GOLDEN ENTERTAINMENT, INC. - Quarter Report: 2006 April (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission File No. 0-24993

LAKES ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

(952) 449-9092

(Registrant’s telephone number, including area code)

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

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

Large Accelerated Filer o          Accelerated Filer þ          Non Accelerated Filer o

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

      As of May 4, 2006, there were 22,874,909 shares of Common Stock, $0.01 par value per share, outstanding.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

INDEX

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

April 2, 2006 and January 1, 2006

See notes to condensed consolidated financial statements

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings (Loss)

Three months ended April 2, 2006 and April 3, 2005

See notes to condensed consolidated financial statements

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Earnings (Loss)

Three months ended April 2, 2006 and April 3, 2005

See notes to condensed consolidated financial statements

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Shareholders’ Equity

Three months ended April 2, 2006

See notes to condensed consolidated financial statements

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

Three months ended April 2, 2006 and April 3, 2005

See notes to condensed consolidated financial statements

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

      The unaudited condensed consolidated financial statements of Lakes Entertainment, Inc., a Minnesota corporation (“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 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 January 1, 2006, previously filed with the SEC on March 8, 2006, 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 only 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.

      Certain minor reclassification to amounts previously reported have been made to conform to the current period presentation.

      Lakes’ cash balance, excluding WPT Enterprises, Inc. (“WPTE”) cash, was approximately $15.6 million as of April 2, 2006. During the remainder of fiscal 2006, Lakes’ corporate costs, excluding WPTE which is not expected to require additional capital from Lakes, will approximate $14 million, which includes approximately $3.0 million of interest related to the financing facility entered into on February 15, 2006 (see Note 4). Project development related costs are expected to approximate $45 million during the remainder of fiscal 2006 and include approximately $24 million related to the Pokagon Band of Potawatomi Indians (“Pokagon Band”) casino resort project as construction is estimated to begin in mid 2006. This $24 million includes a $1.0 million non-refundable payment made in April 2006 to the Pokagon Band scholarship fund upon approval of the management contract between Lakes and the Pokagon Band. Additionally, the Company may be required to pay taxes up to approximately $12 million plus interest and penalties in fiscal 2006 related to two tax matters.

      In December 2005, Lakes obtained a $20 million financing facility from the Lyle Berman Family Partnership (the “Partnership”) and received a $10 million draw on this facility on December 16, 2005. On February 15, 2006, Lakes closed on a $50 million financing facility with an affiliate of Prentice Capital Management, LP (see Note 4). An initial draw of $25 million was made under the facility, another $10 million is immediately available under the facility and the remaining $15 million can be drawn in $5 million increments subject to the satisfaction of certain conditions. All amounts drawn against the facility are repayable within three years. Approximately $10.2 million of the initial draw was used to repay in full the loan from the Partnership.

      Lakes will require additional capital through either public or private financings to meet operating expenses and project development-related costs during fiscal 2006, and accordingly, the Company is currently considering various financing alternatives. The Company believes the assets of Lakes, specifically long-term assets related to Indian casino projects, and common shares of WPTE that have an estimated fair value of over $79.7 million as of May 2, 2006, provide sufficient collateral to obtain the necessary financing. The estimated value of the Company’s shares of WPTE is based on the public trading price, which may not be indicative of what Lakes could realize in a sale of its shares. The Company believes the shares of WPTE could be the source or part of the collateral for additional financing.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      During the quarter ended April 2, 2006, WPTE sold 630,000 common shares of its then 11.7% interest in PokerTek, Inc. (“PokerTek”) at $9.03 per share and received net cash proceeds of approximately $5.7 million. As a result, WPTE realized a gain of approximately $5.7 million and currently owns 450,000 shares, or a 4.75% ownership interest in PokerTek, included in long-term investments in the accompanying balance sheet.

      WPTE accounts for its investment in PokerTek at fair market value and classified it as “available for sale” in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. As of April 2, 2006, the fair market value of the remaining investment was $5.4 million.

      On February 15, 2006, Lakes closed on a $50 million financing facility with PLKS Holdings, LLC, an affiliate of Prentice Capital Management, LP (“PLKS”). An initial draw of $25 million was made under the facility, another $10 million is immediately available under the facility and the remaining $15 million can be drawn in $5 million increments subject to certain conditions. Any funds drawn on the facility bear interest at the rate of 12% per annum, payable in arrears monthly, subject to adjustment based on the value of the collateral described in the following paragraph, and are due and payable in full on the third anniversary of the closing date. Lakes may prepay the facility in whole or in part without penalty at any time. Lakes received net proceeds of approximately $12.1 million after repaying the Partnership facility with accrued interest and after costs and fees associated with the PLKS financing facility. Approximately $10.2 million of the initial draw was used to repay in full Lakes’ December 16, 2005 loan from the Partnership. Pursuant to the terms of the financing agreement, Lakes paid a closing fee of $1.5 million. Lakes is also subject to a loan servicing fee of $5,000 per month; audit and field examination fees at the rate of $1,500 per day; and upon the occurrence of certain events, a collateral maintenance fee equal to 2.00% of the aggregate principal amount of the loan outstanding under the financing facility on the date of the first such event and an additional 2% of the aggregate principal amount of the loan outstanding on such date on the date of each such additional event.

      The $50 million financing facility is secured by most of the assets of Lakes and certain of its subsidiaries (other than WPTE), including all of Lakes’ shares of WPTE. Lakes is permitted to sell up to 3 million of the approximate 12.5 million WPTE shares it owns without application to reduction of the amounts owing under the financing facility, subject to certain conditions.

      As consideration for the financing, Lakes issued to PLKS an aggregate of 4.46 million common stock purchase warrants at an exercise price of $7.50 per share that expire in February 2013. The warrants are subject to customary anti-dilution protections. As of April 2, 2006, 1.25 million of the warrants are immediately exercisable and an additional 1.25 million are exercisable as additional draws under the facility are made. The remaining 1.96 million warrants are exercisable only upon the occurrence of certain specified events relating to declines in the value of the collateral in relation to the principal amount outstanding. The lender has demand registration rights with respect to the Lakes common stock underlying the warrants and, upon certain events, the WPTE shares pledged by Lakes to the lender. In certain circumstances, cash penalties are payable if Lakes does not meet the registration deadlines applicable to the pledged WPTE shares and the holders of the warrants can require Lakes to redeem the warrants if Lakes fails to satisfy its registration obligations with respect to the Lakes common stock underlying the warrants. Lakes has agreed to pay substantially all of the costs incurred in the preparation and filing of these registration statements. The 1.25 million warrants to purchase common stock were valued at $4.7 million using a Black-Scholes pricing model and are being amortized as interest expense over the three-year life of the financing facility. The unamortized portion of the warrants are reported as an in-substance debt discount.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      As part of the PLKS transaction, the Lakes Board of Directors authorized the creation of a new class of Series A Convertible Preferred Stock, par value $0.01 per share. Lakes sold 4,457,751 shares of the preferred stock to PLKS for $44,578. These preferred shares have no dividend rights, have voting rights only if there is a default under the financing agreement, and become convertible into common stock of Lakes (on a fixed one-to-one basis) only if and when the warrants are cancelled in accordance with the terms of the warrants.

      Effective March 30, 2006, Lakes entered into a development financing and services agreement with the Jamul Indian Village (“Jamul Tribe”). As part of the agreement, Lakes will use its best efforts to obtain financing from which advances of up to $350 million will be made to the Jamul Tribe to pay for the design and construction of the project. However, there can be no assurance that third party financing will be available, and if Lakes is unable to obtain the appropriate amount of financing for this project, the project may not be completed as planned. This agreement will help assist the Jamul Tribe in developing a casino with related amenities/services (“Jamul Casino”) on its existing six acre reservation which the Jamul Tribe will manage.

