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GOLDEN ENTERTAINMENT, INC. - Quarter Report: 2014 September (Form 10-Q)

laco20140928_10q.htm

 



 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 28, 2014

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from to

 

Commission File No. 0-24993

 

LAKES ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

 

Minnesota

41-1913991

(State or other jurisdiction

(I.R.S. Employer

of incorporation or organization)

Identification No.)

130 Cheshire Lane, Suite 101

55305

Minnetonka, Minnesota

(Zip Code)

(Address of principal executive offices)

 

 

(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 ☑     No ☐

 

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 ☑     No 

 

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):

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company 

 

(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      No 

 

As of November 7, 2014, there were 13,389,078 shares of Common Stock, $0.01 par value per share, outstanding.

 



 

 
 

 

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

 

INDEX

 

   

Page of

Form 10-Q

     
  PART I. FINANCIAL INFORMATION  

ITEM 1.

FINANCIAL STATEMENTS

 
 

Consolidated Balance Sheets as of September 28, 2014 (unaudited) and December 29, 2013

  3
 

Unaudited Consolidated Statements of Operations for the three and nine months ended September 28, 2014 and September 29, 2013

  4
 

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 28, 2014 and September 29, 2013

  5
 

Notes to Unaudited Consolidated Financial Statements

  6

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  16

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  22

ITEM 4.

CONTROLS AND PROCEDURES

  22
PART II. OTHER INFORMATION  
ITEM 1. LEGAL PROCEEDINGS  22
ITEM 1A. RISK FACTORS  23
ITEM 6. EXHIBITS  23

 

 
2

 

 

Part I.

Financial Information

 

ITEM 1.  FINANCIAL STATEMENTS

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES 

Consolidated Balance Sheets

(In thousands)

 

   

(Unaudited)

         
   

September 28, 2014

   

December 29, 2013

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 33,356     $ 37,897  

Short-term investments

    47,327       49,099  

Income taxes receivable

    -       2,155  

Other

    2,359       1,774  

Total current assets

    83,042       90,925  

Property and equipment

    41,526       37,200  

Accumulated depreciation

    (7,979 )     (5,541 )

Property and equipment, net

    33,547       31,659  
                 

Other assets:

               

Investment in unconsolidated investee

    -       20,997  

Gaming license

    1,910       2,015  

Land held for development

    960       1,130  

Income taxes receivable

    2,155       -  

Other

    486       535  

Total other assets

    5,511       24,677  

Total assets

  $ 122,100     $ 147,261  
                 

Liabilities and shareholders' equity

               

Current liabilities:

               

Current portion of long-term debt, net of discount

  $ 1,367     $ 1,251  

Accounts payable

    364       420  

Accrued taxes, other than income taxes

    407       462  

Accrued payroll and related

    1,609       1,403  

Other accrued expenses

    1,440       1,325  

Total current liabilities

    5,187       4,861  
                 

Long-term debt, net of current portion and discount

    9,278       10,321  
                 

Total liabilities

    14,465       15,182  
                 

Commitments and contingencies

               

Shareholders' equity:

               

Common stock, $.01 par value; authorized 100,000 shares; 13,389 and 13,651 common shares issued and outstanding

    268       267  

Additional paid-in capital

    205,556       205,212  

Deficit

    (98,187 )     (73,400 )

Accumulated other comprehensive loss

    (2 )     -  

Total shareholders' equity

    107,635       132,079  

Total liabilities and shareholders' equity

  $ 122,100     $ 147,261  

 

 

See notes to unaudited consolidated financial statements.        

 

 
3

 

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Operations

(In thousands, except per share data)

 

   

Three months ended

   

Nine months ended

 
   

September 28,

2014

   

September 29,

2013

   

September 28,

2014

   

September 29,

2013

 

Revenues:

                               

Management fees

  $ -     $ 1,384     $ -     $ 7,762  

Gaming

    12,072       10,445       33,460       13,633  

Room

    1,940       1,849       4,884       2,728  

Food and beverage

    1,835       1,665       4,660       2,566  

Other operating

    829       647       1,806       1,154  

License fees and other

    44       26       107       66  

Gross revenues

    16,720       16,016       44,917       27,909  

Less promotional allowances

    790       524       2,570       564  

Net revenues

    15,930       15,492       42,347       27,345  
                                 

Costs and expenses:

                               

Gaming

    6,841       6,037       19,208       8,055  

Room

    226       255       509       580  

Food and beverage

    1,366       1,393       3,589       2,455  

Other operating

    470       483       1,131       1,116  

Selling, general and administrative

    5,455       5,398       16,918       13,782  

Recovery of impairment on notes receivable

    -       (17,382 )     -       (17,382 )

Gain on extinguishment of liabilities

    -       (3,752 )     -       (3,752 )

Gain on sale of cost method investment

    -       -       (1,000 )     -  

Charges related to arbitration award

    2,530       -       2,530       -  

Impairments and other losses

    20,997       3,356       20,997       3,356  

Preopening expenses

    -       -       -       1,163  

Amortization of intangible assets related to Indian casino projects

    -       187       -       716  

Gain on sale of land

    (66 )     -       (66 )     -  

Loss on disposal of property and equipment

    37       -       61       143  

Depreciation and amortization

    896       759       2,613       1,476  

Total costs and expenses

    38,752       (3,266 )     66,490       11,708  
                                 

Earnings (loss) from operations

    (22,822 )     18,758       (24,143 )     15,637  
                                 

Other income (expense):

                               

Interest income

    39       1,276       110       4,770  

Interest expense

    (297 )     (450 )     (923 )     (922 )

Other

    4       15       169       25  

Total other income (expense), net

    (254 )     841       (644 )     3,873  

Earnings (loss) before income taxes

    (23,076 )     19,599       (24,787 )     19,510  

Income tax benefit

    -       -       -       -  

Net earnings (loss)

  $ (23,076 )   $ 19,599     $ (24,787 )   $ 19,510  

Other comprehensive loss

    (3 )     (9 )     (2 )     (9 )

Comprehensive income (loss)

  $ (23,079 )   $ 19,590     $ (24,789 )   $ 19,501  
                                 

Weighted-average common shares outstanding

                               

Basic

    13,389       13,232       13,376       13,225  

Dilutive impact of stock options

    -       184       -       111  

Diluted

    13,389       13,416       13,376       13,336  
                                 

Earnings (loss) per share

                               

Basic

  $ (1.72 )   $ 1.48     $ (1.85 )   $ 1.48  

Diluted

  $ (1.72 )   $ 1.46     $ (1.85 )   $ 1.46  

 

 

See notes to unaudited consolidated financial statements.

