GOLDEN ENTERTAINMENT, INC. - Quarter Report: 2009 September (Form 10-Q)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

Commission File No. 0-24993

LAKES ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

 

 

(952) 449-9092

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of November 3, 2009, there were 26,328,045 shares of Common Stock, $0.01 par value per share, outstanding.

 

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

 

 

See notes to unaudited consolidated financial statements.

 

 

See notes to unaudited consolidated financial statements.

 

 

See notes to unaudited consolidated financial statements.

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

 

Notes to Unaudited Consolidated Financial Statements

 

 

The unaudited consolidated financial statements of Lakes Entertainment, Inc., a Minnesota corporation, and Subsidiaries (individually and collectively “Lakes” or the “Company”), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial information. Accordingly, certain information normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States has been condensed and/or omitted. Lakes owned approximately 61% of the outstanding common stock of WPT Enterprises, Inc. (“WPTE”), a separate publicly-held media and entertainment company until November 21, 2008 when all of these shares were distributed to Lakes’ shareholders through a noncash dividend. Operations of WPTE after the date of distribution are not included in Lakes’ consolidated results of operations, and historical operating results of WPTE up to that date have been retroactively reclassified and presented as discontinued operations (Note 4).

 

Management has evaluated the consolidated financial statements for subsequent events through November 6, 2009, which was the date this Quarterly Report on Form 10-Q was filed with the SEC. For further information, please refer to the annual audited consolidated financial statements of the Company, and the related notes included within the Company’s Annual Report on Form 10-K, as amended, for the year ended December 28, 2008, previously filed with the SEC, from which the balance sheet information as of that date is derived.

 

In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results for the current interim period are not necessarily indicative of the results to be expected for the full year.

 

In addition to discontinued operations, certain minor reclassifications to amounts previously reported have been made to conform to the current period presentation.

 

 

In July 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 168, FASB Accounting Standards Codification (“SFAS 168”), as the single source of authoritative non-governmental U.S. generally accepted accounting principles. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. All existing accounting standards (other than those promulgated by the SEC) have been incorporated into the codification, now known as the Accounting Standards Codification (“ASC”), without change to the standards. The implementation of this standard did not have any effect on our financial position, results of operations or cash flows.

 

In August 2009, the FASB issued ASU 2009-04, Accounting for Redeemable Equity Instruments, which provides updated guidance for distinguishing liabilities from equity. ASU 2009-04 is effective for the first interim reporting period beginning after issuance. The implementation of this standard did not have a material impact on our financial position, results of operations or cash flows.

 

Also in August 2009, the FASB issued ASU 2009-05, Measuring Liabilities at Fair Value, which provides guidance for the fair value measurement of liabilities and clarification regarding circumstances in which a quoted price in an active market for an identical liability is not available. ASU 2009-05 is effective for the first interim reporting period beginning after issuance. The implementation of this standard did not have a material impact on our financial position, results of operations or cash flows.

 

 

The Company’s financial instruments consist of cash and equivalents, accounts receivable, investments in securities, notes receivable and other long-term assets from Indian tribes, an investment in Kansas Gaming Partners, LLC, accounts payable, contract acquisition costs payable, and lines of credit.

 

For the Company’s cash and equivalents, accounts receivable, accounts payable and lines of credit payable, the carrying amounts approximate fair value because of the short duration of these financial instruments. The

Company’s investment in Kansas Gaming Partners, LLC is accounted for using the equity method (Note 15). The Company’s other classes of financial instruments include primarily investments in securities (Notes 5 and 6), notes receivable and other long-term assets related to Indian casino projects, primarily from the Shingle Springs Band of Miwok Indians (the “Shingle Springs Tribe”) (Notes 6, 7 and 8) and contract acquisition costs payable (Note 10). The methods used in estimating the fair value of each is discussed in the referenced notes to the consolidated financial statements.

 

 

On October 1, 2008, Lakes’ Board of Directors declared a non-cash dividend consisting of 12,480,000 shares or approximately 61% (all of its holdings) of the outstanding common stock of WPTE, a separate publicly-held media and entertainment company. The record date for the dividend was October 24, 2008, which established the shareholders of record entitled to the dividend, thereby allowing the determination of the ratio of WPTE shares to be distributed per Lakes share. The dividend ratio for shareholders of record on the record date was approximately 0.479 shares of WPTE common stock for each share of Lakes common stock. The date of distribution was November 21, 2008.

 

Revenues, loss before income taxes and income taxes, related to WPTE, net of amounts allocated to the prior non-controlling interest, for the three months and nine months ended September 28, 2008, have been derived from historical financial information and reported in discontinued operations as follows (in thousands, unaudited):

 

 

 

The Company’s investment portfolio is comprised of investments in auction rate securities (“ARS”), which as of September 27, 2009, have a par value of $24.4 million, all of which are held by UBS Financial Services, Inc. (“UBS”). During the third quarter of 2009, $2.4 million of the Company’s ARS were purchased by UBS at par value. The types of ARS that the Company owns are backed by student loans, the majority of which are guaranteed under the Federal Family Education Loan Program (“FFELP”). See also Note 9 for a discussion of Lakes’ credit line agreement with UBS.