      Under the new agreement, Lakes will receive a flat fee of $15 million for its development design services, and a flat fee of $15 million for its construction oversight services, payable evenly over the first five years after the opening date of the Jamul Casino. In connection with Lakes’ financing of the Jamul Casino, the Jamul Tribe will pay interest over a ten year period on sums advanced by Lakes equal to the rate charged to Lakes for obtaining the funds necessary plus 5%. Amounts previously advanced by Lakes to the Jamul Tribe in connection with the Jamul Tribe’s proposed casino resort are included in the development financing and services agreement financing amount.

      As of March 17, 2006, Lakes entered into a Settlement Agreement with Deephaven Capital Management LLC (“Deephaven”) pursuant to which Deephaven paid Lakes approximately $2.8 million as repayment of short-swing profits under Section 16(b) of the Securities Exchange Act of 1934, as amended, relating to or in connection with one or more funds managed by Deephaven trading in shares of Lakes’ common stock prior to February 14, 2006. The payment has been recorded as an increase in additional paid in capital.

      Lakes entered into a Letter of Settlement (“Settlement Agreement”) with the Kickapoo Traditional Tribe of Texas (“Kickapoo Tribe”) pursuant to which Lakes and the Kickapoo Tribe resolved all outstanding issues relating to the parties’ business relationship that was terminated in November 2005. During fiscal 2005, Lakes recorded a loss of approximately $6.3 million as a result of the terminated business relationship. Pursuant to the Settlement Agreement, during April 2006, Lakes received a cash payment of approximately $2.6 million as reimbursement for payments made directly by Lakes to vendors on behalf of the Kickapoo Tribe and the Kickapoo Tribe agreed to pay $0.6 million into an escrow to be released to Lakes at such time as Lakes transfers title to certain land owned by Lakes to the Kickapoo Tribe. The Company and the Kickapoo Tribe have agreed that title will transfer only after the Kickapoo Tribe assumes, settles or pays certain accounts payable to vendors related to the Kickapoo Tribe’s casino that remain on Lakes’ books, and once Lakes receives full releases for any liability thereto. As a result of the $2.6 million payment, Lakes revalued the note receivable from the Kickapoo Tribe at $2.6 million as of April 2, 2006, and a gain of that amount was recognized in the first quarter of 2006. The land transfer and related release of liabilities will be recognized in the period they occur. When the releases are received from the vendors the Company will recognize a gain. The Company does not have an estimate of when or if this will occur.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      In March 2006, Lakes received notification from the National Indian Gaming Commission (“NIGC”) that it has approved Lakes’ management agreement with the Pokagon Band to develop and manage the Four Winds Casino Resort on the Pokagon Band’s land in New Buffalo Township, Michigan (“Pokagon Casino”). Lakes is in the process of assisting the Pokagon Band with securing financing to begin construction of the casino.

      Lakes has a Stock Option and Compensation Plan and a Director Stock Option Plan, which were carried forward from Lakes’ predecessor Grand Casinos, Inc. (“Grand Casinos”). All options granted under these plans were carried forward with the original terms and vesting and expiration dates.

      Additionally, Lakes has a 1998 Stock Option and Compensation Plan and a 1998 Director Stock Option Plan (the “1998 Plans”), which upon resolution of the Compensation Committee, are approved to grant up to an aggregate of 5.0 million shares and 0.5 million shares, respectively, of incentive and non-qualified stock options to officers, directors, and employees. Stock options granted under the 1998 Plans vest in equal installments over four-year and five-year periods, beginning on the first anniversary of the date of each grant and continue on each subsequent anniversary date until the option is fully vested. The employee must be employed by Lakes on the anniversary date in order to vest in any shares that year. Vested options are exercisable for ten years from the date of grant; however, if the employee is terminated (voluntarily or involuntarily), any unvested options as of the date of termination will be forfeited.

      WPTE has adopted the board-approved, 2004 Stock Incentive Plan (the “2004 Plan”) that is authorized to grant stock awards to purchase up to 3,120,000 shares of common stock, including the options to purchase up to 1,120,000 shares of common stock issued to employees and consultants that were previously outstanding under a previous stock incentive plan at the time of conversion to a publicly-traded company. Under the 2004 Plan, the options vest in equal installments over three-year and five-year periods, beginning on the first anniversary of the date of each grant and will continue on each subsequent anniversary date until the option is fully vested. The employee must be employed with WPTE on the anniversary date in order to vest in any shares that year. Vested options are exercisable for ten years from the date of grant; however, if the employee is terminated (voluntarily or involuntarily), any unvested options as of the date of termination will be forfeited.

      Lakes and WPTE issue new shares of common stock upon exercise of options.

      On January 2, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and employee stock purchases based on estimated fair values. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied certain provisions of SAB 107 in its adoption of SFAS 123(R).

      SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statement of earnings (loss). SFAS 123(R) supersedes the Company’s previous accounting under the provisions of

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). As permitted by SFAS 123, the Company measured compensation cost for options granted prior to January 2, 2006, in accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and related interpretations. Accordingly, no accounting recognition is given to stock options granted at fair market value until they are exercised. Upon exercise, net proceeds, including tax benefits realized, are credited to equity.

      The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 2, 2006, the first day of the Company’s fiscal year 2006. In accordance with the modified prospective transition method, the Company’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). The effect of the change was to decrease net earnings for the three months ended April 2, 2006 by $2.2 million and basic and diluted earnings per share by $0.10 and $0.09, respectively, as compared to what results for the period would have been had the intrinsic method been used. There was no share-based compensation expense related to employee stock options and employee stock purchases recognized in the financial statements during the three months ended April 3, 2005. The following table summarizes the consolidated share-based compensation expense related to employee stock options and stock purchases and non-vested shares under SFAS 123(R) for the three months ended April 2, 2006, which was allocated as follows:

      For the three months ended April 2, 2006, no income tax benefit was recognized in the statement of earnings (loss) for share-based compensation arrangements. Management assessed the likelihood that deferred tax assets relating to future tax deductions from share-based compensation will be recovered from future taxable income and determined that a valuation allowance was required due to uncertainty of realization.

      The Company uses a Black-Scholes option-pricing model to value 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. As the Company does not pay dividends, the dividend rate variable in the Black-Scholes model is zero. The following values for the indicated variables were used to value options granted during the three months ended April 2, 2006, and we expect the assumptions used for grants in future quarters of fiscal 2006 to approximate these values.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      The volatility assumption is based on the historical weekly price data of Lakes’ stock over a two-year period. Management evaluated whether there were factors during that period which were unusual and which would distort the volatility figure if used to estimate future volatility and concluded that there were no such factors.

      The risk-free interest rate assumption is based upon the interpolation of various U.S. Treasury rates determined at the date of option grant.

      The expected term of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding. It is based upon an analysis of the historical behavior of option holders during the period from September 1995 to April 2, 2006. Management believes historical data is representative of future exercise behavior.

      As share-based compensation expense recognized in the consolidated statement of operations pursuant to SFAS 123(R) is based on awards ultimately expected to vest, expense for grants beginning upon adoption of SFAS 123(R) on January 2, 2006 will be reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company has reviewed the historical forfeitures which are minimal and as such will amortize the grants to the end of the vesting period and will adjust for forfeitures at the end of the term. Forfeitures are estimated based partially on historical experience.