 

 
4

 

 

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES 

Unaudited Consolidated Statements of Cash Flows

 (In thousands)

 

   

Nine Months Ended

 
   

September 28, 2014

   

September 29, 2013

 

OPERATING ACTIVITIES:

               

Net earnings (loss)

  $ (24,787 )   $ 19,510  

Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:

               

Depreciation and amortization

    2,613       1,476  

Amortization of debt issuance costs, accretion of debt discount and imputed interest on contract acquisition costs

    385       527  

Accretion and amortization of discounts and premiums on short-term investments and accretion of interest and additions to long-term interest receivable

    214       (3,573 )

Amortization of intangible assets related to Indian casino projects

    -       716  

Share-based compensation

    210       396  

Gain on sale of land

    (66 )     -  

Loss on disposal of property and equipment

    61       143  

Gain on extinguishment of liabilities

    -       (3,752 )

Recovery of impairment on notes receivable

    -       (17,382 )

Impairments and other losses

    20,997       3,356  

Changes in operating assets and liabilities:

               

Management fees receivable

    -       3,983  

Other current assets

    (347 )     (1,487 )

Income taxes receivable

    -       (5 )

Accrued taxes, other than income taxes

    (55 )     437  

Accounts payable and accrued expenses

    265       996  

Net cash provided by (used in) operating activities

    (510 )     5,341  
                 

INVESTING ACTIVITIES:

               

Purchase of short-term investments

    (62,114 )     (48,960 )

Sales and maturities of short-term investments

    63,432       -  

Payments to acquire investment in unconsolidated investee

    -       (836 )

Purchase of property and equipment

    (4,464 )     (18,215 )

Proceeds from sale of land

    236       -  

Proceeds from disposal of property and equipment

    21       25  

Collection on notes receivable

    -       59,253  

Changes in other assets

    25       348  

Net cash used in investing activities

    (2,864 )     (8,385 )
                 

FINANCING ACTIVITIES:

               

Repayments of borrowings

    (1,302 )     (89 )

Proceeds from borrowings

    -       13,792  

Proceeds from issuance of common stock

    135       126  

Contract acquisition costs payable

    -       (1,333 )

Net cash provided by (used in) financing activities

    (1,167 )     12,496  
                 

Net increase (decrease) in cash and cash equivalents

    (4,541 )     9,452  
                 

Cash and cash equivalents - beginning of period

    37,897       32,480  
                 

Cash and cash equivalents - end of period

  $ 33,356     $ 41,932  
                 

SUPPLEMENTAL CASH FLOW INFORMATION:

               

Cash paid during the period for:

               

Interest

  $ 535     $ 359  

Income taxes

    -       5  

Noncash investing activities:

               

Capital expenditures in accounts payable and accrued expenses

  $ 158     $ 1,064  

 

 

See notes to unaudited consolidated financial statements.

 

 
5

 

 

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

 

Notes to Unaudited Consolidated Financial Statements

 

 

 

1.  Nature of Business and Basis of Presentation

 

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. 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, for the year ended December 29, 2013, 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 (consisting of normal recurring adjustments). The results for the current interim period are not necessarily indicative of the results to be expected for the full year.

 

Lakes owns and operates the Rocky Gap Casino Resort in Allegany County, Maryland (“Rocky Gap”) which it acquired on August 3, 2012 for $6.8 million. The resort included a hotel, convention center, spa, two restaurants and the only Jack Nicklaus signature golf course in Maryland. In connection with the closing of the acquisition of Rocky Gap, Lakes entered into a 40 year operating ground lease with the Maryland Department of Natural Resources for approximately 268 acres in the Rocky Gap State Park on which Rocky Gap is situated (see note 16, Commitments and Contingencies). After acquiring Rocky Gap, the Company converted the then-existing convention center into a gaming facility which opened to the public on May 22, 2013 and features 577 video lottery terminals (“VLTs”), 15 table games, two poker tables, 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 during 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.

 

All material intercompany accounts and transactions have been eliminated in consolidation.

 

Investments in unconsolidated investees, which are 20% or less owned and the Company does not have the ability to significantly influence the operating or financial decisions of the entity, are accounted for under the cost method. See note 7, Investment in Rock Ohio Ventures, LLC and note 8, Investment in Dania Entertainment Center, LLC.

 

Effective September 10, 2014, the Company implemented a 1-for-2 reverse split of its common stock where each two shares of issued and outstanding common stock were converted into one share of common stock. The reverse split reduced the number of shares of the Company’s common stock outstanding from approximately 26.8 million to 13.4 million. The par value of the common stock remains at $0.01 per share and the number of authorized shares of common stock decreased from 200 million to 100 million. Proportional adjustments were also made to the company’s outstanding stock options. All share information presented in this Quarterly Report on Form 10-Q gives effect to the reverse stock split.

 

2.  New Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers. This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue from the transfer of goods or services to customers in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. ASU 2014-09 will be effective for the Company’s first quarter of 2017. Lakes is evaluating the impact this new standard will have on its financial statements.

 

In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 requires entities to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss (“NOL”) or tax credit carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. This ASU requires entities to assess whether to net the unrecognized tax benefit with a deferred tax asset as of the reporting date. ASU 2013-11 became effective as of March 30, 2014. The adoption of ASU 2013-11 did not have an impact on the Company’s consolidated financial statements.

 

3.  Debt Termination Agreement with the Shingle Springs Tribe

 

On July 17, 2013, Lakes entered into a Debt Termination Agreement (the “Debt Termination Agreement”) with the Shingle Springs Band of Miwok Indians (the “Shingle Springs Tribe”) relating to amounts Lakes had previously advanced to the Shingle Springs Tribe under the development and management agreement for the Red Hawk Casino between Lakes and the Shingle Springs Tribe. The Debt Termination Agreement required certain conditions to be met, including a lump sum payment by the Shingle Springs Tribe to Lakes 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 Lakes as of that date. The management agreement under which Lakes was managing the Red Hawk Casino also terminated on the Payment Date.

 

 
6

 

 

4.  Short-Term Investments

 

Short-term investments consist of commercial paper, corporate bonds and certificates of deposit which are classified as available-for-sale securities and are carried at current fair 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. If the carrying value of an investment is in excess of its fair market value, an impairment charge to adjust the carrying value to the fair market value is recorded if the impairment is considered other-than-temporary. There were no other-than-temporary impairments related to declines in fair market value of short-term investments during the three or nine months ended September 28, 2014. All short-term investments held as of September 28, 2014 have original maturity dates of twelve months or less and are classified as current assets. Short-term investments consisted of the following as of September 28, 2014 and December 29, 2013 (in thousands):

     

Amortized Cost

      Fair Value      

Unrealized

Gain/(Loss)

 

September 28, 2014

                       

Commercial paper

  $ 33,962     $ 33,969     $ 7  

Corporate bonds

    13,127       13,118       (9 )

Certificates of deposit

    240       240        

Balances at September 28, 2014

  $ 47,329     $ 47,327     $ (2 )
                         

December 29, 2013

                       

Commercial paper

  $ 21,986     $ 21,993     $ 7  

Corporate bonds

    27,113       27,106       (7 )

Balances at December 29, 2013

  $ 49,099     $ 49,099     $  

 

See note 15, Financial Instruments and Fair Value Measurements, for further discussion of the fair value of these investments.