 

In November 2008, the Company accepted an offer from UBS granting nontransferable rights (the “Rights”) to sell the Company’s ARS held by UBS at par value to UBS at any time during the period of June 30, 2010, through July 2, 2012. The Rights represent a free standing asset separate from the ARS. UBS’ obligations under the Rights are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the Rights. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the Rights.

 

The estimated fair value of the Rights was $2.5 million and $4.3 million as of September 27, 2009 and December 28, 2008, respectively. The $1.8 million decrease in the estimated fair value of the Rights is reflected as a reduction in interest income in the unaudited consolidated statement of earnings (loss) and comprehensive earnings (loss) for the nine months ended September 27, 2009. The Rights do not meet the definition of a derivative instrument under ASC 815, Derivatives and Hedging. Therefore, the Company has elected to measure the Rights at estimated fair value under ASC 825, Financial Instruments (“ASC 825”), which permits the Company to elect the fair value option for recognized financial assets, to match the changes in the estimated fair value of the ARS. The Company expects that future changes in the estimated fair value of the Rights will approximate fair value movements in the related ARS.

The Company classifies its ARS as trading securities pursuant to ASC 320, Investments — Debt and Equity Securities, which reflects management’s intent to exercise its Rights during the period June 30, 2010 to July 3, 2012. As a result, the Company’s ARS are classified as short-term investments in securities as of September 27, 2009.

 

As of September 27, 2009 and December 28, 2008, investments in securities with original maturity dates beyond three months consist of the following (in thousands):

 

 

 

The Company’s financial instruments that are measured at estimated fair value use inputs from among the three levels of the fair value hierarchy set forth in ASC 820, however, none of the Company’s financial assets that are presented at their estimated fair value are measured using Level 1 or Level 2 inputs. Level 3 inputs are unobservable inputs that reflect management’s estimates about the assumptions that market participants would use in pricing the asset or liability. Management develops these inputs based on the best information available, including internally-developed data.

 

The Company’s financial assets that are carried at estimated fair value based on level 3 inputs are summarized below (in thousands):

 

 

 

 

 

The Company utilizes valuation models based on management’s estimates of expected cash flow streams and discount rates to value these assets.

 

The following is a list of the most significant factors affecting the Company’s cash flows and discount rate estimates by financial asset type:

 

 

The following table summarizes the activity for the Company’s financial instruments that are reported at estimated fair value utilizing Level 3 inputs (in thousands):

 

 

 

 

 

The majority of the assets related to Indian casino projects are in the form of notes receivable due from the Indian tribes pursuant to the Company’s development, financing, consulting and management agreements. The repayment terms of the loans are specific to each Indian tribe and are dependent upon the successful development and operating performance of each gaming facility. Repayment of the loans is required only if distributable profits are available from the operation of the related casinos. In addition, repayment of the loans and the development, financing, consulting and management fees under contracts are subordinated to certain other financial obligations of the respective operations. Generally, the order of priority of payments from the casinos’ cash flows is as follows: a certain minimum monthly priority payment to the Indian tribe; repayment of senior debt associated with construction and equipping of the casino with interest accrued thereon; repayment of various debt with interest accrued thereon due to Lakes; development, financing, consulting and management fees to Lakes, with the remaining funds distributed to the Indian tribe.

Information with respect to the notes receivable activity is summarized in the following table (in thousands):

 

 

 

 

Shingle Springs Tribe.  The terms and assumptions used to value Lakes’ notes receivable from the Shingle Springs Tribe at estimated fair value at December 17, 2008 are as follows (dollars in thousands):

 

The carrying value of Lakes’ notes receivable from the Shingle Springs Tribe was $51.6 million as of September 27, 2009. Management estimates the fair value of this financial instrument as of September 27, 2009 to be approximately $48.8 million using a discount rate of 19.00% and a remaining term of 75 months.

 

Jamul Tribe.  The terms and assumptions used to value Lakes’ notes receivable from the Jamul Tribe at estimated fair value are as follows (dollars in thousands):

 

 

 

 

Iowa Tribe.  The terms and assumptions used to value Lakes’ notes receivable from the Iowa Tribe at estimated fair value are as follows (dollars in thousands):

 

 

 

 

 

Intangible assets.  Intangible assets consist of costs associated with the acquisition of the management, development, consulting or financing contracts related to tribal gaming projects and are periodically evaluated for impairment after they are initially recorded.

Information with respect to the intangible assets related to the acquisition of management, development, consulting or financing contracts by project is summarized as follows (in thousands):

 

 

 

 

Land held for development.  Land held for development is comprised of land held for possible transfer to Indian tribes for use in certain of the future casino resort projects. In the event that this land is not transferred to the tribes, the Company has the right to sell it. As of September 27, 2009, land held for development related to Indian casino projects was $1.8 million. Lakes currently owns approximately 96 acres of land held for development located adjacent to the Jamul Casino project location, which is carried at $1.0 million as of September 27, 2009.

 

As of September 27, 2009, Lakes owns approximately 139 acres of land held for development located adjacent to the Ioway Casino Resort project location. Lakes has invested $0.8 million in land held for development, which is being held for future transfer to the Iowa Tribe.