      WPTE uses a Black-Scholes option-pricing model to estimate the fair value and compensation cost associated with employee incentive stock options in accordance with SFAS 123(R). The bases for the key assumptions included in the model are as follows:

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      The status of Lakes’ stock option plans during the three months ended April 2, 2006 and April 3, 2005 is as follows:

      The following table summarizes significant ranges of Lakes outstanding and exercisable options as of April 2, 2006:

      The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on Lakes’ closing stock price of $10.88 on March 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of options exercised during the three months ended April 2, 2006 was $2.0 million. As of April 2, 2006, Lakes’ unrecognized share-based compensation related to stock options was approximately $5.3 million. This cost is expected to be expensed over a weighted average period of 2.2 years.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      The following table summarizes WPTE stock option activity through the three months ended April 2, 2006 and April 3, 2005:

      The following table summarizes significant ranges of WPTE outstanding and exercisable options as of April 2, 2006:

      The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on WPTE’s closing stock price of $7.36 on March 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. As of April 2, 2006, the total number of “in-the-money” options exercisable was 330,000. The total intrinsic value of options exercised during the three months ended April 2, 2006 was $0.8 million.

      As of April 2, 2006, total compensation cost related to non-vested share-based options not yet recognized was $6.1 million, which is expected to be recognized over the next 33 months on a weighted-average basis. The total fair value of the shares vested during the three months ended April 2, 2006 was $21,150.

      In 2002, WPTE granted 2,400,000 shares to its President under a management agreement. The shares have been vesting in four equal installments annually beginning February 25, 2003, and were fully vested on February 25, 2006. In connection with this grant, WPTE recorded deferred compensation of $19,200. For the three months ended April 2, 2006 and April 3, 2005, WPTE recognized compensation expense of $736 and $1,200, respectively, for shares earned based upon services provided under the management agreement.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      The following table illustrates the consolidated pro forma effect on net loss and net loss per share if the Company had retroactively applied the fair value recognition provisions of SFAS 123.

      For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options’ vesting period. The weighted-average fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for the period ended April 3, 2005:

      For all periods, basic earnings (loss) per share is calculated by dividing earnings (loss) by the weighted-average number of common shares outstanding. Diluted earnings per share for the three months ended April 2, 2006, 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. The effects of stock options and warrants have not been included in diluted loss per share for the three months ended April 3, 2005 as the effect would have been anti-dilutive as a result of losses.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      Management evaluated its probable ability to utilize deferred tax assets arising from net operating loss carry forwards, deferred tax assets and other ordinary items and determined that a valuation allowance was appropriate at April 2, 2006 and January 1, 2006. Management evaluated all evidence and determined net losses generated over the past three years outweighed the current positive evidence that the Company believes exists surrounding its ability to generate significant income from its long-term assets in Indian casino projects. Therefore the Company recorded a 100% valuation allowance against these items at April 2, 2006 and January 1, 2006. However, the Company has recognized a deferred tax asset related to capital losses during 2001 to 2005. The realization of these benefits is dependant on the generation of capital gains. The Company believes it will have sufficient capital gains in the foreseeable future to utilize these benefits due to significant appreciation in its investment in WPTE, which has a minimal cost basis. The Company owns approximately 12.5 million shares of WPTE common stock valued at approximately $79.7 million as of May 2, 2006, based upon the closing stock price as reported by the Nasdaq National Market on May 2, 2006 of $6.39.

      The Company is currently under examination for income and franchise tax matters. See Note 12 regarding the IRS Tax Audit and the Louisiana Department of Revenue Litigation Tax Matter.

      The Company leases an airplane, under a non-cancelable operating lease. The airplane lease was amended on May 1, 2005, which allows for a base term of one year and two one-year renewal terms. Under the lease agreement, the Company has the option of renewing the lease, purchasing the airplane at amounts which range from approximately $5.2 million to $5.8 million or facilitating the sale of the aircraft at the end of each term included in the up to three-year lease term; however at the conclusion of the lease, the Company is required to either purchase the airplane or facilitate the sale of the airplane. The Company’s airplane lease contains a residual value guarantee of $5.2 million at the end of the three-year lease term.

      The Company is under audit by the Internal Revenue Service (“IRS”) for the fiscal years ended 2001 and 2000. The IRS is challenging the treatment of income categorized as a capital gain. If the Company is unsuccessful in sustaining its position the Company may be required to pay up to approximately $3.2 million plus accrued interest and penalties related to tax on ordinary income. The Company originally carried back capital losses to offset the capital gain. If the Company were to be unsuccessful in sustaining its capital gain position it could use the capital losses in the future to offset future capital gains, if any, prior to their expiration. Management believes that the final outcome of this matter is not likely to have a material adverse effect upon the Company’s future consolidated financial position or results of operations. However, it may have a significant effect on cash flows in the period of settlement.

      In connection with the establishment of Lakes as a public corporation on December 31, 1998, via a distribution of its common stock to the shareholders of Grand Casinos, the Company and Grand Casinos entered into an agreement governing the sharing or allocation of tax benefits accruing to Grand Casinos and certain affiliated companies of Grand Casinos. Lakes asserted claims against Grand Casinos for amounts to which Lakes believed it was entitled under the tax sharing agreement. On December 1, 2004, Lakes entered into a settlement agreement with Grand Casinos and its parent company, Park Place Entertainment Corporation (now known as “Harrah’s Entertainment, Inc.” or “Harrah’s”), pursuant to which Lakes

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

received $11.3 million in December 2004 in satisfaction of its prior claim and its future rights to the tax benefits that were the subject of the dispute. Lakes will be required to provide reimbursement for its share of the disallowed benefits. This settlement income was recorded as other income in the consolidated statement of earnings (loss) in fiscal 2005. Lakes has not recorded any tax related to the settlement payment of $11.3 million, as Lakes believes this settlement is not taxable to Lakes.

      The Company’s management contracts with its tribal partners require the Company to provide financial support related to project development, in the form of loans.

Tribal Casino Development Advances/ Commitments

As of April 2, 2006

      In March 2006, the Jamul Tribe and Lakes entered into a development financing and services agreement (see Note 5).

      For the Pokagon Casino project, the Company has agreed to provide additional financing from its own funds if financing to the Pokagon Band at an interest rate not to exceed 13% is not available from third parties. If this occurs and Lakes is required to provide all financing, this would be an additional commitment of up to approximately $54 million. Based on discussions with prospective lenders the Company presently believes that third-party financing will be available for this project. However, there can be no assurance that third-party financing will be available at the time the project begins construction. Lakes is not required to fund these amounts; however, if Lakes discontinued the funding prior to fulfilling the obligation, Lakes will forfeit the rights under the management contract. Note that included in the $25.7 million remaining commitment is $1.8 million related to non-gaming land advances which Lakes does not expect to make.

      The Company will be obligated to pay an amount to an unrelated third party once the Pokagon Casino is open and Lakes is the manager of the casino. The amount is payable quarterly for five years and is only payable if Lakes is the manager of the casino. The payment is part of a settlement and release agreement associated with Lakes obtaining the management contract with the Pokagon Band. The maximum liability over the five-year period is approximately $11 million. The Company will also be obligated to pay approximately $3.3 million to a third party on behalf of the Pokagon Band; in accordance with the management contract which is payable once the casino opens over 24 months.