 

5. Property and Equipment, net

 

The following table summarizes the components of property and equipment, at cost (in thousands):

 

     

September 28,

2014

     

December 29,

2013

 

Building and site improvements

  $ 27,769     $ 24,611  

Furniture and equipment

    13,212       12,370  

Construction in process

    545       219  

Property and equipment

    41,526       37,200  

Less accumulated depreciation

    (7,979 )     (5,541 )

Property and equipment, net

  $ 33,547     $ 31,659  

 

6. Gaming License

 

In April 2012, the State of Maryland Video Lottery Facility Location Commission awarded a video lottery operation license (“Gaming License”) to the Company for Rocky Gap. Amortization of the Gaming License began on May 22, 2013, the date the gaming facility opened for public play. The Gaming License is being amortized over its 15 year term. Amortization expense related to the Gaming License is as follows:

   

Three Months Ended

   

Nine Months Ended

 
   

September 28,

2014

   

September 29,

2013

   

September 28,

2014

   

September 29,

2013

 

Amortization expense related to the Gaming License

  $ 35     $ 35     $ 105     $ 50  

 

 

Information with respect to the Gaming License is as follows (in thousands):

 

   

September 28,

2014

   

December 29,

2013

 

Original cost

  $ 2,100     $ 2,100  

Accumulated amortization

    (190 )     (85 )
    $ 1,910     $ 2,015  

 

 

 
7

 

 

7.  Investment in Rock Ohio Ventures, LLC        

 

Lakes has a 10% ownership investment in Rock Ohio Ventures, LLC (“Rock Ohio Ventures”), a privately-held company, that owns 80% of the Horseshoe Casino Cleveland in Cleveland, Ohio which opened to the public in May 2012; the Horseshoe Casino Cincinnati in Cincinnati, Ohio which opened in March 2013; the Thistledown Racino in North Randall, Ohio which added VLTs to its existing racetrack in April 2013; and Turfway Park, a thoroughbred horseracing track located in Florence, Kentucky. This investment is accounted for using the cost method since Lakes owns less than 20% of Rock Ohio Ventures and does not have the ability to significantly influence the operating and financial decisions of the entity. At September 28, 2014 and December 29, 2013, Lakes had invested a total of $21.0 million in Rock Ohio Ventures, which is included in investment in unconsolidated investee in the accompanying consolidated balance sheets. This investment was determined to have experienced an other-than-temporary impairment and was reduced to its estimated fair value of zero as of September 28, 2014. As a result, Lakes recognized an impairment loss of $21.0 million, which is included in impairments and other losses in the accompanying consolidated statement of operations for the three and nine months ended September 28, 2014.

 

The Company's cost method investment is 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 investment. Lakes monitors this investment for impairment by considering all information available to the Company including the economic environment of the markets served by the properties Rock Ohio Ventures owns; 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 Rock Ohio Venture’s management; known or expected changes in ownership of Rock Ohio Ventures; and any other known significant factors relating to the business underlying the investment.

 

As part of the review of operational performance and financial results for considering if there are indications of impairment, the Company utilizes financial statements of Rock Ohio Ventures and its owned gaming properties to assess the investee’s ability to operate from a financial standpoint. The Company also analyzes Rock Ohio Ventures’ cash flows and working capital to determine if the Company’s investment in this entity has experienced an other-than-temporary impairment. As part of this process, the Company analyzes actual historical results compared to forecast and has periodic discussions with management of Rock Ohio Ventures to obtain additional information related to the Company’s investment in Rock Ohio Ventures to determine whether any events have occurred that would necessitate further analysis of the Company’s recorded investment in Rock Ohio Ventures for impairment. Based on these procedures, Lakes has determined that the Company’s investment in Rock Ohio Ventures has experienced an other-than-temporary impairment as of September 28, 2014. Based on current information provided by Rock Ohio Ventures, Lakes has determined that there is now significant uncertainty surrounding the recovery of Lakes’ investment in Rock Ohio Ventures. The Ohio gaming properties have not performed as expected which has led to forecasted potential working capital requirement issues that did not exist in prior quarters, based on information previously available to Lakes. As a result, Lakes determined that an other-than-temporary impairment had occurred and reduced the carrying value of the investment in Rock Ohio Ventures to its estimated fair value of zero as of September 28, 2014. In all periods prior to September 28, 2014, Lakes had determined that no other-than-temporary impairments had occurred related to this investment. The fair value of the investment in Rock Ohio Ventures was not estimated in prior periods because based on the information Lakes received from Rock Ohio Ventures in those periods, there were no events or changes in circumstances that may have had a significant adverse effect on the fair value of the investment, and Lakes’ management determined that it was not practicable or necessary to estimate the fair value of the investment. Lakes will continue to evaluate this investment at least quarterly.

 

See note 15, Financial Instruments and Fair Value Measurements, for further discussion of the calculation of the fair value of the investment in Rock Ohio Ventures as of September 28, 2014.

 

Lakes has the right, but not the obligation, to make additional investments up to 10% of equity required by Rock Ohio Ventures to develop the properties it owns in return for a corresponding equity interest in those properties (see note 16, Commitments and Contingencies).

 

8.  Investment in Dania Entertainment Center, LLC

 

On May 22, 2013, Dania Entertainment Center, LLC (“DEC”) purchased the Dania Jai Alai property located in Dania Beach, Florida, from Boyd Gaming Corporation, for $65.5 million.

 

As part of a previous plan to purchase the property, during 2011 Lakes loaned $4.0 million to DEC (the “Loan”) which was written down to zero during the third quarter of 2011 when the acquisition did not close. During 2013, the Loan was exchanged for a 20% ownership interest in Dania Entertainment Holdings, LLC (“DEH”).

 

The Company accounted for its investment in DEH as a cost method investment. At the time the Loan was exchanged for an equity investment in DEH, Lakes determined its value remained at zero due to the negative cash flows of the existing operations of the Dania Jai Alai property as well as uncertainty surrounding completion of the project. Therefore, there was no value recorded for this investment in the Company’s accompanying consolidated balance sheet.

 

 
8

 

 

On April 21, 2014, Lakes entered into a redemption agreement with DEH that resulted in DEH redeeming Lakes’ 20% ownership in DEH in exchange for DEH granting to Lakes 5% ownership in DEC. Concurrently, Lakes entered into an agreement with an unrelated third party, ONDISS Corp. (“ONDISS”), to sell its ownership in DEC to ONDISS for approximately $2.6 million. Lakes received $1.0 million on April 21, 2014, which was recorded as a gain on sale of cost method investment in the consolidated statements of operations during the second quarter of 2014. Also on April 21, 2014, 40% of Lakes’ ownership was transferred to ONDISS. The agreement also required that ONDISS pay Lakes three installments of approximately $0.5 million each on October 21, 2014, April 21, 2015 and October 21, 2015, and on each date one-third of Lakes’ remaining ownership would be transferred to ONDISS. On October 17, 2014, ONDISS paid the entire remaining amount due to Lakes at a discounted amount of approximately $1.4 million. Upon receipt of such payment, Lakes transferred its remaining ownership in DEC to ONDISS. Lakes will account for the receipt of this payment as a gain on sale of cost method investment in the consolidated statements of operations in the fourth quarter of 2014.

 

See note 15, Financial Instruments and Fair Value Measurements, for discussion of the fair value of this investment.

 

9.  Land

 

Lakes owns parcels of undeveloped land related to its previous involvement in a potential casino project with the Jamul Indian Village (the “Jamul Tribe”) near San Diego, California. During the third quarter of 2012, Lakes entered into a ten-year option agreement (“Original Option Agreement”) with Penn National Gaming, Inc. (“Penn National”) that granted Penn National the right to purchase this land for $7.0 million, increasing 1% each year, but Penn National had no obligation to purchase the land. The Original Option Agreement was amended on May 15, 2014 to reduce the purchase price of the land to $5.5 million but requires Penn National to purchase the land within ten days after the Jamul Tribe opens a casino on its reservation. Annual option payments of less than $0.1 million are required to be made by Penn National to Lakes. As of September 28, 2014 and December 29, 2013, this land is carried at approximately $1.0 million on the accompanying consolidated balance sheets.