 

Other.  As of September 27, 2009 and December 28, 2008 these assets consisted primarily of amounts due from Mr. Kevin M. Kean, a partner of Kean Argovitz Resorts (“KAR”) — Shingle Springs, LLC and KAR — Jamul, LLC (together, the “KAR Entities”) that are directly related to the development and opening of Lakes’ Indian casino projects.

Included in other long-term assets related to Indian casino projects are financial instruments related to Mr. Kean with a carrying value of $2.5 million and financial instruments related to the Shingle Springs Tribe of $1.0 million as of September 27, 2009. Management estimates the fair value of the financial instruments related to Mr. Kean and the financial instruments related to the Shingle Springs Tribe to be $1.3 million and $0.5 million, respectively, as of September 27, 2009 using a discount rate of 19.00%.

 

 

Line of credit payable.  During 2008, Lakes entered into an agreement (the “Credit Line”) with UBS, collateralized by Lakes’ ARS held at UBS (Note 5). Amounts due under the Credit Line are payable on demand with interest at 30-day LIBOR plus one percent. In August 2009, $2.4 million of Lakes ARS were purchased by UBS at par and Lakes used approximately $1.7 million to pay against its Credit Line. As of September 27, 2009, approximately $16.3 million was outstanding under the Credit Line.

 

Non-revolving line of credit payable.  Also during 2008, Lakes entered into a two-year interest only $8.0 million non-revolving line of credit loan agreement (the “Loan Agreement”) with First State Bank. Amounts borrowed under the Loan Agreement are collateralized by real property in Minnetonka, Minnesota and bear interest at 8.95%. As of September 27, 2009, Lakes owed $2 million under the Loan Agreement.

 

 

The Company is obligated to pay approximately $11 million to an unrelated third party as part of an agreement associated with the Company obtaining the management contract with the Pokagon Band. The obligation is payable quarterly over the term of the five-year management agreement for the Four Winds Casino Resort. As of September 27, 2009, the remaining carrying amount owed was $5.6 million, net of a $1.7 million discount. Management estimated the fair value of this obligation to be approximately $5.6 million as of September 27, 2009 using a discount rate of approximately 18% and a remaining term of 35 months.

 

During 2006, the Lyle Berman Family Partnership (the “Partnership”) purchased a portion of the $11 million obligation discussed above from an unrelated third party. The Partnership receives approximately $0.3 million per year of the payment stream related to this obligation during the five-year term of the management contract of the Four Winds Casino Resort. Lyle Berman, Lakes’ Chairman and Chief Executive Officer, does not have an ownership or any other beneficial interest in the Partnership. Neil I. Sell, a director of Lakes, is one of the trustees of the irrevocable trusts for the benefit of Lyle Berman’s children who are the partners in and sole beneficiaries of the Partnership.

 

Effective June 2009, the Company became obligated to pay Mr. Argovitz $1 million per year (prorated based on a 365 day year) during the remainder of the seven-year initial term of the management contract which commenced in December 2008 between the Company and the Shingle Springs Tribe, as a result of Mr. Argovitz’s election under an existing agreement related to this project. Also as a result of this election, Mr. Argovitz will not be entitled to obtain a 15% equity interest in the Company’s entity that holds the rights to the management fees earned by the Company from the Red Hawk Casino operations.  This obligation does not have a stated interest rate and has payments terms which extend beyond one fiscal year. As a result, this obligation has been recorded at its net present value with an effective interest rate of approximately 18%, and the difference between the face amount and the net present value of the obligation is recorded as a discount, which is amortized to interest expense over the contract term using the effective interest method. As of September 27, 2009, the remaining carrying amount of the liability was $3.7 million, net of a $2.6 million discount, which approximates its estimated fair value.

 

During September 2009, it became probable that the Company will be required to pay Mr. Kean $1 million per year (prorated based on a 365 day year) during the remainder of the seven-year initial term of the management contract which commenced in December 2008 between the Company and the Shingle Springs Tribe, as a result of Mr. Kean’s election under an existing agreement related to this project. Also as a result of this election, Mr. Kean will not be entitled to receive consulting fees equal to 15% of the management fees earned by the Company from the Red Hawk Casino operations. This obligation does not have a stated interest rate and has payment terms which extend beyond one fiscal year. As a result, this obligation has been recorded at its net present value with an effective interest rate of 18%, and the difference between the face amount and the net present value of the obligation is

recorded as a discount, which is amortized to interest expense over the contract term using the effective interest method. As of September 27, 2009, the remaining carrying amount of the liability was $4.0 million, net of a $2.5 million discount, which approximates its estimated fair value.

 

 

At Lakes’ annual shareholder meeting, which was held on August 6, 2009, Lakes’ shareholders amended the 2007 Lakes Stock Option and Compensation Plan, to increase the number of shares of Lakes common stock authorized for awards from 500,000 to 2,500,000.

 

Share-based compensation expense, which includes stock options and restricted stock units, for the three months and nine months ended September 27, 2009 and September 28, 2008, respectively, were as follows:

 

 

See Note 13 for a discussion of the income tax benefits related to share-based compensation.

