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LACO > SEC Filings for LACO > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for LAKES ENTERTAINMENT INC

Form 10-Q for LAKES ENTERTAINMENT INC


7-Aug-2014

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 June 29, 2014 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. 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. After acquiring Rocky Gap, which included a hotel, convention center, spa, two restaurants and the only Jack Nicklaus signature golf course in Maryland, we converted the then-existing convention center into a gaming facility which opened to the public on May 22, 2013. The gaming facility features 577 video lottery terminals ("VLTs"), 15 table games including poker, a casino bar and a lobby food and beverage outlet. The AAA Four Diamond Award® winning resort also includes an event and conference center that opened in the fourth quarter of 2013, which is able to accommodate large groups and features flexible use meeting rooms. The total cost of the Rocky Gap project was approximately $35.0 million, which included the initial acquisition cost.

• 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; the Thistledown Racino in North Randall, Ohio; and Turfway Park in Florence, Kentucky. As of June 29, 2014, we have contributed approximately $21.0 million to Rock Ohio Ventures. We currently maintain a 10% interest in Rock Ohio Ventures' 80% ownership in its gaming properties. 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. Payment to Lakes in the event of such repurchase would be deferred and paid in accordance with the terms of the Rock Ohio Ventures First Amended and Restated Operating Agreement.

The Horseshoe Casino Cleveland opened in May 2012. The casino features approximately 1,700 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 approximately 1,100 VLTs to its existing racetrack in April 2013. Turfway Park is a thoroughbred horseracing track located in Florence, Kentucky.

• 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. The management agreement under which we were managing the Red Hawk Casino also terminated on the Payment Date.

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 six months ended June 29, 2014.


Three months ended June 29, 2014 compared to the three months ended June 30, 2013

Net Revenues

Net revenues were $14.1 million for the second quarter of 2014 compared to $8.5 million for the second quarter of 2013. The increase in net revenues for the three months ended June 29, 2014 compared to the three months ended June 30, 2013 was due to additional net revenue of $9.2 million related to the operation of Rocky Gap, which Lakes acquired on August 3, 2012 and which commenced gaming operations on May 22, 2013. Included in net revenues for the three months ended June 30, 2013 were $3.7 million in management fees earned related to the Red Hawk Casino. Due to the termination of the management agreement between Lakes and the Shingle Springs Tribe for the management of the Red Hawk Casino during the third quarter of 2013, Lakes' consolidated statements of operations do not include management fee revenues related to the management of the Red Hawk Casino subsequent to August 29, 2013.

Property Operating Expenses

Property operating expenses were $8.2 million for the second quarter of 2014 compared to $3.4 million for the second quarter of 2013 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 a full period of gaming-related expenses in the current year quarter as the gaming facility opened to the public in May 2013.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $5.7 million in the second quarter of 2014 compared to $4.6 million for the second quarter of 2013. Included in these amounts were Lakes corporate selling, general and administrative expenses of $1.9 million and $2.0 million for the second quarters of 2014 and 2013, respectively, and Rocky Gap selling, general and administrative expenses of $3.8 million and $2.6 million for the second quarters of 2014 and 2013, respectively. The increase in Rocky Gap selling, general and administrative expenses was due primarily to the addition of gaming during May 2013.

For the second quarter of 2014, selling, general and administrative expenses consisted primarily of payroll and related expenses of $2.8 million (including share-based compensation), marketing and advertising expenses of $0.7 million, building and rent expenses of $0.6 million, professional fees of $0.5 million and business development expenses of $0.4 million. For the second quarter of 2013, selling, general and administrative expenses consisted primarily of payroll and related expenses of $2.2 million (including share-based compensation), marketing and advertising expenses of $0.4 million, building and rent expenses of $0.5 million and professional fees of $0.8 million.

Gain on Sale of Cost Method Investment

During the second quarter of 2014, Lakes entered into an agreement to sell its interest in Dania Casino & Jai Alai in Dania Beach, Florida for a total of $2.6 million. Per the agreement, on April 21, 2014, Lakes received $1.0 million in exchange for 40% of Lakes' interest in the project. The remaining purchase price will be paid in three equal semi-annual installments of approximately $0.5 million and 20% of Lakes' original ownership will be transferred upon each remaining payment. Upon the receipt of the payment during the second quarter of 2014, Lakes recognized a $1.0 million gain on sale of cost method investment since this asset had previously been written off.

Preopening Expenses

Lakes expenses certain project preopening costs as incurred. There were no preopening expenses during the second quarter of 2014. During the second quarter of 2013, Lakes recognized preopening expenses of $0.9 million related to the Rocky Gap project.

Amortization of Intangible Assets Related to Indian Casino Projects

Amortization of intangible assets related to Indian casino projects was $0.3 million for the second quarter of 2013 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, and therefore there was no amortization of intangible assets related to Indian casino projects for the second quarter of 2014.

Depreciation and Amortization

Depreciation and amortization was $0.9 million for the second quarter of 2014 compared to $0.5 million for the second quarter of 2013. The increase was due primarily to depreciation on Rocky Gap property and equipment.