 

Lakes also owned undeveloped land in Oklahoma related to its previous involvement in a potential casino project with the Iowa Tribe of Oklahoma. During the third quarter of 2014, Lakes sold this land for approximately $0.3 million and recognized a gain of approximately $0.1 million. As of December 29, 2013, the land was classified as held for development and was carried at approximately $0.2 million on the accompanying consolidated balance sheet.

 

The Company performs an impairment analysis on the land it owns at least quarterly and determined that no impairment had occurred as of September 28, 2014 and December 29, 2013.

 

10. Debt

 

Loan Agreement

Lakes had a two-year interest-only $8.0 million revolving line of credit loan agreement (the “Loan Agreement”) with Centennial Bank that expired on October, 28 2014. The Loan Agreement was collateralized by primarily all of Lakes’ interest in the real property it owns in Minnetonka, Minnesota. Lakes’ Chief Executive Officer, Lyle Berman, personally guaranteed the Loan Agreement on behalf of Lakes. The Loan Agreement allowed for an interest rate of 8.95% on any amounts borrowed. No amounts were ever borrowed under the Loan Agreement and as such, as of September 28, 2014 and December 29, 2013, no amounts were outstanding under the Loan Agreement.

 

Financing Facility

In December 2012, Lakes closed on a $17.5 million financing facility with Centennial Bank (the “Financing Facility”) to finance a portion of Rocky Gap project costs. Approximately $13.4 million was drawn on the Financing Facility. Lakes was required to invest $17.5 million in the Rocky Gap project prior to drawing on the Financing Facility. The Financing Facility is collateralized by the leasehold estate and the furniture, fixtures and equipment of Rocky Gap. In addition, Lakes guaranteed repayment of the loan and granted a second mortgage on its real property located in Minnetonka, Minnesota. Effective November 1, 2013, Lakes amended the Financing Facility with Centennial Bank to reduce the interest rate from 10.5% to 5.5%. Monthly payments of principal and interest began on December 1, 2013 and continue for 84 months. Although Lakes does not currently plan to make further draws on the Financing Facility, Lakes has the ability to draw the remaining $4.1 million on the Financing Facility through December 31, 2018. As of September 28, 2014 and December 29, 2013, $12.1 million and $13.3 million of principal was outstanding under the Financing Facility, respectively.

 

As a result of the amendment of the Financing Facility with Centennial Bank effective November 1, 2013, Lakes recorded a $1.7 million gain on modification of debt during the fourth quarter of 2013. This amount included $2.0 million recorded as a discount to the principal amount of the Financing Facility, which is being accreted to interest expense over the term of the Financing Facility using the effective interest method, and $0.3 million of original debt issuance costs expensed at the time of the amendment. Accretion of the discount to interest expense was approximately $0.1 million and $0.4 million for the three and nine months ended September 28, 2014.

 

 
9

 

 

Summary of Outstanding Debt

Long-term debt, net of current maturities and discount, is comprised of the following (in thousands):

 

   

September 28,

2014

   

December 29,

2013

 

Financing Facility

  $ 12,106     $ 13,315  

Capital lease obligations

    88       182  

Total debt

    12,194       13,497  

Less: current maturities, net of discount

    (1,367 )     (1,251 )

Less: unamortized debt discount

    (1,549 )     (1,925 )

Long-term debt, net of current maturities and discount

  $ 9,278     $ 10,321  

 

11. Promotional Allowances

 

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 promotional allowances. Guests may be given, on a discretionary basis, coupons to use towards the purchase of rooms, food and beverage, and other amenities. Lakes recognizes a reduction in revenue as a promotional allowance for these coupons when the coupons are redeemed. The estimated retail value of the promotional allowances is as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 28,

2014

   

September 29,

2013

   

September 28,

2014

   

September 29,

2013

 

Food and beverage

  $ 127     $ 67     $ 373     $ 87  

Rooms

    606       457       2,092       477  

Other

    57             105        

Total promotional allowances

  $ 790     $ 524     $ 2,570     $ 564  

 

 

The estimated cost of providing these promotional allowances, which are included in gaming costs and expenses, is as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 28,

2014

   

September 29,

2013

   

September 28,

2014

   

September 29,

2013

 

Food and beverage

  $ 53     $ 67     $ 179     $ 87  

Rooms

    146       110       502       115  

Other

    5             82        

Total promotional allowances

  $ 204     $ 177     $ 763     $ 202  

 

12.  Share-Based Compensation

 

Share-based compensation expense related to stock options for the three and nine months ended September 28, 2014 and September 29, 2013 were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 28,

2014

   

September 29,

2013

   

September 28,

2014

   

September 29,

2013

 

Total cost of share-based payment plans

  $ 67     $ 113     $ 210     $ 396  

 

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. There were 3,000 and 11,000 options granted during the three and nine months ended September 28, 2014, respectively. The weighted-average grant-date fair value of the stock options issued during the three and nine months ended September 28, 2014 were $3.98 and $4.65, respectively. There were 3,000 and 224,750 options granted during the three and nine months ended September 29, 2013, respectively. The weighted-average grant-date fair value of the stock options issued during the three and nine months ended September 29, 2013 was $4.31 and $3.45, respectively.

 

 
10

 

 

The following table summarizes Lakes’ stock option activity during the nine months ended September 28, 2014 and September 29, 2013:

   

Number of Common Shares

         
     

Options

Outstanding

      Exercisable      

Available

for Grant

     

Weighted-

Average

Exercise

Price 

 
                                 

2014

                               

Balance at December 29, 2013

    798,171       585,769       263,424     $ 5.97  

Forfeited/cancelled/expired

    (25,211 )             24,211       5.19  

Exercised

    (28,343 )                   4.73  

Granted

    11,000               (11,000 )     9.18  

Balance at September 28, 2014

    755,617       615,792       276,635       6.09  
                                 

2013

                               

Balance at December 30, 2012

    764,034       649,412       437,797     $ 5.84  

Forfeited/cancelled/expired

    (51,502 )             51,502       6.17  

Exercised

    (19,275 )                   6.54  
Granted     224,750               (224,750 )     6.16  

Balance at September 29, 2013

    918,007       626,771       264,549       5.88  

 

As of September 28, 2014, the options outstanding had a weighted average remaining contractual life of 6.1 years, weighted average exercise price of $6.09 and aggregate intrinsic value of $1.8 million. The options exercisable have a weighted average exercise price of $6.00, a weighted average remaining contractual life of 5.5 years and aggregate intrinsic value of $1.5 million as of September 28, 2014.

 

There were 500 and 28,343 options exercised during the three and nine months ended September 28, 2014, respectively and 19,275 options exercised during the three and nine months ended September 29, 2013. The total intrinsic value of options exercised during the three and nine months ended September 28, 2014 was less than $0.1 million and $0.1 million, respectively. Lakes’ unrecognized share-based compensation expense related to stock options was approximately $0.4 million as of September 28, 2014, which is expected to be recognized over a weighted-average period of 1.6 years.

 

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

 

13.  Earnings (Loss) per Share

 

For all periods, basic earnings (loss) per share (“EPS”) is calculated by dividing net earnings (loss) by the weighted-average common shares outstanding. Diluted EPS in profitable periods reflects the effect of all potentially dilutive common shares outstanding by dividing net earnings by the weighted-average of all common and potentially dilutive shares outstanding. Potentially dilutive stock options of 755,617 for each of the three and nine months ended September 28, 2014 and 733,942 and 807,497 for the three and nine months ended September 29, 2013, respectively, were not used to compute diluted earnings (loss) per share because the effects would have been anti-dilutive.