      Lakes may be required to provide a guarantee of tribal debt financing or otherwise provide support for the tribal obligations related to any of the projects. Any guarantees by Lakes or similar off-balance sheet liabilities will increase Lakes’ potential exposure in the event of a default by any of these tribes.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

Legal proceedings

      In 1994, William H. Poulos filed a class-action lawsuit in the United States District Court for the Middle District of Florida against various parties, including Lakes’ predecessor, Grand Casinos, and numerous other parties alleged to be casino operators or slot machine manufacturers. This lawsuit was followed by several additional lawsuits of the same nature against the same, as well as additional defendants, all of which were subsequently consolidated into a single class-action pending in the United States District Court for the District of Nevada. Following a court order dismissing all pending pleadings and allowing the plaintiffs to re-file a single complaint, a complaint has been filed containing substantially identical claims, alleging that the defendants fraudulently marketed and operated casino video poker machines and electronic slot machines, and asserting common law fraud and deceit, unjust enrichment and negligent misrepresentation and claims under the federal Racketeering-Influenced and Corrupt Organizations Act. Various motions were filed by the defendants seeking to have this new complaint dismissed or otherwise limited. In December 1997, the District Court, in general, ruled on all motions in favor of the plaintiffs. The plaintiffs then filed a motion seeking class certification and the defendants opposed it. In June 2002, the District Court entered an order denying class certification. On August 10, 2004, the Ninth Circuit Court of Appeals affirmed the District Court’s denial of class certification. On September 14, 2005, the United States District Court for the District of Nevada granted the defendants’ motions for summary judgment, and judgment was entered against the plaintiffs on that same day. The plaintiffs have appealed the judgment dismissing their claims to the Ninth Circuit Court of Appeals. The briefing of the appeal is scheduled to be completed by early June 2006.

      The Company has not recorded any liability for this matter, as currently an estimate of any possible loss cannot be made. Management currently believes the final outcome of this matter is not likely to have a material adverse effect upon the Company’s consolidated financial statements.

      On January 3, 2003, El Dorado County filed an action in the Superior Court of the State of California, seeking to prevent the construction of a highway interchange that was approved by a California state agency. The action, which was consolidated with a similar action brought by Voices for Rural Living and others, does not seek relief directly against Lakes. However, the interchange is necessary to permit the construction of a casino to be developed and managed by Lakes through a joint venture. The casino will be owned by the Shingle Springs Tribe. The matter was tried to the court on August 22, 2003. On January 2, 2004, Judge Lloyd G. Connelly, Judge of the Superior Court of the State of California, issued his ruling on the matter denying the petition in all respects except one. As to the one exception, the court sought clarification as to whether the transportation conformity determination used to determine the significance of the air quality impact of the interchange operations considered the impact on attainment of the state ambient air quality standard for ozone. The California Department of Transportation (CalTrans) prepared and filed the clarification addendum sought by the court. Prior to the court’s determination of the adequacy of the clarification, El Dorado County and Voices for Rural Living appealed Judge Connelly’s ruling to the California Court of Appeals on all of the remaining issues.

      A ruling with respect to the addendum was issued June 21, 2004 by the Superior Court of the State of California, County of Sacramento. The ruling indicated that the addendum provided to the court by CalTrans did not provide a quantitative showing to satisfy the court’s earlier request for a clarification on meeting the state ambient ozone standard. The court recognized that the information provided by CalTrans does qualitatively show that the project may comply with the state standard, but concluded that a quantitative analysis is necessary even though the court recognized that the methodology for that analysis “is not readily apparent”. In addition, the ruling specifically stated, “Moreover, such methodology appears necessary for the CEQA analysis of transportation projects throughout the state, including transportation projects for which

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

respondents (i.e., CalTrans) have approval authority.” CalTrans, the Shingle Springs Tribe and Lakes responded to the court with a revised submission in August 2004. Representatives of the California Air Resources Board and the Sacramento Area Council of Governments filed declarations supporting the revised submission to the court. Opposition to that revised submission was filed, a hearing on the revised submission took place on August 20, 2004 and the court again found the revised submission of CalTrans, the Shingle Springs Tribe and Lakes to be inadequate. That ruling was separately appealed to the California Court of Appeals (the “Court”) and an oral argument for these appeals and the appeals of El Dorado County and Voices of Rural Living was held before the Court on August 29, 2005.

      The Court issued its decision on the appeals on November 8, 2005. The Court ruled in favor of CalTrans’ appeal, rejecting the El Dorado County’s argument that the transportation conformity analysis did not conform to state standards. The Court also rejected all but two of the legal claims asserted in the appeal by El Dorado County and Voices for Rural Living against the environmental impact report (“EIR”) prepared by CalTrans for the interchange that will connect Highway 50 to the Shingle Springs Rancheria. For the remaining two issues, the Court held that CalTrans must supplement its environmental analysis by adding some discussion to the air quality chapter to further explain the project’s contribution to overall vehicular emissions in the region, and that CalTrans also must evaluate whether a smaller casino and hotel would reduce environmental impacts. The Court acknowledged CalTrans lacks jurisdiction to require the Shingle Springs Tribe to develop a smaller casino, but nevertheless required some discussion of this alternative in the interchange EIR. On December 19, 2005, CalTrans filed a Petition for Review with the Supreme Court of the State of California, and on February 8, 2006 the Supreme Court denied the Petition for Review and ordered the Court of Appeals decision to be depublished. CalTrans is now preparing to comply with the Court of Appeals order.

      The Company has not recorded any liability for this matter as management currently believes that the Court’s rulings will ultimately allow the project to commence. However, there can be no assurance that the final outcome of this matter is not likely to have a material adverse effect upon the Company’s consolidated financial statements.

      The Louisiana Department of Revenue maintains a position that Lakes owes additional Louisiana corporation income tax for the period ended January 3, 1999 and the tax years ended 1999 through 2001 and additional Louisiana corporation franchise tax for the tax years ended 2000 through 2002. This determination is the result of an audit of Louisiana tax returns filed by Lakes for the tax periods at issue and relates to the reporting of income earned by Lakes in connection with the managing of two Louisiana-based casinos. On December 20, 2004, the Secretary of the Department of Revenue of the State of Louisiana filed a petition to collect taxes in the amount of $8.6 million, excluding interest, against Lakes in the 19th Judicial District Court, East Baton Rouge Parish, Louisiana (Docket No. 527596, Section 23). In the petition to collect taxes the Department of Revenue of the state of Louisiana asserts that additional corporation income tax and corporation franchise tax are due by Lakes for the taxable periods set forth above. Lakes maintains that it has remitted the proper Louisiana corporation income tax and Louisiana corporation franchise tax for the taxable periods at issue. On February 14, 2005, Lakes filed an answer to the petition to collect taxes asserting all proper defenses and maintaining that no additional taxes are owed and that the petition to collect taxes should be dismissed. Management intends to vigorously contest this action by the Louisiana Department of Revenue. Lakes may be required to pay up to the $8.6 million assessment plus interest if Lakes is not successful in this matter. The Company has recorded a provision for its estimated settlement related to this examination including accrued interest, which is included as part of income taxes payable on the Company’s consolidated balance sheets.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

      On September 19, 2005, WPTE filed suit in the California Superior Court seeking to keep the Travel Channel, LLC (“TRV”) from interfering with WPTE’s prospective contractual relationship with third party networks in connection with the sale of the broadcast rights to the Professional Poker Tour (“PPT”), and to clarify and enforce WPTE’s rights with respect to the World Poker Tour television episodes. Under WPTE’s existing agreement with TRV for the World Poker Tour program (the “WPT Agreements”), TRV is afforded the right to negotiate exclusively with WPTE with respect to certain types of programming developed by WPTE during a 60 day period. Pursuant to the WPT Agreements, WPTE submitted the PPT to TRV and began negotiations but failed to reach an agreement with TRV within the allotted negotiation window. Consequently, WPTE began discussions with other networks. While WPTE later revived its attempts to reach a deal with TRV after TRV’s exclusive bargaining window had ended, WPTE ultimately received an offer from ESPN. WPTE submitted this offer to TRV pursuant to TRV’s contractual last right to match the deal as specified under the WPT Agreements. Thereafter, TRV sent letters to WPTE and ESPN asserting, among other things, that WPTE was not entitled to complete a deal for the PPT with a third party. Following TRV’s letters, WPTE filed suit on September 19, 2005, alleging that TRV breached the WPT Agreements and interfered with WPTE’s prospective contractual relationship with ESPN, and seeking a judicial declaration of WPTE’s rights under the WPT Agreements to produce non-World Poker Tour branded programs covering poker tournaments. Subsequent to WPTE filing, ESPN withdrew its offer to WPTE to acquire the broadcast rights to the PPT. On September 22, 2005, TRV and Discovery Communications, Inc. filed an answer and cross-complaint and subsequently filed a motion for judgment on the pleadings and an “anti-SLAPP” motion, both of which were denied on November 10, 2005. On January 25, 2006, the parties settled the lawsuit and TRV entered into an agreement with WPTE to air Season One of the PPT television series (see Note 14).