 

Stock options.  The Company uses the Black Scholes option pricing model to estimate the fair value and compensation cost associated with employee incentive stock options which requires the consideration of historical employee exercise behavior data and the use of a number of assumptions including volatility of the Company’s stock price, the weighted average risk-free interest rate and the weighted average expected life of the options.

 

The following values represent the average per grant for the indicated variables used to value options granted during the three months and nine months ended September 27, 2009 and September 28, 2008, respectively. There have been no significant changes to the assumptions thus far in 2009 and none are expected during the remainder of 2009.

 

 

 

 

 

 

The following table summarizes Lakes’ stock option activity during the three months and nine months ended September 27, 2009 and September 28, 2008 (unaudited):

 

 

 

 

 

The replacement stock option grants have a new term of 10 years and a renewed vesting period ranging from two to five years depending upon the original stock option grant date. Lakes accepted eligible options from 41 participants in Lakes’ stock option modification, and the stock option modification did not result in any additional share-based compensation expense for the nine months ended, September 27, 2009.

 

The following table summarizes significant ranges of Lakes’ outstanding and exercisable options as of September 27, 2009 (unaudited):

 

 

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on Lakes’ closing stock price of $3.31 on September 25, 2009, which would have been received by the option holders had all option holders exercised their options as of that date. There were no options exercised during the three months ended September 27, 2009. Options exercised during the nine months ended September 27, 2009 did not have a significant intrinsic value. Options exercised during the three months and nine months ended September 28, 2008 had an intrinsic value of $3.4 million. As of September 27, 2009, Lakes’ unrecognized share-based compensation was approximately $1.0 million, which is expected to be recognized over a weighted-average period of 3.4 years.

 

Lakes issues new shares of common stock upon the exercise of options.

 

Restricted stock units.  The following table summarizes Lakes’ restricted stock unit activity during the three months and nine months ended September 27, 2009 (unaudited):

 

As of September 27, 2009, Lakes’ unrecognized share-based compensation was approximately $0.3 million related to non-vested shares, which is expected to be recognized over a weighted-average of 2.1 years. No restricted stock units vested during the three months or nine months ended September 27, 2009.

 

 

For all periods, basic earnings (loss) applicable to Lakes Entertainment, Inc. per share (“EPS”) is calculated by dividing net earnings (loss) applicable to Lakes Entertainment, Inc. by the weighted-average common shares outstanding. Diluted EPS in profitable years reflects the effect of all potentially dilutive common shares outstanding by dividing net earnings (loss) applicable to Lakes Entertainment, Inc. by the weighted-average of all common and potentially dilutive shares outstanding. Potentially dilutive stock options applicable to Lakes Entertainment, Inc. of 370,477 and 313,449 shares for the three months and nine months ended September 28, 2008, were not used to compute diluted loss per share applicable to Lakes Entertainment, Inc. because the effects would have been anti-dilutive.

 

 

Our effective tax rates were (0.6%) and 46.6% for the nine months ended September 27, 2009 and the corresponding 2008 period, respectively. The effective tax rate differs from the federal tax rate of 35% due to state income taxes, permanent differences, release of valuation allowance, stock based compensation deductions included in net operating loss carryforwards, and provisions for interest charges on uncertain tax positions. At December 28, 2008, the Company had recorded a 100% valuation allowance against the remaining deferred tax assets arising from net operating loss and capital loss carryforwards. Management has evaluated all evidence and has determined that cumulative net losses generated over the past three years outweigh the current positive evidence that the Company believes exists surrounding its ability to generate significant income from its long-term assets related to Indian casino projects. However, the Company has released approximately $4.1 million of deferred taxes related to net operating loss carryforwards and management currently expects to release a total of $5.5 million of deferred tax assets related to net operating loss carryforwards that will offset current taxable income for 2009, of which approximately $1.3 million will be credited to additional paid-in capital relating to the release of valuation allowances against tax windfall benefits related to share-based compensation from prior years.

 

The Company recorded $0.2 million and $0.6 million of interest related to the uncertain tax positions to income tax expense for the three months and nine months ended September 27, 2009, respectively.

 

 

General.  The recent decline in general economic conditions in the United States may negatively impact the local economic conditions near the casinos Lakes manages and may negatively impact Lakes’ management fees and the availability of credit to finance Lakes’ development projects.

 

Kansas Gaming Partners, LLC.  Our initial capital requirement for a 16.67% ownership in Kansas Gaming Partners, LLC is $25 million. As of September 27, 2009, we have contributed approximately $8.4 million as required as of that date (Note 15).