 

14.  Income Taxes     

 

There was no income tax benefit for either the nine months ended September 28, 2014 or September 29, 2013 because there is no remaining potential to carry back losses to prior years and future realization of the benefit is uncertain. The Company’s effective tax rate was 0% for each of the nine months ended September 28, 2014 and September 29, 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.

 

Lakes has recorded income taxes receivable of $2.2 million as of September 28, 2014 and December 29, 2013 related to the Company’s ability to carry back 2012 taxable losses to a prior year and receive a refund of taxes previously paid.

 

Deferred tax assets are evaluated by considering historical levels of income, estimates of future taxable income and the impact of tax planning strategies.  Management has evaluated all available evidence and has determined that negative evidence continues to outweigh positive evidence for the realization of deferred tax assets and as a result continues to provide a full valuation allowance against its deferred tax assets.

 

As of September 28, 2014, Lakes had approximately $89.1 million of federal net operating loss carryforwards, which will begin to expire in 2022, and approximately $113.4 million of state net operating loss carryforwards, which will expire at various times depending on specific state laws.

 

 
11

 

 

The Company is currently under IRS audit for the 2009-2012 tax years and the IRS has proposed certain adjustments to the 2009-2011 tax filings. However, Lakes believes it is more likely than not that it will prevail in challenging the proposed adjustments and maintains that the positions taken were proper and supported by applicable laws and regulations. While the outcome of this matter cannot be predicted with certainty, Lakes does not believe, when resolved, that this dispute will have a material effect on its consolidated financial statements. However, an unexpected adverse resolution could have a material effect on the consolidated financial statements in a particular quarter or fiscal year. The Company is currently under audit by the State of California for the 2010 tax year. No adjustments have been made as a result of the State of California audit. However, there is no assurance that the taxing authority will not propose adjustments that are different from the Company’s expected outcome and that may impact the provision for income taxes.

 

15. Financial Instruments and Fair Value Measurements

 

Overview

Estimates of fair value for financial assets and liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value, and requires certain disclosures. The framework discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

 

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

 

The Company’s financial instruments consist of cash and cash equivalents, short-term investments, cost method investments, accounts payable and debt.

 

For the Company’s cash and cash equivalents, accounts payable and current portion of debt, the carrying amounts approximate fair value because of the short duration of these financial instruments. As of September 28, 2014 and December 29, 2013, the fair value of the Company’s long-term debt approximates the carrying value based upon the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.     

 

Balances Measured at Fair Value on a Recurring Basis

The following table (in thousands) shows certain of the Company’s financial instruments measured at fair value on a recurring basis using Level 2 inputs, as they are priced principally by independent pricing services using observable inputs:

 

   

September 28, 2014

   

December 29, 2013

 

Short-Term Investments

               

Commercial paper

  $ 33,969     $ 21,993  

Corporate bonds

    13,118       27,106  

Certificates of deposit

    240        

 

Balances Measured at Fair Value on a Nonrecurring Basis

The Company’s investment in Rock Ohio Ventures was measured using unobservable (Level 3) inputs as of September 28, 2014.  The fair value of zero was calculated using both a discounted cash flow method, which is an application of the income approach, and a comparable public company method, which is an application of the market approach. An option-based method was also employed in the allocation of value among debt and equity investors. Management judgment is required in developing the assumptions used in the calculation of the fair value of the investment. Significant inputs include financial forecasts for Rock Ohio Caesars, LLC (the entity through which Rock Ohio Ventures invests in certain gaming businesses), discount rates, market multiples for similar businesses, expected volatility, the expected timing of a liquidity/refinancing event and a discount for lack of marketability.  A change in any significant unobservable input may lead to a change in the estimated fair value of the investment.

 

See note 7, Investment in Rock Ohio Ventures, LLC, for further discussion regarding the impairment of this investment as of September 28, 2014.

 

 
12

 

  

Balances Disclosed at Fair Value

 

Cost Method Investment – Investment in Rock Ohio Ventures, LLC - The fair value of the Company’s investment in Rock Ohio Ventures was not estimated as of December 29, 2013, as there were no events or changes in circumstances that may have had a significant adverse effect on the fair value of the investment, and Lakes’ management determined that it was not practicable or necessary to estimate the fair value of the investment (see note 7, Investment in Rock Ohio Ventures, LLC).

 

Cost Method Investment – Investment in Dania Entertainment Center, LLC - As of September 28, 2014, the fair value of the Company’s investment in Dania Entertainment Center, LLC was determined to be approximately $1.4 million, which was the negotiated sale price of Lakes’ remaining investment in DEC (see note 8, Investment in Dania Entertainment Center, LLC). The fair value of this investment was considered impracticable to estimate as of December 29, 2013 without incurring excessive costs relative to the materiality of the investment. 

 

16. Commitments and Contingencies

 

Operating Lease with the Maryland Department of Natural Resources Related to Rocky Gap

In connection with the closing of the acquisition of Rocky Gap, Lakes entered into a 40-year operating ground lease (the “Lease Agreement”) with the Maryland Department of Natural Resources for approximately 268 acres in the Rocky Gap State Park on which Rocky Gap is situated. The Lease Agreement contains an option to renew for 20 years after the initial 40-year term.

 

From August 3, 2012 and until the casino opened for public play on May 22, 2013, rent in the form of surcharges was due and payable with a minimum annual payment of $150,000. From May 22, 2013 through the remaining term of the Lease Agreement, rent payments are due and payable annually in the amount of $275,000 plus 0.9% of any gross operator share of gaming revenue (as defined in the Lease Agreement) in excess of $275,000, and $150,000 plus any surcharge revenue in excess of $150,000. Surcharge revenue consists of amounts billed to and collected from guests and are $3.00 per room per night and $1.00 per round of golf. Rent expense for the three and nine months ended September 28, 2014 and September 29, 2013 were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 28,

2014

   

September 29,

2013

   

September 28,

2014

   

September 29,

2013

 

Rent expense

  $ 70     $ 74     $ 241     $ 258  

 

Future minimum lease payments under the Lease Agreement at September 28, 2014 are as follows (in thousands):

 

    2015     2016     2017     2018     2019     Thereafter  

Minimum lease payment

  $ 425     $ 425     $ 425     $ 425     $ 425     $ 13,600  

 

Rock Ohio Ventures, LLC

Lakes has a 10% ownership in Rock Ohio Ventures and as of September 28, 2014, Lakes has invested approximately $21.0 million as required. As of September 28, 2014, Lakes reduced the carrying value of the investment in Rock Ohio Ventures to its estimated fair value of zero due to the determination that the investment had experienced an other-than-temporary impairment (see note 7, Investment in Rock Ohio Ventures, LLC). Lakes may invest additional capital up to $4.1 million as needed to maintain its equity position in Rock Ohio Ventures. If Lakes chooses not to fund additional amounts of capital as needed to maintain its equity position in Rock Ohio Ventures, it will maintain an ownership position in Rock Ohio Ventures in a pro rata amount of what its $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.

