Agreement with the Shingle Springs Tribe relating to amounts we had previously advanced to the Shingle Springs Tribe for the development of the Red Hawk Casino. Per the terms of the Debt Termination Agreement, the Shingle Springs Tribe paid us $57.1 million on August 29, 2013. This Debt Payment constituted full and final payment of all debt owed to us by the Shingle Springs Tribe. As a result of the receipt of the Debt Payment, during the third quarter of 2013, we recognized approximately $17.4 million in recovery of impairment on notes receivable because the Shingle Springs Notes had previously been impaired and were valued at $39.7 million. The face value of the Shingle Springs Notes including accrued interest was $69.7 million as of the Payment Date. The management agreement under which Lakes was managing the Red Hawk Casino also terminated on the Payment Date.

During the nine months ended September 29, 2013, our management fee revenues were derived from the management of the Red Hawk Casino. Because our agreement for the management of this casino terminated on August 29, 2013, we will no longer earn fees for the management of the Red Hawk Casino.

On August 3, 2012, we acquired the assets of Rocky Gap for $6.8 million. In connection with the acquisition of Rocky Gap, we entered into a 40 year operating ground lease with the Maryland DNR for approximately 268 acres in the Rocky Gap State Park on which Rocky Gap is situated. We converted existing convention center space at Rocky Gap into a gaming facility which opened to the public on May 22, 2013 and features 558 VLTs, 10 table games, three poker tables, a casino bar and a new lobby food and beverage outlet. A new event and conference center is being constructed which will be able to accommodate large groups and will feature flexible use meeting rooms and is expected to be available for use in mid-November of 2013. The total cost of the Rocky Gap project is currently expected to be approximately $35.0 million, which includes the initial acquisition cost. We have a $17.5 million financing facility in place to finance a portion of the gaming facility project and new event and conference center construction costs. As of September 29, 2013, $13.4 million had been drawn and was outstanding under this financing facility and we do not currently plan to make further draws. Effective November 1, 2013, we amended our $17.5 million financing facility with Centennial Bank to reduce the interest rate from 10.5% to 5.5%. Monthly principal and interest payments on the outstanding amount of the financing facility will begin on December 1, 2013 and continue for 84 months. We have drawn $13.4 million on the financing facility and although we don't currently plan to make additional draws on the financing facility, we have the ability to draw the remaining $4.1 million through December 31, 2018.

Room, food and beverage, and other operating revenues and expenses from Rocky Gap are included in operations from the date of the acquisition of the property. Gaming revenues and expenses are included in operations from May 22, 2013, the date that the gaming facility opened for public play.

We have a total investment of $21.0 million in Rock Ohio Ventures. Per our agreement with Rock Ohio Ventures related to the casino properties in Cincinnati and Cleveland, Ohio and the Thistledown Racetrack in North Randall, Ohio, we may be required to invest additional funds of up to $4.1 million in those projects. The Horseshoe Casino Cleveland opened in May 2012, the Horseshoe Casino Cincinnati opened in March 2013 and the Thistledown Racino added 1,100 VLTs to its existing racetrack in April 2013.

We have an interest-only $8.0 million revolving bank line of credit loan agreement (the "Loan Agreement") that expires on October 28, 2014. As of September 29, 2013, no amounts were outstanding under the Loan Agreement.

Critical Accounting Policies and Estimates

This Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the balance sheet date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, long-term assets related to Indian casino projects, investments in unconsolidated investees, litigation costs, income taxes and share-based compensation. We base our estimates and judgments on historical experience and on various other factors that are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

See note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included in Item 8 of the Company's Annual Report on Form 10-K for the year ended December 30, 2012, previously filed with the SEC, for our critical accounting policies in addition to the policies discussed below that involve the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Gaming License

The Company's gaming license represents the right to conduct gaming in the State of Maryland. This intangible asset is subject to amortization as it has a definite life of 15 years. Amortization of the gaming license began on the date the gaming facility opened for public play, which was May 22, 2013. We evaluate this intangible asset for impairment on at least a quarterly basis.

Short-Term Investments

Short-term investments consist of commercial paper and corporate bonds which are classified as available-for-sale securities and are valued at current market value, with the resulting unrealized gains and losses excluded from earnings and reported, net of tax, as a separate component of shareholders' equity until realized. Any impairment loss to reduce an investment's carrying amount to its fair market value is recognized in income when a decline in the fair market value of an individual security below its cost or carrying value is determined to be other than temporary.


Investment in Unconsolidated Investees

Investments in an entity where the Company owns 20% or less of the voting stock of the entity and does not exercise significant influence over operating and financial policies of the entity are accounted for using the cost method.

The Company has a policy in place to review its investments at least annually, to evaluate the accounting method and carrying value of its investments in unconsolidated investees. The Company's cost method investments are evaluated, on at least a quarterly basis, for potential other-than-temporary impairment, or when an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investments. Lakes monitors the investments for impairment by considering all information available to the Company including the economic environment of the markets served by the properties; market conditions including existing and potential future competition; recent or expected changes in the regulatory environment; . . .

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