 

Louisiana Department of Revenue litigation tax matter.  The Louisiana Department of Revenue maintains a position that Lakes owes additional Louisiana corporation income tax for the period ended January 3, 1999 and the tax years ended 1999 through 2001 and additional Louisiana corporation franchise tax for the tax years ended 2000 through 2002. This determination is the result of an audit of Louisiana tax returns filed by Lakes for the tax periods at issue and relates to the reporting of income earned by Lakes in connection with the managing of two Louisiana-based casinos. On December 20, 2004, the Secretary of the Department of Revenue of the State of Louisiana filed a petition to collect taxes in the amount of $8.6 million, plus interest, against Lakes for the taxable periods set forth above. Lakes maintains that it remitted the proper Louisiana corporation income tax and Louisiana corporation franchise tax for the taxable periods at issue. On February 14, 2005, Lakes filed an answer to the petition to collect taxes asserting all proper defenses and maintaining that no additional taxes were owed and that the petition to collect taxes should be dismissed. A trial date for this matter has been set for February 2010. Management intends to continue to vigorously contest this action by the Louisiana Department of Revenue. However, Lakes may be

required to pay up to the $8.6 million assessment plus interest if Lakes is not successful in this matter. Lakes has recorded an estimated liability related to this examination including accrued interest and fees, which is included as part of income taxes payable on the accompanying consolidated balance sheets.

 

Miscellaneous legal matters.  Lakes and its subsidiaries 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, and although unable to estimate the minimum costs, if any, to be incurred in connection with these matters, management currently believes that the likelihood of an unfavorable outcome is remote, and is not likely to have a material adverse effect upon Lakes’ unaudited consolidated financial statements. Accordingly, no provision has been made with regard to these matters.

 

 

In August 2009, Lakes announced that it entered into a joint venture with the Chisholm Creek Casino Resort, LLC (“Chisholm Creek”) relating to an application to the Kansas Lottery to develop and operate a casino project in south central Kansas. Phase one of the proposed casino is planned to feature 1,300 to 1,500 slot machines, 30 table games, and other amenities, which may include a number of restaurants and a hotel to be developed by a third party developer. Additional phases of development could include expanded gaming positions, an entertainment center, and other amenities. On August 27, 2009, the Kansas Lottery Commission approved the management contract for Chisholm Creek. The management contract has been forwarded to the Lottery Review Board for its ultimate decision regarding whether it will permit Chisholm Creek the right to operate the casino, which decision is expected to occur during the fourth quarter of 2009. Lakes has not yet been notified of the Lottery Review Board’s decision.

 

On September 24, 2009, Lakes Kansas Casino Management, LLC, an indirect wholly-owned consolidated subsidiary of Lakes, entered into a Limited Liability Company Agreement (“LLC Agreement”) with Kansas Gaming Partners, LLC (“Kansas Partners”) and certain unrelated parties, which set forth the terms and conditions of the parties’ ownership and governance rights in Kansas Partners. Kansas Partners wholly owns Chisholm Creek. The LLC Agreement initially requires that Lakes contributes $25 million in exchange for 16.67% with limited voting rights as described in the LLC Agreement.

 

Also on September 24, 2009, Lakes entered into a Development Services and Management Agreement (“Management Agreement”) with Chisholm Creek, wherein Lakes agreed to perform certain development and management services for the development and management of the Chisholm Creek Casino Resort. The term of the Management Agreement is for 15 years, subject to earlier termination as described in the Management Agreement. In exchange for its services, Lakes shall receive approximately 6.8% of the Casino’s earnings before interest, taxes, depreciation, amortization and management fee.

 

As of September 27, 2009, Lakes’ investment in Kansas Partners was approximately $8.4 million.

 

 

Ohio.  On October 29, 2009, Lakes entered into an agreement with Penn Ventures, LLC (“Penn Ventures”) whereby it (1) agreed to fund 10% of Penn Ventures’ costs of the referendum in November 2009 to amend the Ohio constitution to authorize casino gaming in Ohio (“Referendum”), and (2) has the option, but not the obligation, to fund up to 10% of equity required to develop potential casinos in Columbus and Toledo, in return for a corresponding equity stake up to 10% in such casinos. Lakes has made an initial payment of $1.9 million. If Lakes chooses not to fund any additional amount, it will receive an equity position in the casinos in a pro rata amount of what its $1.9 million payment is to the total amount funded by Penn Ventures for the Referendum and for the equity required to develop the casinos.

 

Also on October 29, 2009, Lakes entered into an agreement with Rock Ohio Ventures, LLC (“Rock Ventures”) whereby it has the right, but not the obligation, to invest up to 10% of Rock Ventures’ costs of the Referendum and the equity required to develop potential casinos in Cleveland and Cincinnati in return for a corresponding equity stake up to 10% in the such casinos. Lakes has made an initial investment of $2.4 million. If Lakes chooses not to fund any additional amount, it will maintain an equity position in the casinos in a pro rata amount of what its $2.4 million payment is to the total amount funded by Rock Ventures for the Referendum and for the equity required to develop the casinos.

 

Overview

 

We develop, finance and manage Indian-owned and non-Indian-owned casino properties. We currently have development and management or financing agreements with four separate tribes for casino operations in Michigan, California, and Oklahoma for a total of five separate casino projects. We also have entered into a joint venture aimed at developing and operating a casino project in the South Central Zone of Kansas. An overview of our Indian-owned projects follows:

 

 

We have also explored, and continue to explore, other development projects with Indian tribes. We also explore other non-Indian casino development projects and other business activities. We have received various regulatory approvals to develop a casino near Vicksburg, Mississippi. However, uncertainty exists surrounding the development of this project due primarily to changes in the economic environment and credit markets. As a result, the assets associated with the Vicksburg project are recorded at their estimated fair value of $5.4 million as of September 27, 2009.