 

Jerry Argovitz Litigation

On March 12, 2014, Lakes received a demand for arbitration from Jerry Argovitz (“Argovitz”) relating to a Consent and Agreement to Buyout and Release by and between Argovitz and Lakes KAR Shingle Springs, LLC (“LKAR”), Lakes Entertainment, Inc., and Lakes Shingle Springs, Inc. dated January 30, 2003 (“Buyout Agreement”).  The Buyout Agreement provided that LKAR was to make certain payments to Argovitz for so long as LKAR was managing the Red Hawk Casino for the Shingle Springs Tribe.  Lakes made the payments required under the Buyout Agreement while it was managing the Red Hawk Casino, and discontinued the payments after its management contract to manage the Red Hawk Casino was terminated.  Argovitz asserted claims for breach of the Buyout Agreement and the implied covenant of good faith and fair dealing relating to the payments he alleged he was entitled to receive after the management agreement was terminated.  He sought damages of approximately $2.7 million, plus interest, costs, and attorney fees. 

 

 
13

 

 

On September 9, 2014, Argovitz was awarded approximately $2.4 million related to the arbitration action brought by Argovitz against Lakes. As a result, Lakes recognized charges related to arbitration award in its consolidated statement of operations of approximately $2.5 million during the third quarter of 2014, which included the $2.4 million award and $0.1 million of legal fees. The action is now closed and no further claims can be made by Argovitz related to this matter.

 

Quest Media Group, LLC Litigation

On May 17, 2012, Lakes received service of a breach of contract lawsuit filed in the Franklin County Court of Common Pleas, Franklin County, Ohio by Quest Media Group, LLC (“Quest”) with respect to an agreement (the “Agreement”) entered into between Lakes Ohio Development, LLC (a wholly owned subsidiary of Lakes) (“Lakes Ohio Development”) and Quest on March 9, 2010.  The Agreement relates to Quest assisting Lakes Ohio Development in partnering with Rock Ohio Ventures, LLC and Penn Ventures, LLC (“Penn Ventures”) with respect to funding the proposed citizen-initiated referendum in November 2009 to amend the Ohio constitution to permit one casino each in Cleveland, Cincinnati, Toledo and Columbus, Ohio. The lawsuit alleged, among other things, that Lakes breached the Agreement by selling Lakes Ohio Development’s interest in the Toledo and Columbus, Ohio casino projects to Penn Ventures, failing to pay the proper fee to Quest as a result of such sale, and incorrectly calculating the costs that are to be offset against Quest’s fee.  The lawsuit sought unspecified compensatory damages in excess of $25,000, punitive damages, declaratory and injunctive relief.  The lawsuit named as defendants Lakes Entertainment, Inc., Lakes Ohio Development, LLC and Lyle Berman, Chairman and CEO of Lakes. Lakes removed the case to federal court, answered the pleadings and filed a motion to dismiss the claims against all defendants.  Prior to the judge’s ruling on the motion to dismiss, the parties settled all but one of Quest’s claims (including obtaining a dismissal of Lyle Berman from the lawsuit) at no out-of-pocket expense to Lakes.  The judge granted Lakes’ motion to dismiss and dismissed the remaining claims against Lakes. Quest subsequently appealed the dismissal to the Sixth Circuit Court of Appeals. Lakes continues to believe that the suit is without merit and will continue to vigorously defend the matter.

 

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.

 

17.  Related Party Transaction

 

In March 2013, Lakes transferred to Lyle Berman, Lakes' Chairman of the Board and Chief Executive Officer, a $250,000 secured note from an unrelated third party company in exchange for a cash payment of $150,000 from Mr. Berman. The secured note was in default and related to a fiscal 2012 potential business development opportunity that Lakes decided not to pursue. The note receivable was written down to $150,000 in fiscal 2012.

 

18.  Segment Information

 

Lakes’ segments reported below (in millions) are the segments of the Company for which separate financial information is available and for which operating results are evaluated by the chief operating decision-maker in deciding how to allocate resources and in assessing performance.

 

The Rocky Gap segment includes results of operations and assets related to the Rocky Gap Casino Resort near Cumberland, Maryland. The Indian Casino Projects segment includes results of operations and assets related to the development, financing, and management of the gaming-related property for the Shingle Springs Tribe. The Other segment includes Lakes’ cash and cash equivalents, short-term investments, Lakes corporate overhead and the investment in Rock Ohio Ventures. Costs in Other have not been allocated to the other segments because these costs are not easily allocable and to do so would not be practical. Amounts in Eliminations represent the intercompany management fee for Rocky Gap.

 

 
14

 

 

       Rocky Gap    

Indian

Casino

Projects

       Other       Eliminations        Consolidated   
                                         

Three months ended September 28, 2014

                                       

Net revenue

  $ 15.9     $     $ 0.5     $ (0.5 )   $ 15.9  

Management fee revenue – Rocky Gap

                0.5       (0.5 )      

Management fee expense – Rocky Gap

    (0.5 )                 0.5        

Impairments and other losses

                (21.0 )           (21.0 )

Depreciation and amortization expense

    (0.8 )           (0.1 )           (0.9 )

Earnings (loss) from operations

    1.7             (24.5 )           (22.8 )

Interest expense

    (0.3 )                       (0.3 )
                                         

Three months ended September 29, 2013

                                       

Net revenue

  $ 14.1     $ 1.4     $ 0.4     $ (0.4 )   $ 15.5  

Management fee revenue – Rocky Gap

                0.4       (0.4 )      

Management fee expense – Rocky Gap

    (0.4 )                 0.4        

Impairments and other losses

          (3.4 )                 (3.4 )

Amortization of intangible assets related to Indian casino projects

          (0.2 )                 (0.2 )

Depreciation and amortization expense

    (0.7 )           (0.1 )           (0.8 )

Earnings (loss) from operations

    0.7       19.0       (0.9 )           18.8  

Interest expense

    (0.3 )     (0.1 )                 (0.4 )
                                         

Nine months ended September 28, 2014

                                       

Net revenue

  $ 42.2     $     $ 1.3     $ (1.2 )   $ 42.3  

Management fee revenue – Rocky Gap

                1.2       (1.2 )      

Management fee expense – Rocky Gap

    (1.2 )                 1.2        

Impairments and other losses

                (21.0 )           (21.0 )

Depreciation and amortization expense

    (2.5 )           (0.1 )           (2.6 )

Earnings (loss) from operations

    2.7             (26.8 )           (24.1 )

Interest expense

    (0.9 )                       (0.9 )
                                         

Nine months ended September 29, 2013

                                       

Net revenue

  $ 19.5     $ 7.7     $ 0.6     $ (0.5 )   $ 27.3  

Management fee revenue – Rocky Gap

                0.5       (0.5 )      

Management fee expense – Rocky Gap

    (0.5 )                 0.5        

Impairments and other losses

          3.4                   3.4  

Amortization of intangible assets related to Indian casino projects

          (0.7 )                 (0.7 )

Depreciation and amortization expense

    (1.3 )           (0.2 )           (1.5 )

Earnings (loss) from operations

    (4.3 )     24.8       (4.9 )           15.6  

Interest expense

    (0.4 )     (0.5 )                 (0.9 )
                                         

As of September 28, 2014

                                       

Total assets

  $ 37.9     $     $ 84.2     $     $ 122.1  

Capital expenditures

    4.4             0.1             4.5  

Investment in unconsolidated investees

                             
                                         

As of December 29, 2013

                                       

Total assets

  $ 34.4     $     $ 112.9     $     $ 147.3  

Capital expenditures

 

20.6

            0.1             20.7  

Investment in unconsolidated investees

                21.0             21.0  

 

 
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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 28, 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”), 17 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 September 28, 2014, we have invested approximately $21.0 million to Rock Ohio Ventures. As of September 28, 2014, we reduced the carrying value of our investment in Rock Ohio Ventures to its estimated fair value of zero due to the determination that the investment had experienced an other-than-temporary impairment. We currently maintain a 10% interest in Rock Ohio Ventures’ 80% ownership in its gaming properties. If we choose not to fund additional amounts of capital, up to $4.1 million, as needed to maintain our equity position in Rock Ohio Ventures, 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 1,600 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 features approximately 1,150 VLTs, which were added 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 nine months ended September 28, 2014.