      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, management currently believes that the final outcome of these matters, including the matters discussed above, are not likely to have a material adverse effect upon the Company’s consolidated financial statements.

      Lakes’ principal business is the development and management of gaming-related properties. Additionally, the Company is the majority owner of WPTE. Substantially all of Lakes’ and WPTE’s operations are conducted in the United States. Episodes of the World Poker Tour television series are distributed internationally by a third party distributor. 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

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements — (Continued)

performance. The amounts in Corporate and Eliminations below have not been allocated to the other segments because these costs are not easily allocable and to do so would not be practical.

      In April 2006, Lakes received notification from the NIGC that it has approved Lakes management agreement with the Iowa Tribe to refurbish and manage the Cimarron Casino project on the Iowa Tribe’s land in Perkins, Oklahoma.

      On May 1, 2006, the Travel Channel (TRV) notified WPTE that it had chosen to not exercise its option for Season II and subsequent seasons of the Professional Poker Tour (“PPT”). The PPT’s first season, which includes 24 two-hour episodes, has already been filmed and is scheduled to air on TRV beginning in July 2006. WPTE will immediately begin discussions to find a new broadcast partner for the PPT going forward.

      On May 8, 2006, WPTE executed an Amendment to Lease agreement with RREEF America REIT II Corp. BBB (as successor in interest to Wilshire Courtyard L.L.C.) (“RREEF”), pursuant to which WPTE agreed to lease an additional 9,896 square feet of office space in WPTE’s current office facilities, pursuant to the same terms as WPTE’s current lease with RREEF, including the lease expiration date in June 2011. WPTE is obligated to pay $28,698 per month for the additional space, subject to annual upward adjustments so that in the final year of the lease, WPTE will be obligated to pay $32,932 per month. In addition, WPTE is obligated to increase the size of its letter of credit, as required by its current office space lease to cover certain of its obligations under the lease, to a total amount of $445,422, which is adjusted downward each year during the lease term until, by the last year of the lease term, the letter of credit will be in the amount of $50,069. Lease payments on the new space will begin in July 2006.

Overview

      Lakes develops/finances Indian-owned casino properties and intends to manage such casinos when applicable regulatory approvals have been received and we have satisfied other contingencies. Lakes currently has development (which includes certain financing requirements) and management agreements with three separate tribes for one new casino development project in Michigan, two in California, and with two separate tribes in Oklahoma for five various casino projects. Lakes is also involved in other business activities including development of a non-Indian casino in Mississippi and the development of new table games for licensing to both Tribal and non-Tribal casinos. In addition, as of April 2, 2006, Lakes owned approximately 62% of WPT Enterprises, Inc (“WPTE”), a separate publicly held media and entertainment company principally engaged in the development, production and marketing of gaming themed televised programming, the licensing and sale of branded products and the sale of corporate sponsorships. Lakes’ consolidated financial statements include the results of operations of WPTE, and in recent periods, the majority of Lakes’ revenues have been derived from WPTE’s business.

      WPTE creates branded entertainment and consumer products driven by the development, production and marketing of televised programming based on gaming themes. WPTE’s World Poker Tour^®, or WPT, television series, based on a series of high-stakes poker tournaments, airs in the U.S. on the Travel Channel and in more than 150 territories globally. WPTE has four operating units:

      WPT Studios, WPTE’s multi-media entertainment division, generates revenue through the domestic and international licensing of broadcast and telecast rights and through casino host fees. Since WPTE’s inception, the WPT Studios division has been responsible for approximately 75% of total revenue. WPTE licenses the WPT series to The Travel Channel, L.L.C. (TRV or Travel Channel) for telecast in the U.S. under an exclusive license agreement. WPTE also has license agreements for the distribution of WPTE’s World Poker Tour episodes in over 150 territories, for which WPTE receives license fees, net of WPTE’s agent’s sales fee and agreed upon sales and marketing expenses. In addition, WPTE recently signed a license agreement with TRV to telecast WPTE’s new Professional Poker Tour^tm, or PPT^tm, series, which is expected to begin airing in the third quarter of 2006. WPTE also collects annual host fees from the member casinos that host World Poker Tour events (WPTE’s member casinos).

      WPTE has entered into a series of agreements with TRV for the U.S. distribution of the World Poker Tour^® (WPT) television series (the “WPT Agreements”). Since WPTE’s inception, fees from TRV under the WPT Agreements have been responsible for approximately 59% of WPTE’s total revenue. For each season covered by the WPT Agreements and related options, TRV has exclusive rights to exhibit the episodes in that season an unlimited number of times on its television network (or any other television network owned by Discovery Communications) in the U.S. for four years (three years for the episodes in Season One). WPTE has produced three complete seasons of the World Poker Tour series under the WPT Agreements, and Season Four is currently in production. On March 16, 2006, TRV exercised their option to order a 5th season of the WPT and has options to license the following two seasons (Seasons Six and Seven).

      Under the WPT Agreements, TRV pays fixed license fees for each episode WPTE produces, which are payable at various times during the pre-production, production and post-production process and are recognized upon TRV’s receipt and acceptance of the completed episode. Television production costs related to WPT episodes are generally capitalized and charged to cost of revenues as revenues are recognized. Therefore, the timing and number of episodes involved in the various seasons of the series affect the timing of the revenues and expenses of the WPT Studios business. The following table describes the timing of Seasons One through Five of the World Poker Tour series, including the delivery and exhibition of the episodes each season:

      In January 2006, WPTE also entered into an agreement with TRV for the U.S. distribution of the PPT television series. Similar to the WPT Agreements and related options, TRV has exclusive rights to exhibit the PPT episodes in that season an unlimited number of times on its television network (or any other television network owned by the Discovery Channel) in the U.S. for four years. WPTE is currently in production on Season One of the PPT. Under WPTE’s agreement with TRV regarding PPT, TRV had options to license the following three seasons (Seasons Two through Four); however, TRV has advised WPTE that it does not intend to exercise the options with respect to Season Two and succeeding seasons. In accordance with WPTE’s accounting policy of not capitalizing production costs until a firm commitment for distribution is in place, WPTE expensed approximately $4.3 million of production expenses related to the Professional Poker Tour during fiscal 2005. Now that the agreement to telecast the PPT series has been completed, in the first quarter of 2006, WPTE began capitalizing additional expenses associated with the production of the PPT series that are to be expensed as episodes are delivered to the Travel Channel. During the first quarter of 2006, WPTE capitalized $0.4 million in PPT-related expenses and delivered one episode of the PPT series, resulting in cost of revenues of $67,000.

      Further, under the WPT and PPT Agreements, TRV has the right to receive a percentage of WPTE’s adjusted gross revenues from international television licenses, product licensing and publishing, merchandising and certain other sources, after specified minimum amounts are met. For the three months ended April 2, 2006, WPTE recognized $0.2 million of Travel Channel participation expense that was recorded in cost of revenues.