In August 2009, we announced that we entered into a joint venture with the Chisholm Creek Casino Resort, LLC (“Chisholm Creek”) relating to an application to the Kansas Lottery to develop and operate a casino project in south central Kansas. Phase one of the proposed casino is planned to feature 1,300 to 1,500 slot machines, 30 table games, and other amenities, which may include a number of restaurants and a hotel to be developed by a third party developer. Additional phases of development could include expanded gaming positions, an entertainment center, and other amenities. On August 27, 2009, the Kansas Lottery Commission approved the management contract for Chisholm Creek. The management contract has been forwarded to the Lottery Review Board for its ultimate decision regarding whether it will permit Chisholm Creek to operate the Chisholm Creek Casino Resort, expected to occur during the fourth quarter of 2009.

 

On October 1, 2008, Lakes’ Board of Directors declared a noncash dividend consisting of all of the shares of WPTE then owned by Lakes. Lakes previously owned 12,480,000 or approximately 61% of the outstanding common stock of WPTE, a separate publicly-held media and entertainment company. The record date for the dividend was October 24, 2008, which established the shareholders of record entitled to the dividend, thereby allowing the determination of the ratio of WPTE shares to be distributed per Lakes share. The date of distribution was November 21, 2008. Operations of WPTE after the date of distribution are not included in Lakes’ consolidated results of operations, and historical operating results of WPTE up to that date are presented as discontinued operations.

 

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 months and nine months ended September 27, 2009.

 

Three months ended September 27, 2009 compared to the three months ended September 28, 2008

 

Revenues.  Total revenues for the third quarter of 2009 were $6.6 million, compared to prior-year period revenues of $8.4 million. This decrease was primarily due to a one-time addition to revenue of approximately $1.8 million in the third quarter of 2008 which was the result of an approved compact amendment between the Pokagon Band and the State of Michigan that reduced the Four Winds Casino Resort gaming tax. The decrease was also affected by new competition that entered the Four Winds Casino Resort market during the third quarter of 2009, offset by fees from the Red Hawk Casino, which opened in December 2008.

 

Selling, general and administrative expenses.  Selling, general and administrative expenses were $3.5 million in the third quarter of 2009 compared to $4.2 million for the third quarter of 2008. For the third quarter of 2009, Lakes’ selling, general and administrative expenses consisted primarily of payroll and related expenses of $1.8 million, including share-based compensation, travel expenses of $0.5 million, professional fees of $1.0 million, and costs associated with the application for a gaming site in the State of Kansas of $0.2 million. For the third quarter of 2008, Lakes’ selling, general and administrative expenses consisted primarily of payroll and related expenses of $2.5 million, including share-based compensation, travel expenses of $0.8 million, and professional fees of $0.5 million.

 

Ohio initiative costs.  Development costs associated with the 2008 Ohio casino resort initiative were $4.7 million during the third quarter of 2008.

 

Impairment losses.  Impairment losses were $0.6 million in the third quarter of 2009. There were no impairment losses during the third quarter of 2008. The 2009 impairment losses related primarily to continued uncertainty surrounding the Jamul Casino project.

 

Amortization of intangible assets related to Indian casino projects.  Amortization of intangible assets related to Indian casino projects for the third quarter of 2009 was $2.6 million compared to $1.7 million for the third quarter of 2008. The increase of $0.9 million related to the amortization of intangible assets associated with the Red Hawk Casino, which began when it opened in December 2008. Amortization for the third quarter of 2008 related primarily to the intangible assets associated with the Four Winds Casino Resort.

Net unrealized gains on notes receivable.  Net unrealized gains on notes receivable relate primarily to our notes receivable from Indian tribes for casino projects that are not yet open, which are adjusted to estimated fair value, based upon the current status of the related tribal casino projects and evolving market conditions. In the third quarter of 2009, net unrealized gains on notes receivable were $0.9 million, compared to net unrealized gains of $1.8 million in the prior year period. The net unrealized gains in the third quarter of 2009 consisted of $0.7 million related to the Jamul Casino project with the Jamul Tribe and $0.2 million related to the Iowa Tribe’s Ioway Casino project due primarily to improvement in the credit markets. Net unrealized gains in the third quarter of 2008 were related primarily to the notes receivable related to the Red Hawk Casino project with the Shingle Springs Tribe associated with continued progress toward a fourth quarter 2008 opening of the Red Hawk Casino, partially offset by unrealized losses associated with a decrease in probability of opening of the Jamul Casino.

 

Other income (expense), net.  Other income (expense), net for the third quarter of 2009 was $1.1 million compared to other expense of $0.2 million for the third quarter of 2008. The increase was due primarily to interest earned on the notes receivable from the Shingle Springs Tribe.