Other Income (Expense), net

Other income (expense), net was $(0.3) million for the second quarter of 2014 compared to $1.5 million for the second quarter of 2013. A significant portion of the 2013 amount was related to non-cash interest income associated with accretion on notes receivable from the Shingle Springs Tribe.

Income Taxes

There was no income tax benefit for either the second quarter of 2014 or 2013 because there is no remaining potential to carry back losses to prior years and future realization of the benefit is uncertain. Our effective tax rate was 0% for each of the second quarters of 2014 and 2013. The effective tax rate differs from the federal tax rate of 35% for both periods primarily due to the limitation of the income tax benefit due to the uncertainty of its future realization.

Six months ended June 29, 2014 compared to the six months ended June 30, 2013

Net Revenues

Net revenues were $26.4 million for the six months ended June 29, 2014 compared to $11.9 million for the six months ended June 30, 2013. The increase in net revenues was due to additional net revenue of $20.9 million related to the operation of Rocky Gap, which Lakes acquired on August 3, 2012 and which commenced gaming operations on May 22, 2013. Included in net revenues for the six months ended June 30, 2013 were $6.4 million in management fees earned related to the management of the Red Hawk Casino. Due to the termination of the management agreement between Lakes and the Shingle Springs Tribe for the management of the Red Hawk Casino during the third quarter of 2013, Lakes' consolidated statements of operations do not include management fee revenues related to the management of the Red Hawk Casino subsequent to August 29, 2013.

Property Operating Expenses

Property operating expenses were $15.5 million for the six months ended June 29, 2014 compared to $4.0 million for the six months ended June 30, 2013 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 a full period of gaming-related expenses as gaming commenced in May 2013.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $11.5 million for the six months ended June 29, 2014 compared to $8.4 million for the six months ended June 30, 2013. Included in these amounts were Lakes corporate selling, general and administrative expenses of $4.0 million for each of the second quarters of 2014 and 2013, and Rocky Gap selling, general and administrative expenses of $7.5 million and $4.4 million for the second quarters of 2014 and 2013, respectively. The increase in Rocky Gap selling, general and administrative expenses was due primarily to the addition of gaming during May 2013.

For the six months ended June 29, 2014, selling, general and administrative expenses consisted primarily of payroll and related expenses of $5.6 million (including share-based compensation), marketing and advertising expenses of $1.3 million, building and rent expenses of $1.4 million, professional fees of $1.1 million and business development expenses of $0.8 million. For the six months ended June 30, 2013, selling, general and administrative expenses consisted primarily of payroll and related expenses of $4.1 million (including share-based compensation), marketing and advertising expenses of $0.5 million, building and rent expenses of $0.9 million and professional fees of $1.8 million.

Gain on Sale of Cost Method Investment

During the six months ended June 29, 2014, Lakes entered into an agreement to sell its interest in Dania Casino & Jai Alai in Dania Beach, Florida for a total of $2.6 million. Per the agreement, on April 21, 2014, Lakes received $1.0 million in exchange for 40% of Lakes' interest in the project. The remaining purchase price will be paid in three equal semi-annual installments of approximately $0.5 million and 20% of Lakes' original ownership will be transferred upon each remaining payment. Upon the receipt of the payment during the second quarter of 2014, Lakes recognized a $1.0 million gain on sale of cost method investment since this asset had previously been written off.

Preopening Expenses

Lakes expenses certain project preopening costs as incurred. There were no preopening expenses during the six months ended June 29, 2014. During the six months ended June 30, 2013, Lakes recognized preopening expenses of $1.2 million related to the Rocky Gap project.


Amortization of Intangible Assets Related to Indian Casino Projects

Amortization of intangible assets related to Indian casino projects was $0.5 million for the six months ended June 30, 2013 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, and therefore there was no amortization of intangible assets related to Indian casino projects for the six months ended June 29, 2014.

Depreciation and Amortization

Depreciation and amortization was $1.7 million for the six months ended June 29, 2014 compared to $0.7 million for the six months ended June 30, 2013. The increase was due primarily to depreciation on Rocky Gap property and equipment.

Other Income (Expense), net

Other income (expense), net was $(0.4) million for the six months ended June 29, 2014 compared to $3.0 million for the six months ended June 30, 2013. A significant portion of the 2013 amount was related to non-cash interest income associated with accretion on notes receivable from the Shingle Springs Tribe.

Income Taxes

There was no income tax benefit for either the six months ended June 29, 2014 or June 30, 2013 because there is no remaining potential to carry back losses to prior years and future realization of the benefit is uncertain. Our effective tax rate was 0% for each of the six months ended June 29, 2014 and June 30, 2013. The effective tax rate differs from the federal tax rate of 35% for both periods primarily due to the limitation of the income tax benefit due to the uncertainty of its future realization.

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 statements of operations have not included 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 June 29, 2014, we had $38.2 million in cash and cash equivalents and $45.4 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 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.

During the three and six months ended June 30, 2013, our management fee revenues were derived from the management of the Red Hawk Casino. 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 of the Payment Date, the Shingle Springs Notes 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, and as a result, we no longer earn fees for the management of the Red Hawk Casino.