      WPT Consumer Products, WPTE’s branded consumer products division, generates revenues principally through royalties from the licensing of WPTE’s brand to companies seeking to use the World Poker Tour brand and logo in the retail sales of their consumer products. In addition, this business unit generates revenue from direct sales of company-produced branded merchandise. WPTE has generated significant revenues from existing licensees, including US Playing Card, Hands-On Mobile, and MDI. WPTE also has a number of licensees that are developing new licensed products including electronic casino-based poker related gaming machines from IGT, and interactive television games from Pixel Play.

      WPT Corporate Alliances, WPTE sponsorship and event management division, generates revenue through corporate sponsorship and management of live events. WPTE’s sponsorship program uses the professional sports model as a method to foster entitlement sponsorship opportunities and naming rights to major corporations. Anheuser-Busch has been the largest source of revenues through its sponsorship of Seasons Two and Three of the World Poker Tour series on TRV. During the third quarter of 2005, Anheuser-Busch announced that its sponsorship in Season Four will now feature its largest brand, Budweiser, as the official beer of the World Poker Tour on the Travel Channel.

      WPT Online Gaming, WPTE’s online poker and casino gaming division, generates revenue through WPTE’s agreement with WagerWorks, Inc. (“WagerWorks”) pursuant to which WPTE granted to WagerWorks a license to utilize the WPT brand to create a WPT-branded online gaming website, WPTonline.com, which features an online poker room and an online casino with a broad selection of slots and table games. In exchange for the license to WagerWorks of WPTE’s brand, WagerWorks shares with WPTE a percentage of all net revenue it collects from the operation of the online poker room and online casino. Although any Internet user can access WPTonline.com via the World Wide Web, the website does not permit bets to be made from players in the U.S. and other restricted jurisdictions. WPTonline.com generated approximately $0.9 million in revenue for the three months ended April 2, 2006, compared to costs of revenues of approximately $0.4 million.

Financial Overview

      In the first quarter of the fiscal year ending December 31, 2006 (“2006”) and in the first quarter of the fiscal year ended January 1, 2006 (“2005”), substantially all of Lakes’ consolidated revenues were derived from the WPTE business, mainly from license fees for domestic and international telecast of World Poker Tour television episodes and product licensing fees associated with the World Poker Tour brand and logo. Domestic telecast license fees have depended on the number of episodes delivered in a particular period. Revenues from other parts of the WPTE business are relatively small but continue to grow.

Results of Operations

      Total revenues increased by $2.5 million (62%) during the three months ended April 2, 2006 compared to the three months ended April 3, 2005. Domestic television licensee fees increased $1.1 million (55%) in the first quarter of 2006 compared to the same period in 2005. The increase was primarily a result of the delivery in the first quarter of fiscal 2006 of six episodes of Season IV of the WPT television series versus the delivery of five episodes of Season III in the same period in 2005, and the delivery of one episode of Season I of the PPT television series in the first quarter versus no episodes of the PPT delivered in the same period in 2005. Product licensing revenues decreased $0.4 million (34%) in the first quarter of 2006 compared to the same period in 2005. The decrease was due, in part, to lower license revenues from WPTE’s lottery game partner, MDI, which were partially offset by increased mobile gaming sales from Hands-On Mobile (formerly Mforma). International television licensee fees increased $0.5 million (116%) due to increased distribution agreements in the first quarter of 2006 compared to the same period in 2005. Specifically WPTE has expanded into additional territories and have agreements now for WPT Seasons One, Two and Three. Online gaming, host fees, sponsorship and merchandise revenues also increased $1.1 million (179%) in the first quarter of 2006 compared to the same period in 2005, of which $0.9 million is due to the online gaming revenue during 2006, which had not yet been launched during the first quarter of 2005.

      Production costs. Production costs are associated with WPTE operations, which decreased by approximately $0.8 million (24%) in the first quarter of 2006 compared to the same period in 2005. The decrease was primarily due to lower recognized PPT production costs, as WPTE began capitalizing these costs in the first quarter of fiscal 2006 versus previously expensing them. During the quarter, costs of revenues associated with the PPT were $0.1 million compared to $1.4 million in the prior year quarter. The favorable variance was offset by $0.4 million in online gaming cost of revenues during the first quarter of 2006 compared to $0 in the same period in the prior year. Additionally, a decrease of $0.2 million related to non-cash compensation expense related to consultant stock options contributed to the favorable variance. Overall gross margins were 63% in the first quarter of 2006 compared to 22% in the first quarter of 2005. Domestic television licensing margins were 44% in the first quarter compared to negative 60% in the same period of 2005 primarily due to

the expensing of PPT production costs in 2005. Increased revenues from international television distribution and our online gaming operations helped contribute to the higher overall gross margins in 2006.

      Selling and administrative expenses. Selling, general and administrative expenses were $9.2 million for the first quarter of 2006, compared to $6.5 million for the first quarter of 2005. The increase of approximately $2.7 million was primarily due to the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee and director stock options and stock purchases based on estimated fair values. For the three months ended April 2, 2006, share-based compensation expense recognized under SFAS 123(R) related to employee and director stock options of approximately $2.2 million, of which approximately $1.5 million related to WPTE and $0.7 million related to Lakes. There was no share-based compensation expense related to employee and director stock options and stock purchases recognized during the three months ended April 3, 2005. The remaining increase in selling, general and administrative expenses in the first quarter of 2006 as compared to the first quarter of 2005 was due primarily to additional headcount related costs.

      Net unrealized gains on notes receivable were $15.5 million and $2.8 million for the three months ended April 2, 2006 and April 3, 2005, respectively, related to the adjustment to estimated fair value of the Company’s notes receivable from Indian tribes. These fair value calculations are determined based on current assumptions related to the projects and management’s evaluation of critical milestones as discussed below under “Critical Accounting Policies and Estimates — Accounting for long-term assets related to Indian casino projects.” Unrealized gains of approximately $12.9 million related primarily to increased probability of opening related to the casino development projects with the Pokagon Band in New Buffalo, Michigan and with the Jamul Tribe near San Diego, California as well as the increased interest rate charged on the notes with the Jamul Tribe as a result of the new development financing and services agreement entered into on March 30, 2006 with the Jamul Tribe. Gains of approximately $2.6 million related to the settlement with the Kickapoo Tribe (see below discussion under — “Liquidity and Capital Resources”).

      Other income was $5.5 million and $0.4 million for the three months ended April 2, 2006 and April 3, 2005, respectively. WPTE recognized $5.7 million in a gain on sale of investment in the first quarter of 2006, relating to the sale of a portion of WPTE’s stock in PokerTek, which went public in October 2005.

      The Company recorded a tax provision of $2.7 million and $0.4 million for the three months ended April 2, 2006 and April 3, 2005, respectively. WPTE recorded a provision of $1.3 million for the three months ended April 2, 2006. WPTE’s provision for income taxes is due to positive taxable income that WPTE expects to generate which would allow WPTE to realize its net operating loss carryforward from 2005. A valuation allowance was previously recorded by WPTE for the net deferred tax asset related to WPTE’s 2005 net operating loss carryforward. During the three months ended April 2, 2006, Lakes reversed approximately $1.0 million of the capital loss related to the Kickapoo Tribe which was reflected as a deferred tax asset, as a result of the settlement. Lakes has recorded a deferred tax asset related to capital losses in the amount of approximately $5.9 million. The realization of these benefits is dependent on the generation of capital gains. The Company believes it will have sufficient capital gains in the future to utilize these benefits. The Company owns approximately 12.5 million shares of WPTE common stock with a minimal cost basis and the capital gain from the sale of a portion of these shares could be used against the capital losses. Additionally, in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), Lakes evaluated the ability to utilize deferred tax assets arising from net operating loss carry forwards, net deferred tax assets relating to Lakes’ accounting for advances made to Indian tribes and other ordinary items and determined that a valuation allowance was appropriate at April 2, 2006 and January 1, 2006. Lakes evaluated all evidence and determined the negative evidence relating to net losses generated over

the past four years outweighed the current positive evidence that the Company believes exists surrounding its ability to generate significant income from its long-term assets related to Indian casino projects. The Company recorded a 100% valuation allowance against these items at April 2, 2006 and January 1, 2006 based upon the above factors.