 

Income taxes (benefit).  The estimated income tax benefit for the third quarter of 2009 was $0.4 million compared to an income tax provision of $2.4 million for the third quarter of 2008. Our estimated effective tax rates were (22.9%) and 374.0% for the third quarter of 2009 and the third quarter of 2008, respectively. The estimated effective tax rate differs from the federal tax rate of 35% due to state income taxes, permanent differences, release of valuation allowance, stock based compensation deductions included in net operating loss carryforwards, and provisions for interest charges on uncertain tax positions. Lakes’ estimated income tax benefit in the current year period consists primarily of the release of valuation allowance against deferred taxes related to net operating loss carryforwards, partially offset by $0.2 million of interest on a Louisiana tax audit matter (Note 14 to the unaudited consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q). In the prior-year period, the income tax provision was primarily related to an adjustment of the valuation allowance against deferred tax assets related to capital losses for the portion that was not expected to be realized.

 

Nine months ended September 27, 2009 compared to the nine months ended September 28, 2008

 

Revenues.  Total revenues for the nine months ended September 27, 2009 were $21.0 million, up 11% from prior-year period revenues of $18.9 million. This increase was primarily due to fees from the Red Hawk Casino, which opened in December 2008, partially offset by a decrease at the Four Winds Casino Resort due to new competition that entered the market during the third quarter of 2009.

 

Selling, general and administrative expenses.  Selling, general and administrative expenses for the nine months ended September 27, 2009 were $11.3 million compared to $11.7 million in the prior year period. For the first nine months of 2009, Lakes’ selling, general and administrative expenses consisted primarily of payroll and related expenses of $5.8 million, including share-based compensation, travel expenses of $2.2 million, professional fees of $2.3 million, and costs associated with the application for a gaming site in the State of Kansas of $0.5 million. For the first nine months of 2008, Lakes’ selling, general and administrative expenses consisted primarily of payroll and related expenses of $6.8 million, including share-based compensation, travel expenses of $2.0 million, and professional fees of $1.6 million.

 

Ohio initiative costs.  Development costs associated with the 2008 Ohio casino resort initiative were $10.4 million during the first nine months of 2008.

 

Impairment losses.  Impairment losses were $2.9 million for the nine months ended September 27, 2009. There were no impairment losses during the first nine months of 2008. The 2009 impairment losses related primarily to continued uncertainty surrounding the Jamul Casino project.

 

Amortization of intangible assets related to Indian casino projects.  Amortization of intangible assets related to Indian casino projects for the nine months ended September 27, 2009 was $7.6 million compared to $5.0 million in the prior-year period. The increase related to the amortization of intangible assets associated with the Red Hawk Casino, which began when it opened in December 2008. Amortization for the first nine months of 2008 related primarily to the intangible assets associated with the Four Winds Casino Resort.

Net unrealized gains on notes receivable.  Net unrealized gains on notes receivable relate primarily to our notes receivable from Indian tribes for casino projects that are not yet open, which are adjusted to estimated fair value, based upon the current status of the related tribal casino projects and evolving market conditions. In the first nine months of 2009, net unrealized gains on notes receivable were $3.2 million, compared to net unrealized gains of $1.0 million in the prior-year period. The net unrealized gains for the nine months ended September 27, 2009 consisted of $2.8 million related to the Jamul Casino project with the Jamul Tribe and $0.4 million related to the Iowa Tribe’s Ioway Casino project due primarily to improvement in the credit markets. Net unrealized gains in the prior-year period were due primarily to the notes receivable related to the Red Hawk Casino project with the Shingle Springs Tribe associated with the continued progress toward a fourth quarter 2008 opening of the Red Hawk Casino, partially offset by unrealized losses associated with a decrease in probability of opening of the Jamul Casino.

 

Other income (expense), net.  Other income (expense), net for the nine months ended September 27, 2009 was $3.9 million compared to less than $0.1 million in the prior-year period. The increase was due primarily to interest earned on the notes receivable from the Shingle Springs Tribe.

 

Income taxes (benefit).  The estimated income tax benefit was less than $0.1 million compared to an income tax provision of $3.5 million for the nine months ended September 27, 2009 and September 28, 2008, respectively. Our estimated effective tax rates were (0.6%) and 46.6% for the nine months ended September 27, 2009 and the corresponding 2008 period, respectively. The estimated effective tax rate differs from the federal tax rate of 35% due to state income taxes, permanent differences, release of valuation allowance, stock based compensation deductions included in net operating loss carryforwards, and provisions for interest charges on uncertain tax positions. Lakes’ estimated income tax benefit in the current year period consists primarily of release of valuation allowance against deferred taxes related to net operating loss carryforwards, partially offset by $0.5 million of interest on a Louisiana tax audit matter (Note 14 to the unaudited consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q), which were offset by an additional paid-in capital adjustment of $0.8 million. In the prior year period, the income tax provision was primarily related to a valuation allowance against deferred tax assets related to capital losses for the portion that was not expected to be realized.