We have a $17.5 million financing facility that was used to finance a portion of the Rocky Gap gaming facility project and new event and conference center construction costs. We drew approximately $13.4 million on the financing facility, of which $12.5 million remains outstanding as of June 29, 2014. Although we do not 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. Effective November 1, 2013, we amended this financing facility to reduce the interest rate from 10.5% to 5.5%. Monthly principal and interest payments on the outstanding amount of the financing facility began on December 1, 2013 and continue for 84 months.


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, the Thistledown Racetrack in North Randall, Ohio and Turfway Park, a thoroughbred horseracing track located in Florence, Kentucky, we may be required to invest additional funds of up to $4.1 million in those projects.

On April 21, 2014, Lakes entered into a redemption agreement with Dania Entertainment Holdings ("DEH") that resulted in DEH redeeming Lakes' 20% ownership in DEH in exchange for DEH granting to Lakes 5% ownership in Dania Entertainment Center, LLC (the entity that owns the Dania Casino & Jai Alai in Dania Beach, Florida) ("DEC"). Concurrently, Lakes entered into an agreement with an unrelated third party to sell its ownership in DEC for approximately $2.6 million. Lakes had invested $4.0 million in this project, which was previously written down to zero. Lakes received $1.0 million on April 21, 2014 in exchange for 40% of its ownership. Per the terms of the agreement, Lakes will also receive three payments of approximately $0.5 million each on October 21, 2014, April 21, 2015 and October 21, 2015, and will transfer one-third of its remaining ownership on each of those dates.

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 June 29, 2014, 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, short-term investments, 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.

The following represent our accounting policies that involve the more significant judgments and estimates used in the preparation of our consolidated financial statements. 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 29, 2013, previously filed with the SEC, for a discussion of all of our significant accounting policies.

Revenue Recognition and Promotional Allowances

Revenue from the management, development, financing of and consulting with Indian-owned casino gaming facilities is recognized as it is earned pursuant to each respective agreement. Food, beverage, and retail revenues are recorded at the time of sale. Room revenue is recorded at the time of occupancy. Sales taxes and surcharges collected from guests and remitted to governmental authorities are presented on a net basis. Accounts receivable deemed uncollectible are charged off through a provision for uncollectible accounts.

Gaming revenue, which is defined as the difference between gaming wins and losses, is recognized as wins and losses occur from gaming activities. The retail value of rooms, food and beverage, and other services furnished to guests without charge is included in gross revenues and then deducted as a promotional allowance. Our guests may be given, on a discretionary basis, coupons to use towards the purchase of rooms, food and beverage, and other amenities. We recognize a reduction in revenue as a promotional allowance for these coupons when the coupons are redeemed. The estimated cost of providing such promotional allowances is included in gaming expenses.


Short-Term Investments and Concentrations of Credit Risk

Short-term investments consist of commercial paper, corporate bonds and certificates of deposit which are classified as available-for-sale securities and are valued at current market value, with the resulting unrealized gains and losses, if any, excluded from earnings and reported, net of tax, as a separate component of shareholders' equity until realized. All of our investments in commercial paper and corporate bonds carry a rating by one or more of the nationally recognized statistical rating organizations. Any change in such rating agencies' approach to evaluating credit and assigning an opinion could negatively impact the fair value of our investments. 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.

Investments in Unconsolidated Investees

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

We have a policy in place to review our investments at least annually, to evaluate the accounting method and carrying value of our investments in unconsolidated investees. Our 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. We monitor the investments for impairment by considering all information available to us 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; operational performance and financial results; known changes in the objectives of the properties' management; known or expected changes in ownership; and any other known significant factors relating to the businesses underlying the investments. If we believe that the carrying value of an investment is in excess of its estimated fair value, it is our policy to record an impairment charge to adjust the carrying value to the estimated fair value, if the impairment is considered other-than-temporary.

Income Taxes

The determination of our income tax-related account balances requires the exercise of significant judgment by management. Accordingly, we determine deferred tax assets and liabilities based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Management assesses the likelihood that deferred tax assets will be recovered from future taxable income and establishes a valuation allowance when management believes recovery is not likely.

We record estimated penalties and interest related to income tax matters, including uncertain tax positions, if any, as a component of income tax expense.

Share-Based Compensation Expense

We have various share-based compensation programs, which provide for equity awards including stock options and restricted stock. We use the straight-line method to recognize compensation expense associated with share-based awards based on the fair value on the date of grant, net of the estimated forfeiture rate, if any. Expense is recognized over the requisite service period related to each award, which is the period between the grant date and the award's stated vesting term. The fair value of stock options is estimated using the Black-Scholes option pricing model. All of our stock compensation expense is recorded in selling, general and administrative expenses in the consolidated statements of operations.

Seasonality

We believe that the operations of all casino and resort properties owned and/or managed by us are affected by seasonal factors, including holidays, weather and travel conditions.

Regulation and Taxes

The casino we manage and own is subject to extensive regulation by state gaming authorities. Changes in applicable laws or regulations could have an adverse effect on us.

The gaming industry represents a significant source of tax revenues to regulators. From time to time, various federal legislators and officials have proposed changes in tax law, or in the administration of such law, affecting the . . .

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