 

Three months ended September 28, 2014 compared to the three months ended September 29, 2013

 

Net Revenues

Net revenues were $15.9 million for the third quarter of 2014 compared to $15.5 million for the third quarter of 2013. The increase in net revenues for the three months ended September 28, 2014 compared to the three months ended September 29, 2013 was due to additional net revenue of $1.8 million related to the operation of Rocky Gap, primarily due to additional net revenue associated with increased win per-unit per-day. Included in net revenues for the three months ended September 29, 2013 were $1.4 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.

  

 
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Property Operating Expenses

Property operating expenses were $8.9 million for the third quarter of 2014 compared to $8.2 million for the third 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 an increase in gaming-related expenses, most notably gaming taxes, due to the increase in gaming-related revenue in the current year quarter.

 

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $5.5 million for the third quarter of 2014 compared to $5.4 million for the third quarter of 2013. Included in these amounts were Lakes corporate selling, general and administrative expenses of $1.5 million and $1.3 million for the third quarters of 2014 and 2013, respectively, and Rocky Gap selling, general and administrative expenses of $4.0 million and $4.1 million for the third quarters of 2014 and 2013, respectively.    

 

For the third 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, and professional fees of $0.6 million. 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.

 

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.

 

Charges Related to Arbitration Award

On September 9, 2014, Lakes received notice of Final Award in the matter of Jerry Argovitz v. Lakes Entertainment, Inc. and Lakes Shingle Springs, Inc. awarding Jerry Argovitz approximately $2.4 million. As a result, Lakes recognized an expense of approximately $2.5 million, which includes $0.1 million of legal fees, during the third quarter of 2014.

 

Impairments and Other Losses

Lakes recognized impairments and other losses of $21.0 million during the third quarter of 2014 related to its investment in Rock Ohio Ventures. Based on current information provided by Rock Ohio Ventures, Lakes has determined that there is now significant uncertainty surrounding the recovery of Lakes’ investment in Rock Ohio Ventures. The Ohio gaming properties have not performed as expected, which has led to forecasted potential working capital requirement issues that did not exist in prior quarters. As a result, Lakes determined that an other-than-temporary impairment had occurred and reduced the carrying value of the investment to its estimated fair value of zero as of September 28, 2014.

 

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.

 

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 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 third quarter of 2014.

 

Depreciation and Amortization

Depreciation and amortization was $0.9 million for the third quarter of 2014 compared to $0.8 million for the third 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 third quarter of 2014 compared to $0.8 million for the third 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.

  

 
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Income Taxes

There was no income tax benefit for either the third 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 third 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.

 

Nine months ended September 28, 2014 compared to the nine months ended September 29, 2013

 

Net Revenues

Net revenues were $42.3 million for the nine months ended September 28, 2014 compared to $27.3 million for the nine months ended September 29, 2013. The increase in net revenues was due to additional net revenue of $22.7 million related to the operation of Rocky Gap which commenced gaming operations on May 22, 2013. Included in net revenues for the nine months ended September 29, 2013 were $7.8 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 $24.4 million for the nine months ended September 28, 2014 compared to $12.2 million for the nine months ended September 29, 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 $16.9 million for the nine months ended September 28, 2014 compared to $13.8 million for the nine months ended September 29, 2013. Included in these amounts were Lakes corporate selling, general and administrative expenses of $5.5 million and $5.3 million for the nine months ended 2014 and 2013, respectively, and Rocky Gap selling, general and administrative expenses of $11.4 million and $8.5 million for the nine months ended 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 nine months ended September 28, 2014, selling, general and administrative expenses consisted primarily of payroll and related expenses of $8.4 million (including share-based compensation), marketing and advertising expenses of $2.0 million, building and rent expenses of $2.0 million, professional fees of $1.7 million and business development expenses of $0.8 million. 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 expenses of $1.7 million and professional fees of $2.2 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.

 

Gain on Sale of Cost Method Investment

During the nine months ended September 28, 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. 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.

 

Charges Related to Arbitration Award

On September 9, 2014, Lakes received notice of Final Award in the matter of Jerry Argovitz v. Lakes Entertainment, Inc. and Lakes Shingle Springs, Inc. awarding Jerry Argovitz approximately $2.4 million. As a result, Lakes recognized an expense of approximately $2.5 million, which includes $0.1 million of legal fees, during the third quarter of 2014.

 

Impairments and Other Losses

During the nine months ended September 28, 2014, Lakes recognized impairments and other losses of $21.0 million related to its investment in Rock Ohio Ventures. Based on current information provided by Rock Ohio Ventures, Lakes has determined that there is now significant uncertainty surrounding the recovery of Lakes’ investment in Rock Ohio Ventures. The Ohio gaming properties have not performed as expected, which has led to forecasted potential working capital requirement issues that did not exist in prior quarters. As a result, Lakes determined that an other-than-temporary impairment had occurred and reduced the carrying value of the investment to its estimated fair value of zero as of September 28, 2014.

 

 
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During the nine months ended September 29, 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 for nine months ended September 29, 2013.

  

Preopening Expenses

Lakes expenses certain project preopening costs as incurred. There were no preopening expenses during the nine months ended September 28, 2014. During the nine months ended September 29, 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 $0.7 million for the nine months ended September 29, 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 nine months ended September 28, 2014.

 

Depreciation and Amortization

Depreciation and amortization was $2.6 million for the nine months ended September 28, 2014 compared to $1.5 million for the nine months ended September 29, 2013. The increase was due primarily to depreciation on Rocky Gap property and equipment.

 

Other Income (Expense), net

Other income (expense), net was $(0.6) million for the nine months ended September 28, 2014 compared to $3.9 million for the nine months ended September 29, 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 nine months ended September 28, 2014 or September 29, 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 nine months ended September 28, 2014 and September 29, 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, a portion of Lakes’ revenues have 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 September 28, 2014, we had $33.4 million in cash and cash equivalents and $47.3 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 nine months ended September 29, 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.

 

 
19

 

 

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 $12.1 million remains outstanding as of September 28, 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.

 

Gaming revenues and expenses are included in operations from May 22, 2013, the date that the gaming facility opened for public play.

 

We have invested $21.0 million in Rock Ohio Ventures which was determined to be impaired and was reduced to its estimated fair value of zero as of September 28, 2014. 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 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. On October 17, 2014, ONDISS paid the entire remaining amount due to Lakes at a discounted amount of approximately $1.4 million. Upon receipt of such payment, Lakes transferred its remaining ownership in DEC to ONDISS.

 

We had an interest-only $8.0 million revolving bank line of credit loan agreement (the “Loan Agreement”) that expired on October 28, 2014. As of September 28, 2014, no amounts were outstanding under the Loan Agreement.

 

On September 9, 2014, Jerry Argovitz was awarded approximately $2.4 million related to an arbitration action brought by Jerry Argovitz against Lakes. As a result, Lakes remitted the $2.4 million and recognized charges related to arbitration award in its consolidated statements of operations of approximately $2.5 million during the third quarter of 2014, which included the $2.4 million award and $0.1 million of legal fees.