 

Liquidity and Capital Resources

 

As of September 27, 2009, we had $7.0 million in cash and equivalents and $24.3 million of investments in securities recorded at estimated fair value (including nontransferable rights to sell our auction rate securities (“ARS”) back to UBS Financial Services, Inc. (“UBS”) (“Rights”) of approximately $2.5 million) which is partially offset by advances on an existing line of credit with UBS of $16.3 million described below. We currently believe that our cash and equivalents balance, our cash flows from operations and our existing financing sources discussed below may not be sufficient to meet our recorded obligations and operating expenses during the next 12 months. Lakes is involved in an ongoing litigation matter with the Louisiana Department of Revenue (Note 14 to the unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q) and if Lakes is not successful in this matter and is required to pay up to an $8.6 million assessment plus interest during the next 12 months, it may be necessary for Lakes to obtain additional financing. Lakes currently expects to be able to obtain funds in order to fulfill its potential future liquidity needs. However, we cannot assure you that such financing will be available at all, or at acceptable terms, or that such financing will not be dilutive to our stockholders.

 

Our operating results and performance depend significantly on future economic conditions and their effects on consumer spending in the casinos we manage. Declines in consumer spending cause our revenue generated from the management of Indian casinos to be adversely affected. The recent decline in general economic conditions in the United States negatively impacted the local economic conditions near the casinos Lakes manages and negatively affects Lakes management fees and the availability of credit to finance Lakes development projects.

 

On October 1, 2008, Lakes’ Board of Directors declared a noncash dividend consisting of all of the shares of WPTE then owned by Lakes. The date of distribution was November 21, 2008. WPTE cash and investments have not been used in our business. Accordingly, the exclusion of WPTE from our consolidated financial statements does not have an effect on Lakes’ cash position.

 

All of our investments in securities are ARS, held by UBS and are classified as trading securities as of September 27, 2009. The types of ARS that we own are backed by student loans, the majority of which are

guaranteed under the Federal Family Education Loan Program (“FFELP”). None of our investments in ARS qualify, or have ever been classified in our consolidated financial statements, as cash or equivalents.

 

In November 2008, we accepted an offer from UBS granting Rights to sell our ARS held by UBS at par value to UBS at any time during the period of June 30, 2010, through July 2, 2012. We expect to sell our ARS under the Rights. However, if the Rights are not exercised before July 2, 2012 they will expire and UBS will have no further rights or obligation to buy our ARS. UBS’s obligation under the Rights are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the Rights. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the Rights.

 

During 2008, we entered into a credit agreement with UBS (the “Credit Line”) which is due and payable on demand with interest at 30-day LIBOR plus one percent. As of September 27, 2009, approximately $16.3 million was outstanding under the Credit Line.

 

Also during 2008, we closed on a two-year interest only $8.0 million non-revolving line of credit loan agreement (the “Loan Agreement”) with First State Bank. Amounts borrowed under the Loan Agreement bear interest at 8.95%. As of September 27, 2009, Lakes has drawn $2 million under the Loan Agreement.

 

Our initial capital requirement of 16.67% ownership in Kansas Gaming Partners, LLC is $25 million. As of September 27, 2009, we have contributed approximately $8.4 million based upon amounts required as of that date. Lakes plans to raise additional equity or debt capital or a combination thereof as needed to satisfy this obligation. Any equity financing would be dilutive to our shareholders, and any debt financing may involve restrictive covenants.

 

Per our recent agreements related to potential Ohio casinos (Note 16 to the unaudited consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q) Lakes may choose to invest additional funds in those casinos. As a result, Lakes may need to obtain additional financing.

 

During the first nine months of 2009, Lakes has recognized significant revenues from the management of Indian casino properties, and going forward Lakes expects this trend to continue as Lakes is managing the Cimarron Casino, the Four Winds Casino Resort and the Red Hawk Casino. However, because of the relatively short operating history of the casinos we manage, and the uncertainty in the economic environment, no assurance can be given that this trend will occur. Lakes’ agreements with tribal partners require that we provide certain financing for project development in the form of loans, which has been a major use of cash over the past three years, in addition to on-going corporate costs and costs incurred during 2008 for the Ohio casino resort initiative. These loans to our tribal partners are interest bearing; however, the loans and related interest are not due until the casino is built and has established profitable operations. In the event that the casinos are not built, our only recourse is to attempt to liquidate assets of the development, if any, excluding any land in trust.

 

Our cash forecast requirements do not include construction-related costs that will be incurred when pending and future development projects begin construction because the construction of our pending casino projects will depend on the ability of the tribes and/or Lakes to obtain additional financing for the projects, which based on the general economic environment, is subject to considerable uncertainty. If such financing cannot be obtained on acceptable terms, it may not be possible to complete these projects, which could have a material adverse effect on our future results of operations, cash flows and financial condition. To assist the tribes, we may be required to guarantee the tribes’ debt financing or otherwise provide support for the tribes’ obligations. Guarantees by us, if any, will increase our potential exposure to losses and other adverse consequences in the event of a default by any of the tribes.

 

If our casino development projects with the Iowa Tribe and the Jamul Tribe are not constructed or if constructed, do not achieve profitable operations in the highly competitive market for gaming activities, it is likely that we would incur substantial or complete losses on our related notes receivable and intangible assets associated with those projects. In addition, we may lack the funds to compete for and develop future gaming or other business opportunities and our business could be adversely affected to the extent that we may be forced to cease our operations entirely.

The following table summarizes our contractual obligations as of September 27, 2009 (in millions):