      The minority interest portion of WPTE’s earnings was $1.4 million for the three months ended April 2, 2006 compared to losses of $0.6 million for the three months ended April 3, 2005. The amount represents the minority interest portion of WPTE net earnings (losses) of $3.6 million and ($1.6) million for the three months ended April 2, 2006 and April 3, 2005, respectively.

Liquidity and Capital Resources

      At April 2, 2006, Lakes’ unaudited condensed consolidated balance sheet included unrestricted cash and cash equivalents and short-term investment balances of $55.2 million, comprised of Lakes’ cash of $15.6 million, WPTE cash of $3.7 million and WPTE short-term investments of $35.9 million. WPTE cash and investments will not be used in Lakes’ business. As of April 2, 2006, Lakes’ has had minimal operating revenues from casino operations since the expiration of the management contract with the Coushatta Tribe in January 2002.

      Lakes entered into a Settlement Agreement with the Kickapoo Tribe pursuant to which Lakes and the Kickapoo Tribe resolved all outstanding issues relating to the parties’ business relationship that was terminated in November 2005. During fiscal 2005, Lakes recorded a loss of approximately $6.3 million as a result of the terminated business relationship. Pursuant to the Settlement Agreement, during April 2006, Lakes received a cash payment of approximately $2.6 million as reimbursement for payments made directly by Lakes to vendors on behalf of the Kickapoo Tribe and the Kickapoo Tribe agreed to pay $0.6 million into an escrow to be released to Lakes at such time as Lakes transfers title to certain land owned by Lakes to the Kickapoo Tribe. The Company and the Kickapoo Tribe have agreed that title will transfer only after the Kickapoo Tribe assumes, settles or pays certain accounts payable to vendors related to the Kickapoo Tribe’s casino that remain on Lakes’ books, and once Lakes receives full releases for any liability thereto. As a result of the $2.6 million payment, Lakes revalued the note receivable from the Kickapoo Tribe at $2.6 million as of April 2, 2006, and a gain of that amount was recognized in the first quarter of 2006. The land transfer and related release of liabilities will be recognized in the period they occur. When the releases are received from the vendors the Company will recognize a gain. The Company does not have an estimate of when or if this will occur.

      Also during the first quarter ended April 2, 2006, Lakes settled a short-swing profit matter, which resulted in a payment to Lakes of approximately $2.8 million. This settlement did not impact Lakes’ earnings.

      On February 15, 2006 Lakes closed on a $50 million financing facility with an affiliate of Prentice Capital Management, LP. An initial draw of $25 million was made under the facility, another $10 million is immediately available under the facility and the remaining $15 million can be drawn in $5 million increments subject to the satisfaction of certain conditions. All amounts drawn against the facility will be repayable three years from the date of closing. Approximately $10.2 million of the initial draw was used to repay in full our December 16, 2005, loan from the Lyle Berman Family Partnership (the “Partnership”). As a result of repaying the Partnership loan prior to February 28, 2006, the two million common stock purchase warrants previously issued to the Partnership were terminated. Lakes plans to continue pursuing other financing alternatives to fund its operational and development needs, and the Company believes the assets of Lakes provide sufficient collateral to obtain the necessary financing.

      Our agreements with our tribal partners require that we provide certain financing for project development in the form of loans. These loans are interest bearing; however, the loans and related interest are not due until the casino is built and has established profitable operations. In the event that the casinos are not built, our only recourse is to attempt to liquidate assets of the development, if any, excluding any land in trust. Approximately $10.9 million of the loans due from the Pokagon Band were used by the Pokagon Band to purchase the project

site. The Company’s first deed of trust against this property was relinquished when the Bureau of Indian Affairs (“BIA”) placed the land into trust in January 2006. The Company holds a deed of trust against related non-gaming land which has a cost basis of approximately $13.2 million.

      We currently believe that our casino development projects currently in progress and included in the table below will be constructed and achieve profitable operations; however, no assurance can be made that this will occur. If this does not occur, it is likely that Lakes would incur substantial or complete losses on its notes receivable from Indian tribes and related intangible assets associated with the acquisition of the management contracts. In addition, if Lakes’ current casino development projects are not completed or, upon completion, fail to successfully compete in the highly competitive market for gaming activities, Lakes may lack the funds to compete for and develop future gaming or other business opportunities and Lakes’ business could be adversely affected to the extent that it may be forced to cease its operations entirely.

      Following is a table summarizing remaining contractual obligations as of April 2, 2006 (in millions):

Casino Development Advances/ Commitments

As of April 2, 2006

      The Company has incurred cumulative development costs of approximately $6.4 million relating to the non-Indian casino it is developing in Vicksburg, Mississippi. These costs are included in property and equipment as construction in progress. The Company is working toward obtaining all necessary approvals to move forward with this project. Lakes does not expect to have access to the capital necessary to make this a viable project for the Company until such time that one of its other casino projects is open and therefore, this is now planned to be a 2007 project.

      During the remainder of fiscal 2006, Lakes’ corporate costs, excluding WPTE which is not expected to require additional capital from Lakes, will be approximately $14 million, which includes $3.0 million of interest related to the financing facility entered into on February 15, 2006. Development project-related costs are expected to be approximately $45 million during the remainder of fiscal 2006 and include approximately $24 million related to the Pokagon project as construction is estimated to begin in mid 2006. This $24 million includes a $1.0 non-refundable payment made in April 2006 to the Pokagon Band scholarship fund upon approval of the management contract between Lakes and the Pokagon Band. Lakes’ cash balance, excluding WPTE cash, was approximately $15.6 million as of April 2, 2006. Additionally, the Company may be required to pay taxes up to approximately $12 million plus interest and penalties in fiscal 2006 related to two tax matters. Lakes will require additional capital through public or private financings or the sale of some or all of the Company’s shares of WPTE to meet operating expenses and development project-related costs during fiscal 2006 and the Company is currently considering various financing alternatives. The Company believes the assets of Lakes provide sufficient collateral to obtain the necessary financing. The assets of Lakes include approximately 12.5 million common shares of WPTE that have an estimated fair value of $79.7 million as of May 2, 2006, based on the public trading price, on that date, which may not be indicative of what Lakes could realize in a sale of its shares. The Company believes the shares of WPTE could be the source or part of the collateral for the additional financing.

      Our major use of cash over the past three years has been pre-construction financing provided to our tribal partners. Lakes also anticipates that it will incur additional pre-construction costs which will require the Company to obtain additional sources of financing. These development costs do not include construction-related costs that will be incurred when any of the projects begin construction. Management is pursuing other sources of financing. If the financing is in the form of equity financing it will be dilutive to Lakes’ shareholders, and any debt financing may involve additional restrictive covenants. An inability to raise such funds when needed might require Lakes to delay, scale back or eliminate some of its expansion and development goals.

      In addition, the construction of the Company’s Indian casino projects may depend on the ability of the tribes to obtain financing for the projects. If such financing cannot be obtained on acceptable terms, it may not be possible to complete these projects, which could have a material adverse effect on Lakes’ results of operations and financial condition. In order to assist the tribes, Lakes may be required to guarantee the tribes’ debt financing or otherwise provide support for the tribes’ obligations. Guarantees by Lakes, if any, will increase Lakes’ potential exposure in the event of a default by any of these tribes.