 

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.

  

 
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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 gaming industry. It is not possible to determine the likelihood of possible changes in tax law or in the administration of such law. Such changes, if adopted, could have a material adverse effect on our future financial position, results of operations and cash flows.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors, except for the financing commitments previously discussed.

 

 
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Private Securities Litigation Reform Act

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information included in this Quarterly Report on Form 10-Q and other materials filed or to be filed by Lakes with the United States Securities and Exchange Commission (“SEC”) as well as information included in oral statements or other written statements made or to be made by Lakes contain statements that are forward-looking, such as plans for future expansion and other business development activities as well as other statements regarding capital spending, financing sources, the effects of regulation (including gaming and tax regulation) and competition.

 

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

 

These risks and uncertainties include, but are not limited to, the need for potential future financing to meet Lakes’ development needs and expansion goals; the highly competitive industry in which Lakes operates; possible changes in regulations; risks of entry into new businesses; reliance on Lakes’ management; and litigation costs. For more information, review Lakes’ filings with the Securities and Exchange Commission. For further information regarding the risks and uncertainties, see the “Risk Factors” section in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 29, 2013, previously filed with the SEC.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

At September 28, 2014, our investment portfolio included $47.3 million of commercial paper, corporate bonds and certificates of deposit classified as fixed income securities and cash and cash equivalents of $33.4 million. The fixed income securities, like all fixed income instruments, are subject to interest rate risks and will decline in value if market interest rates increase. However, while the value of the investment may fluctuate in any given period, we intend to hold our fixed income investments until maturity. Consequently, we would not expect to recognize an adverse impact on net income or cash flows during the holding period. We adjust the carrying value of our investments if impairment occurs that is other than temporary.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, (the “1934 Act”) as of the end of the period covered by this quarterly report. Based on their evaluation, our chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports it files or submits under the 1934 Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information required to be disclosed by the Company in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Company’s management, including its chief executive officer and chief financial officer as appropriate to allow timely decisions regarding required disclosure.

 

On May 14, 2013, the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued an updated version of its Internal Control - Integrated Framework (the “2013 Framework”). Originally issued in 1992 (the “1992 Framework”), the framework helps organizations design, implement and evaluate the effectiveness of internal control concepts and simplify their use and application. The 1992 Framework remains available during the transition period, which extends to December 15, 2014, after which time COSO will consider it as superseded by the 2013 Framework. As of September 28, 2014, the Company continues to utilize the 1992 Framework during the transition to the 2013 Framework.

 

Part II.

Other Information

 

ITEM 1.  LEGAL PROCEEDINGS

 

Jerry Argovitz Litigation

On March 12, 2014, Lakes received a demand for arbitration from Jerry Argovitz (“Argovitz”) relating to a Consent and Agreement to Buyout and Release by and between Argovitz and Lakes KAR Shingle Springs, LLC (“LKAR”), Lakes Entertainment, Inc., and Lakes Shingle Springs, Inc. dated January 30, 2003 (“Buyout Agreement”).  The Buyout Agreement provided that LKAR was to make certain payments to Argovitz for so long as LKAR was managing the Red Hawk Casino for the Shingle Springs Tribe.  Lakes made the payments required under the Buyout Agreement while it was managing the Red Hawk Casino, and discontinued the payments after its management contract to manage the Red Hawk Casino was terminated.  Argovitz asserted claims for breach of the Buyout Agreement and the implied covenant of good faith and fair dealing relating to the payments he alleged he was entitled to receive after the management agreement was terminated.  He sought damages of approximately $2.7 million, plus interest, costs, and attorney fees. 

 

 
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On September 9, 2014, Argovitz was awarded approximately $2.4 million related to the arbitration action brought by Argovitz against Lakes. As a result, Lakes recognized charges related to arbitration award in its consolidated statement of operations of approximately $2.5 million during the third quarter of 2014, which included the $2.4 million award and $0.1 million of legal fees. The action is now closed and no further claims can be made by Argovitz related to this matter.

 

Quest Media Group, LLC Litigation

On May 17, 2012, Lakes received service of a breach of contract lawsuit filed in the Franklin County Court of Common Pleas, Franklin County, Ohio by Quest Media Group, LLC (“Quest”) with respect to an agreement (the “Agreement”) entered into between Lakes Ohio Development, LLC (a wholly owned subsidiary of Lakes) (“Lakes Ohio Development”) and Quest on March 9, 2010.  The Agreement relates to Quest assisting Lakes Ohio Development in partnering with Rock Ohio Ventures, LLC and Penn Ventures, LLC (“Penn Ventures”) with respect to funding the proposed citizen-initiated referendum in November 2009 to amend the Ohio constitution to permit one casino each in Cleveland, Cincinnati, Toledo and Columbus, Ohio. The lawsuit alleged, among other things, that Lakes breached the Agreement by selling Lakes Ohio Development’s interest in the Toledo and Columbus, Ohio casino projects to Penn Ventures, failing to pay the proper fee to Quest as a result of such sale, and incorrectly calculating the costs that are to be offset against Quest’s fee.  The lawsuit sought unspecified compensatory damages in excess of $25,000, punitive damages, declaratory and injunctive relief.  The lawsuit named as defendants Lakes Entertainment, Inc., Lakes Ohio Development, LLC and Lyle Berman, Chairman and CEO of Lakes. Lakes removed the case to federal court, answered the pleadings and filed a motion to dismiss the claims against all defendants.  Prior to the judge’s ruling on the motion to dismiss, the parties settled all but one of Quest’s claims (including obtaining a dismissal of Lyle Berman from the lawsuit) at no out-of-pocket expense to Lakes.  The judge granted Lakes’ motion to dismiss and dismissed the remaining claims against Lakes. Quest subsequently appealed the dismissal to the Sixth Circuit Court of Appeals. Lakes continues to believe that the suit is without merit and will continue to vigorously defend the matter.

 

Miscellaneous Legal Matters

We are involved in various other inquiries, administrative proceedings, and litigation relating to various contracts and other matters arising in the normal course of business. While any proceeding or litigation has an element of uncertainty, management currently believes that the likelihood of an unfavorable outcome is remote, and is not likely to have a material adverse effect upon our unaudited consolidated financial statements.

 

ITEM 1A.  RISK FACTORS

 

There have been no material changes to our risk factors identified in the “Risk Factors” section in Item IA of our Annual Report on Form 10-K for the year ended December 29, 2013, previously filed with the SEC.

 

 

 

ITEM 6.  EXHIBITS

 

Exhibits

 

Description

     

31.1

 

Certification of CEO pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     

31.2

 

Certification of CFO pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     

32.1

 

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

     

101.INS

 

XBRL Instance Document

     

101.SCH

 

XBRL Taxonomy Extension Schema Document

     

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

     

101.DEF

 

XBRL Taxonomy Extension Calculation Definition Document

     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 
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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

    LAKES ENTERTAINMENT, INC.  

 

 

Registrant

 

 

 

 

 

    /s/ LYLE BERMAN    

 

 

Lyle Berman

 

 

 

Chairman of the Board and Chief Executive Officer

 

    (Principal Executive Officer)  

 

    /s/ TIMOTHY J. COPE  

 

 

Timothy J. Cope

 

 

 

 President and Chief Financial Officer

 

    (Principal Financial and Accounting Officer)  

 

 

Dated: November 12, 2014