      For the Pokagon Casino project, the Company has agreed to finance all phases of the project entirely from its own funds if financing at an interest rate of 13% or less is not available from the capital markets. If this occurs and Lakes is required to provide all financing, this would be an additional commitment of up to approximately $54 million. Currently, management believes that third party financing will be available for this project. However, there can be no assurance third party financing will be available and that Lakes will not be required to provide this additional financing.

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 U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the balance sheet date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, long-term assets related to Indian casino projects, deferred television costs, investments, litigation costs and income taxes. 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 under different assumptions or conditions.

      We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements.

      Revenue recognition: Revenue from the management of Indian-owned casino gaming facilities is recognized in accordance with our policy described below under the caption “Accounting for long-term assets related to Indian casino projects.”

      Revenue from the domestic and international distribution of WPTE’s television series is recognized as earned under the following criteria established by the American Institute of Certified Public Accountants Statement of Position (SOP) No. 00-2, Accounting by Producers or Distributors of Films:

      In accordance with the terms of the WPT and PPT agreements, WPTE recognizes domestic television license revenues upon the receipt and acceptance of completed episodes. However, due to restrictions and practical limitations applicable to WPTE’s operating relationships with foreign networks, WPTE currently does not consider collectibility of international television license revenues to be reasonably assured until the international distributor has received payment, and accordingly, WPTE does not recognize such revenue until that time. Additionally, WPTE presents international distribution license fee revenues net of the distributor’s fees, as the distributor is the primary obligor in the transaction with the ultimate customer pursuant to Emerging Issues Task Force (EITF) 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-9”).

      Product licensing revenues are recognized when the underlying royalties from the sales of the related products are earned. WPTE recognizes minimum revenue guarantees ratably over the term of the license or as earned royalties based on actual sales of the related products, if greater. WPTE presents product licensing fees gross of licensing commissions, which are recorded as selling and administrative expenses as WPTE is the primary obligor in the transaction with the ultimate customer pursuant to EITF 99-19.

      Online gaming revenues are recognized monthly based on detailed statements received from WagerWorks, WPTE’s online gaming partner, for online poker and casino activity throughout the previous month. In accordance with EITF 99-19, WPTE presents online gaming revenues gross of WagerWorks costs, including WagerWorks management fee, royalties, credit card processing and chargebacks that are recorded as cost of revenues, since WPTE has the ability to adjust price and specifications of the online gaming site, WPTE bears the majority of the credit risk and WPTE is responsible for the sales and marketing of the gaming site. The Company includes certain promotional expenses related to free bets and deposit bonuses

along with customer charge backs as deductions of revenue. All other promotional expenses are generally recorded as sales and marketing expenses.

      Event hosting fees are paid by host casinos for the privilege of hosting the events and are recognized as the episodes that feature the host casino are aired, and sponsorship revenues are recognized as the episodes that feature the sponsor are aired. Licensing advances and guaranteed payments collected, but not yet earned, by WPTE, as well as casino host fees and sponsorship receipts collected prior to the airing of episodes, are classified as deferred revenue in the accompanying balance sheets.

      Deferred television costs: WPTE accounts for deferred television costs in accordance with FASB Statement of Position No. 00-2 (“SOP 00-2”). Deferred television costs include capitalizable direct costs, production overhead and development costs related to episodes of the WPT, and are stated at the lower of cost or net realizable value based on anticipated revenue. WPTE has not currently anticipated any revenues in excess of those subject to existing contractual relationships because WPTE has insufficient operating history to enable such anticipation. In January 2006, WPTE signed an agreement for the PPT with Discovery Communications, Inc, the parent company of the Travel Channel, therefore, on-going PPT television costs will be capitalized beginning in the first quarter of fiscal 2006 and will be expensed as episodes are delivered to the Travel Channel. Marketing, distribution and general and administrative costs are expensed as incurred. Capitalized television production costs for each episode are expensed as revenues are recognized upon delivery and acceptance by the Travel Channel of the completed episode. WPTE management currently estimates that 100% of capitalized television costs at April 2, 2006 are expected to be expensed by the end of fiscal 2006.

      Investment: Until October 2005, WPTE had an investment (consisting of a 15% equity interest carried at its nominal cost basis) in and a loan receivable from PokerTek, a company formed in August 2003 to develop and market the PokerPro system, an electronic poker table designed to provide a fully automated poker room environment, to tribal casinos, commercial casinos and card clubs. As a result of PokerTek’s initial public offering in October 2005, WPTE’s ownership interest was diluted to 11.7%. As of April 2, 2006, WPTE’s Executive Chairman of the Board, Lyle Berman, along with his son Bradley Berman, who also sits on the WPTE’s Board of Directors, have personal investments in PokerTek and, hold a combined ownership of approximately 9% in PokerTek. Lyle Berman also serves as Chairman of the Board of PokerTek and received options to purchase 200,000 shares of common stock in that company.

      On January 20, 2006, WPTE entered into an agreement to sell 630,000 shares of PokerTek’s common stock held by WPTE, at a price per share of $9.03. WPTE closed the transaction on February 28, 2006, and received net cash proceeds of approximately $5.7 million. As a result, WPTE currently owns 450,000 shares, or a 4.75% ownership interest in PokerTek.

      WPTE accounted for this investment as “available for sale” pursuant to SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, and adjusted the investment to fair market value of $5.4 million at April 2, 2006, with the change in fair market value accounted for as a component of other comprehensive income in the statement of stockholders’ equity.

      Share-Based Compensation Expense: On January 2, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee and director stock options and employee and director stock purchases based on estimated fair values. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied certain provisions of SAB 107 in its adoption of SFAS 123(R).

      SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statement of earnings (loss). SFAS 123(R) supersedes the Company’s previous accounting under the provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). As permitted by SFAS 123, the Company measured compensation cost for options granted prior to January 2, 2006, in accordance with

Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and related interpretations. Accordingly, no accounting recognition is given to stock options granted at fair market value until they are exercised. Upon exercise, net proceeds, including tax benefits realized, are credited to equity.

      The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 2, 2006, the first day of the Company’s fiscal year 2006. In accordance with the modified prospective transition method, the Company’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Share-based compensation expense recognized in the Company’s unaudited condensed consolidated statement of earnings was approximately $2.2 million for the three months ended April 2, 2006 and included both compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1, 2006 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to January 1, 2006. There was no share-based compensation expense related to employee and director stock options and employee and director stock purchases recognized during the three months ended April 3, 2005.

      Upon adoption of SFAS 123(R), the Company also continued the use of the Black-Scholes option pricing method that it had used to establish fair value of options granted prior to January 2, 2006. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility, and actual and projected employee stock option exercise behaviors. Any changes in these assumptions may materially affect the estimated fair value of the share-based award.

      In November 2005, the FASB issued FSP FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”). FSP 123R-3 provides a simplified alternative method to calculate the beginning pool of excess tax benefits against which excess future deferred tax assets (that result when the compensation cost recognized for an award exceeds the ultimate tax deduction) could be written off under Statement 123R. The guidance in FSP 123R-3 was effective on November 10, 2005. We may make a one-time election to adopt the transition method described in FSP 123R-3 before the end of our fiscal year ending December 31, 2006. We are currently evaluating the available transition alternatives of FSP 123R-3.

      Lakes is involved as the exclusive developer and manager or consultant of Indian-owned casino projects. The Company has formal procedures governing its evaluation of opportunities for potential development projects that it follows before entering into agreements to provide financial support for the development of these properties. Lakes determines that there is probable future economic benefit prior to recording any asset related to the Indian casino project. No asset related to an Indian casino project is recognized unless it is considered probable that the project will be built and result in an economic benefit to Lakes sufficient to recover the asset. Lakes initially evaluates the following six factors involving critical milestones that affect the probability of developing and operating a casino:

      In addition to the above factors, Lakes also considers economic and qualitative factors affecting Lakes’ future economic benefits from the project, including the following: