LAKES ENTERTAINMENT INC - 10-Q Quarterly Report

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

----------------------------

FORM 10-Q
(Mark One)

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

For the quarterly period ended September 29, 2002

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
Minnetonka, Minnesota 55305
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)

(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 [X] No [ ]

As of November 8, 2002, there were 10,638,320 shares of Common Stock, $0.01 par
value per share, outstanding.

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
INDEX

2

LAKES GAMING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

3

LAKES GAMING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

4

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(IN THOUSANDS)
(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

5

LAKES GAMING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

6

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(IN THOUSANDS)
(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

7

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.

8

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BUSINESS

Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")
was established as a public corporation on December 31, 1998, via a distribution
(the "Distribution") of its common stock, par value $.01 per share (the "Common
Stock") to the shareholders of Grand Casinos, Inc. ("Grand").

Lakes currently has development and management agreements with four separate
tribes for four new casino operations, one in Michigan, two in California and
one with the Nipmuc Nation on the east coast. The Company also has agreements
for the development of one additional casino on Indian owned land in California
through a joint venture. Each of these projects is currently in the development
phase.

During March 2002, the Company made an investment in a joint venture with Steven
Lipscomb, a producer of televised poker tournaments. The purpose of this joint
venture, which is currently consolidated by Lakes, is to launch the World Poker
Tour and establish poker as the next significant televised mainstream sport. The
terms of this investment required Lakes to make an investment of $0.1 million
for an approximate 78% ownership position in the joint venture. Lakes is also
required to lend up to $3.2 million to the joint venture as needed. The joint
venture has issued a note to Lakes at 6.2% interest per annum with principal
payable at the end of three years. The amount outstanding on the note was $1.2
million as of September 29, 2002. The Lakes' note is secured by a blanket
security interest in all assets of the joint venture. If certain predetermined
goals are not achieved by the joint venture, Lakes has the right to stop
advances on the note. If Lakes were to elect to stop funding the joint venture,
all outstanding principal amounts would be due one year from the date Lakes
stopped funding.

LAND HELD UNDER CONTRACT FOR SALE

On December 28, 2001, the Company transferred title and ownership obligations of
the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction
with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and
obligations of the adjacent Travelodge property consisting of a long-term land
lease and a motel operation. This transaction was accounted for under the
deposit method of accounting under the requirements of Statement of Financial
Accounting Standards No. 66, Accounting for Sales of Real Estate, rather than as
a sale. Therefore, the property is included as land held under contract for sale
on the accompanying balance sheets as of September 29, 2002 and December 30,
2001. The total price for this combined transaction was approximately $30.9
million. Terms of the transaction include a $1.0 million down payment, a
contractual commitment to pay Lakes $23.3 million by December 29, 2002, and a
second contractual agreement to pay Lakes $7.5 million on June 30, 2004. Lakes'
collateral for the two contractual commitments is the property and lease rights
described above which would revert back to Lakes in the event of default by
Metroflag. The transaction was closed subject to certain administrative
post-closing conditions that must be satisfied within six months after the
closing. This post-closing period was extended through September 27, 2002. These
conditions were satisfied as of September 27, 2002.

9

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

Lakes and Metroflag have restructured the terms of the Polo Plaza and Travelodge
property transactions due to deteriorating economic conditions. The parties have
reduced the purchase price for the Polo Plaza property from $23.3 million to
$21.3 million. On the payment date, which is scheduled to be no later than
January 31, 2003, $17.3 million of the purchase price is payable to Lakes in
cash and $4.0 million is payable through the issuance to Lakes of a preferred
membership interest in Metroflag. On or before December 24, 2003, Metroflag Polo
may elect to distribute to Lakes $3.0 million in cash as full return of Lakes'
preferred interest. If Lakes' preferred interest remains outstanding at any time
on or after December 24, 2006, Lakes can require Metroflag to repurchase the
preferred interest for $4.0 million plus a priority return of eight percent (8%)
per annum. Effective June 30, 2002, Lakes recorded a $3.0 million impairment
charge for these properties relating to the adjustment in the purchase price and
the potential discount on the return of Lakes' preferred interest.

LAND HELD FOR DEVELOPMENT

Lakes continues to own the Shark Club property, which is an approximate 3.5 acre
undeveloped site adjacent to the Polo Plaza shopping center and Travelodge
sites. During August 2002, Lakes formed a joint venture with Diamond Resorts,
LLC, a Nevada limited liability company and time-share developer for the purpose
of developing the Shark Club parcel as an upscale time-share project. The terms
of this joint venture agreement require that Diamond and Lakes each make an
initial working capital contribution of $250,000. Subject to Diamond obtaining a
financing commitment for a construction loan sufficient to fund at least the
first phase of the building improvements contemplated by the time-share project,
the joint venture agreement will require Lakes to contribute the relevant
portion of the Shark Club parcel, valued at $16 million. Diamond has agreed to
perform sales, marketing, administrative and managerial services for the
project. The terms of the joint venture agreement provide for the repayment to
Lakes of its contribution of property in cash based on the joint venture's cash
flow and time-share unit sales. It is contemplated that Lakes will be required
to make no other material contributions of cash or property to the project.

On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest
will accrue at a rate of 10.0% per annum. The loan is due and payable from first
available cash flow of the joint venture (excluding any required capital
contribution from a member) and no later than October 1, 2004.

Also included in land held for development is land held for possible transfer to
Indian tribes for use in future casino resort projects in the amount of $12.6
million and $8.9 million as of September 29, 2002 and December 30, 2001,
respectively.

10

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
all business combinations initiated after June 30, 2001 be accounted for under a
single method, the purchase method. SFAS No. 142 addresses financial accounting
and reporting for acquired goodwill and other intangible assets and supersedes
Accounting Principles Board ("APB") Opinion No. 17, Intangible Assets. These
statements were effective January 1, 2002 and adoption did not have a material
impact on the Company's financial position or results of operation.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 supersedes previous guidance for financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies to legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset and will be effective on January 1, 2003.

In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or
Disposal of Long-Lived Assets, which provides new accounting and financial
reporting guidance for the impairment or disposal of long-lived assets and the
disposal of segments of a business. This statement was effective January 1, 2002
and its adoption did not have a material impact on the Company's financial
position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. SFAS No. 146 eliminates the definition and requirement for recognition
of exit costs in Emerging Issues Task Force Issue No. 94-3 where a liability for
an exit is recognized at the date of an entity's commitment to an exit plan.
This statement is effective for exit or disposal activities initiated after
December 31, 2002.

The Company does not believe that the adoption of SFAS No. 143 and 146 will have
a material impact on its financial position or results of operations.

2. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements include
the accounts of Lakes and its wholly-owned and majority-owned subsidiaries.
Investments in unconsolidated affiliates representing 50% or less of voting
interests are accounted for on the equity method. All significant intercompany
balances and transactions have been eliminated in consolidation.

Lakes' investments in unconsolidated affiliates include a 50 percent ownership
interest in PCG Santa Rosa, LLC, a joint venture formed to develop a casino on
Indian-owned land in California. During the first quarter of 2001, Lakes wrote
off its 50 percent investment in PCG Corning, LLC, also a joint venture formed
to develop a casino on Indian-owned land in California. Additionally, as a
result of its spin-off from Grand, Lakes received a 27 percent ownership
interest in New Horizon Kids Quest, Inc. (NHKQ), a publicly held provider of
child care facilities.

11

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

In June 2001, Lakes entered into an agreement with NHKQ pursuant to which NHKQ
acquired Lakes' interest in NHKQ. As a result of this transaction, Lakes
incurred a one time write-down of $0.7 million before tax, during the second
quarter of 2001.

The condensed consolidated financial statements have been prepared by the
Company in accordance with accounting principles generally accepted in the
United States of America for interim financial information, in accordance with
the rules and regulations of the Securities and Exchange Commission. Pursuant to
such rules and regulations, certain financial information and footnote
disclosures normally included in the condensed consolidated financial statements
have been condensed or omitted.

In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for fair presentation have been included.
Operating results for the nine months ended September 29, 2002, are not
necessarily indicative of the results that may be expected for the year ending
December 29, 2002. The condensed consolidated financial statements should be
read in conjunction with the condensed consolidated financial statements and
notes thereto included in the Company's annual report on Form 10-K/A for the
year ended December 30, 2001.

3. MANAGEMENT CONTRACTS OF LIMITED DURATION

The ownership, management and operation of gaming facilities are subject to
extensive federal, state, provincial, tribal and/or local laws, regulation, and
ordinances, which are administered by the relevant regulatory agency or agencies
in each jurisdiction. These laws, regulations and ordinances vary from
jurisdiction to jurisdiction, but generally concern the responsibility,
financial stability and character of the owners and managers of gaming
operations as well as persons financially interested or involved in gaming
operations. The Company is prohibited by the Indian Gaming Regulatory Act
("IGRA") from having an ownership interest in any casino it manages for Indian
tribes.

The management contract for Grand Casino Coushatta expired January 16, 2002,
which is seven years from the date the casino opened, and was not renewed. This
non-renewal has resulted in the loss of revenues to the Company derived from
such contract, which has had a material adverse effect on the Company's results
of operations. As of September 29, 2002, the Company has no other management
contracts from which it will derive revenues in 2002.

4. NOTES RECEIVABLE

The notes receivable from Indian Tribes are generally for the development of
gaming properties to be managed by the Company. The repayment terms are specific
to each tribe and are largely dependent upon the operating performance of each
gaming property. Repayments of the aforementioned notes receivable are required
to be made only if distributable profits are available from the operation of the
related casinos. Repayments are also the subject of certain distribution
priorities specified in the management contracts. In addition, repayment of the
notes receivable and the manager's fees under the management contracts may be
subordinated to certain other financial obligations of the respective casinos.
Through September 29, 2002, no amounts have been withheld under these
provisions.

12

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

Notes receivable consist of the following (in thousands):

Interest income on notes receivable from Indian Tribes related to casino
development projects is deferred because realizability of the interest is
contingent upon the completion and positive operating cash flow of the casino.
Interest deferred during the development period is recognized over the remaining
life of the note using the effective interest method. As of September 29, 2002
and December 30, 2001, $9.6 million and $6.1 million of interest on notes
related to properties under development has been deferred.

Management periodically evaluates the recoverability of such notes receivable
based on the current and projected operating results of the underlying facility
and historical collection experience. No impairment losses on such notes
receivable have been recognized through September 29, 2002.

The terms of these notes require the casinos to be constructed and to generate
positive cash flows prior to the Company receiving repayment. As such, an
estimate of the fair value of these notes requires an assessment of the timing
of the construction of the related casinos and the profitability of the related
casinos. Due to the significant uncertainty involved in such an assessment, the
Company does not believe that it is practicable to accurately estimate the fair
value of these notes with the degree of precision necessary to make such
information meaningful.

13

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

5. LONG-TERM DEBT

The Company currently has one note payable with a third party. This note is
collateralized by certificates of deposit, with $1.0 million outstanding at
September 29, 2002 and December 30, 2001. Interest is compounded and paid on a
quarterly basis at 10%. The principal and any unpaid interest are due December
22, 2002. A second note which was collateralized by property with $0.4 million
outstanding at June 20, 2002 and December 30, 2001 was repaid on June 20, 2002.

6. CAPITAL LEASE OBLIGATIONS

Pursuant to the terms of the Distribution Agreement, Grand assigned to Lakes,
and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes'
current corporate office space of approximately 65,000 square feet with a lease
term of fifteen years. The lease commenced on October 14, 1996. During 2001,
also pursuant to the terms of the Distribution Agreement, Lakes entered into a
capital lease arrangement for the corporate office space at which time the
operating lease was cancelled. Accordingly, Lakes recorded a capital leased
asset and liability in the amount of approximately $5.8 million. These amounts
are included in the accompanying condensed consolidated balance sheet as of
December 30, 2001. On January 2, 2002, the Company completed the purchase of its
corporate office building for $6.4 million, including transaction expenses. This
transaction resulted in the extinguishment of the Company's capital lease
obligation related to the building.

7. COMMITMENTS AND CONTINGENCIES:

LEASES

The Company leases an airplane under a non-cancelable operating lease. The
airplane lease expires May 1, 2003 and provides for two one-year renewal terms.
Approximate future minimum lease payments, due under this lease as of September
29, 2002, assuming both one-year renewals are exercised, are as follows (in
thousands):

PURCHASE OPTIONS

The Company has the right to purchase the airplane it leases during the base
lease term and any renewal term for approximately $8 million.

During 2001, the option to purchase the Cable property in Las Vegas, Nevada for
the purchase price of $39.1 million was allowed to lapse.

14

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

INDEMNIFICATION AGREEMENT

As a part of the transaction establishing Lakes as a separate public company on
December 31, 1998, the Company has agreed to indemnify Grand against all costs,
expenses and liabilities incurred in connection with or arising out of certain
pending and threatened claims and legal proceedings to which Grand and certain
of its subsidiaries are likely to be parties. The Company's indemnification
obligations include the obligation to provide the defense of all claims made in
proceedings against Grand and to pay all related settlements and judgments.

As security to support Lakes' indemnification obligations to Grand, Lakes agreed
to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of
Park Place, an aggregate of $30 million, to cover various commitments and
contingencies related to or arising out of, Grand's non-Mississippi business and
assets (including by way of example, but not limitation, tribal loan guarantees,
real property lease guarantees for Lakes' subsidiaries and director and
executive officer indemnity obligations) consisting of four annual installments
of $7.5 million, during the four-year period subsequent to December 31, 1998.
Any surplus proceeds remaining in this trust after all the secured obligations
are indefeasibly paid in full and discharged shall be paid over to Lakes.

Lakes made the first deposit of $7.5 million on December 31, 1999 and in July
2000, Lakes deposited $18 million in an escrow account in partial satisfaction
of the indemnification obligation. The $18 million deposit represented a
settlement agreement which was reached in June 2000 regarding both the
Stratosphere Shareholders' litigation and the Grand Casinos, Inc. Shareholders'
litigation. On August 14, 2001, the Court issued an order giving final approval
to the settlement. As such, the $18 million in restricted cash was removed from
the Company's condensed consolidated balance sheet. In January 2001, Lakes also
purchased the Shark Club property in Las Vegas for $10.1 million in settlement
of another obligation that was subject to the indemnification obligations. As of
September 29, 2002 and December 30, 2001, $7.5 million related to security to
support Lakes' indemnification obligations to Grand is included as restricted
cash in the accompanying condensed consolidated balance sheets.

As part of the indemnification agreement, Lakes has agreed that it will not
declare or pay any dividends, make any distribution of Lakes' equity interests,
or otherwise purchase, redeem, defease or retire for value any equity interests
in Lakes without the written consent of Park Place.

LEGAL PROCEEDINGS

The following summaries describe certain known legal proceedings to which Grand
is a party which Lakes has assumed, or with respect to which Lakes may have
agreed to indemnify Grand, in connection with the Distribution.

15

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

SLOT MACHINE LITIGATION

In April 1994, William H. Poulos brought an action in the U.S. District Court
for the Middle District of Florida, Orlando Division -- William H. Poulos, et al
v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various
parties (including Grand) alleged to operate casinos or be slot machine
manufacturers were named as defendants. The plaintiff sought to have the action
certified as a class action.

A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et
al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was
consolidated with the Poulos action.

Both actions included claims under the federal Racketeering-Influenced and
Corrupt Organizations Act and under state law, and sought compensatory and
punitive damages. The plaintiffs claimed that the defendants are involved in a
scheme to induce people to play electronic video poker and slot machines based
on false beliefs regarding how such machines operate and the extent to which a
player is likely to win on any given play.

In December 1994, the consolidated actions were transferred to the U.S. District
Court for the District of Nevada.

In September 1995, Larry Schreier brought an action in the U.S. District Court
for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al
- -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier
action were similar to those made by the plaintiffs in the Poulos and Ahearn
actions, except that Schreier claimed to represent a more precisely defined
class of plaintiffs than Poulos or Ahearn.

In December 1996, the court ordered the Poulos, Ahearn and Schreier actions
consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et
al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the
plaintiffs to file a consolidated and amended complaint. In February 1997, the
plaintiffs filed a consolidated and amended complaint.

In March 1997, various defendants (including Grand) filed motions to dismiss or
stay the consolidated action until the plaintiffs submitted their claims to
gaming authorities and those authorities considered the claims submitted by the
plaintiffs.

In December 1997, the court denied all of the motions submitted by the
defendants, and ordered the plaintiffs to file a new consolidated and amended
complaint. That complaint has been filed. Grand has filed its answer to the new
complaint.

The plaintiffs have filed a motion seeking an order certifying the action as a
class action. Grand and certain of the defendants have opposed the motion. The
Court has not ruled on the motion.

16

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

STANDBY EQUITY COMMITMENT LITIGATION

In September 1997, the Stratosphere Trustee under the indenture pursuant to
which Stratosphere issued its first mortgage notes filed a complaint in the U.S.
District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company,
Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand
as defendant.

The complaint alleges that Grand failed to perform under the Standby Equity
Commitment entered into between Stratosphere and Grand in connection with
Stratosphere's issuance of such first mortgage notes in March 1995. The
complaint seeks an order compelling specific performance of what the Trustee
claims are Grand's obligations under the Standby Equity Commitment.

The Stratosphere Trustee filed the complaint in its alleged capacity as a third
party beneficiary under the Standby Equity Commitment. Pursuant to the Second
Amended Plan, a new limited liability company (the "Stratosphere LLC") was
formed to pursue certain alleged claims and causes of action that Stratosphere
and other parties may have against numerous third parties, including Grand
and/or officers and/or directors of Grand. The Stratosphere LLC has been
substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding.

In August 2000, the Court and the parties agreed to try the action upon an
amended joint pre-trial order and a series of post-trial briefs. Post-trial
briefing concluded on December 12, 2000 and oral argument was held on January
22, 2001. On April 4, 2001, the Court entered judgment in favor of Grand and
issued its findings of fact and conclusions of law.

The plaintiff filed an appeal with the Ninth Circuit Court of Appeals on May 4,
2001, Case No. 01-15947. On August 13, 2002, the Ninth Circuit affirmed the
prior ruling in favor of Grand.

STRATOSPHERE PREFERENCE ACTION

In April 1998, Stratosphere served on Grand and Grand Media & Electronics
Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a
complaint in the Stratosphere bankruptcy case seeking recovery of certain
amounts paid by Stratosphere to (i) Grand as management fees and for costs and
expenses under a management agreement between Stratosphere and Grand, and (ii)
Grand Media for electronic equipment purchased by Stratosphere from Grand Media.

Stratosphere claims in its complaint that such amounts are recoverable by
Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand
responded to Stratosphere's complaint denying that Stratosphere is entitled to
recover the amounts described in the complaint. Discovery was completed on
December 31, 2001 and the case proceeded to trial before the United States
Bankruptcy Court for the District of Nevada on June 20, 2002. A decision has not
yet been issued.

17

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

OTHER LITIGATION

The Company has recorded a reserve assessment related to various of the above
items based on management's best estimate. The reserve is reflected as a
litigation and claims accrual on the accompanying condensed consolidated balance
sheet as of September 29, 2002 and December 30, 2001.

Grand and Lakes 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 is not likely to have a material adverse effect upon Grand's or the
Company's consolidated financial position or results of operations.

8. RELATED PARTY TRANSACTIONS

During 2001 and 2000, Lakes made a total of $4.0 million in unsecured loans to
ViatiCare Financial Services, LLC, which has since been acquired by Living
Benefits Financial Services. In March 2001, the Board of Directors of Lakes
decided not to make further loans to ViatiCare. A $4.0 million impairment charge
for this note was recorded during the quarter ended June 30, 2002, due to
increased competition in the viatical insurance business and restrictions on
ability to make further policy acquisitions.

Subsequent to the decision by the Lakes Board to make no further loans to
ViatiCare, L. B. Acquisitions, LLC, which is owned by Lyle Berman, the Chief
Executive Officer and a Director of Lakes, has made loans to Living Benefits. As
an incentive to make the loans, L. B. Acquisitions was granted an initial 9%
voting interest in Living Benefits and was given the option to convert the loan
balance into 45% of the voting interest in Living Benefits. Therefore, Lyle
Berman, through L. B. Acquisitions, beneficially owns a total of approximately
55% of the voting interest of Living Benefits.

9. RESTATEMENT

Subsequent to the issuance of the Company's financial statements for the three
and nine months ended September 30, 2001, management of the Company determined
that the interest on notes receivable related to the development of casinos
should have been deferred because the interest is not payable until the casinos
are open and generating operating cash flow. As a result, the accompanying
condensed consolidated financial statements for the three and nine month periods
ended September 30, 2001 have been restated to correct the accounting for these
transactions.

18

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

A summary of the significant effects of the restatement is as follows (in
thousands):

19

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(UNAUDITED)

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

As discussed in Note 9 to the condensed consolidated financial statements
included in Item 1, the accompanying condensed consolidated financial statements
have been restated. The following Management's Discussion and Analysis reflects
this restatement.

OVERVIEW

Lakes Entertainment, Inc., a Minnesota corporation ("Lakes" or the "Company")
was established as a public corporation on December 31, 1998, via a distribution
(the "Distribution") of its Common Stock, to the shareholders of Grand Casinos,
Inc. ("Grand").

As a result of the Distribution, Lakes operates the Indian casino management
business and holds various other assets previously owned by Grand. Lakes' main
business is the development, construction and management of casinos and related
hotel and entertainment facilities in emerging and established gaming
jurisdictions. Lakes has entered into the following contracts for the
development, management and/or financing of new casino operations, all of which
are subject to various regulatory approvals before construction can begin: (1)
Lakes has a contract to be the exclusive developer and manager of an
Indian-owned gaming resort near New Buffalo, Michigan. (2) Lakes and another
company have formed partnerships with contracts to develop and manage two
casinos to be owned by Indian tribes in California, one near San Diego and the
other near Sacramento. (3) Lakes and another company have formed a partnership
with a contract to finance the construction of an Indian-owned casino
approximately 75 miles north of San Francisco, California. (4) Lakes has also
signed contracts with a Massachusetts Indian tribe for development and
management of a potential future gaming resort in the eastern United States;
however, this tribe has received a negative finding regarding federal
recognition from the Bureau of Indian Affairs (BIA). The tribe has submitted
additional information to the BIA for reconsideration.

Additionally, in March 2002, the Company made an investment in World Poker Tour,
LLC, a joint venture formed to film and produce poker tournaments for television
broadcast.

Lakes owns the Shark Club property which is an approximate 3.5 acre undeveloped
site on the Las Vegas Strip in Las Vegas, Nevada. See "Capital Resources,
Capital Spending and Liquidity" below.

On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest
will accrue at a rate of 10.0% per annum. The loan is due and payable from first
available cash flow of the joint venture and no later than October 1, 2004.

20

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

Lakes' historical revenues have been derived almost exclusively from management
fees. During 2001, Lakes managed a land-based, Indian-owned casino, Grand Casino
Coushatta, in Kinder, Louisiana ("Grand Casino Coushatta"). Pursuant to the
Coushatta management contract, Lakes received a fee based on the net
distributable profits (as defined in the contracts) generated by Grand Casino
Coushatta. The management contract expired January 16, 2002, and was not
renewed. This non-renewal has resulted in the loss of revenues to the Company
derived from such contract, which has had a material adverse effect on the
Company's results of operations.

Lakes' limited operating history may not be indicative of Lakes' future
performance. In addition, a comparison of results from year to year may not be
meaningful due to the opening of new facilities and the buy-out and/or cessation
of other casino management contracts. Lakes' growth strategy contemplates the
development of existing projects, the pursuit of opportunities to develop and
manage additional gaming facilities and the pursuit of new business
opportunities. The successful implementation of this growth strategy is
contingent upon the satisfaction of various conditions, including obtaining
governmental approvals, the impact of increased competition, and the occurrence
of certain events, many of which are beyond the control of Lakes.

CRITICAL ACCOUNTING POLICIES

The significant accounting policies, which Lakes believes are the most critical
to aid in fully understanding and evaluating its reported financial results,
include the following: revenue recognition and realizability of notes
receivable.

REVENUE RECOGNITION: Revenue from the management of Indian-owned casino gaming
facilities is recognized when earned according to the terms of the management
contracts. Currently all of the Indian-owned casino projects that Lakes is
involved with are in development stages and are not yet open. Therefore, Lakes
is not currently recognizing revenue related to Indian casino management.

REALIZABILITY OF NOTES RECEIVABLE: The Company's notes receivable from Indian
Tribes are generally for the development of gaming properties to be managed by
the Company. The repayment terms are specific to each tribe and are largely
dependent upon the operating performance of each gaming property. Repayments of
the notes receivable are required to be made only if distributable profits are
available from the operation of the related casinos. Repayments are also the
subject of certain distribution priorities specified in the management
contracts. In addition, repayment of the notes receivable and the manager's fees
under the management contracts may be subordinated to certain other financial
obligations of the respective casinos. Through September 29, 2002, no amounts
have been withheld under these provisions. Management periodically evaluates the
recoverability of such notes receivable based on the current and projected
operating results of the underlying facility and historical collection
experience.

21

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

Interest income on notes receivable from Indian Tribes related to casino
development projects is deferred because realizability of the interest is
contingent upon the completion and operating cash flow of the casino. Interest
deferred during the development period is recognized over the remaining life of
the note using the effective interest method. As of September 29, 2002 and
December 30, 2001, $9.6 million and $6.1 million of interest on notes related to
properties under development has been deferred.

The following discussion and analysis should be read in conjunction with the
condensed consolidated financial statements and notes thereto and management's
discussion and analysis included in the Company's Annual Report on Form 10-K/A
for the year ended December 30, 2001.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
all business combinations initiated after June 30, 2001 be accounted for under a
single method, the purchase method. SFAS No. 142 addresses financial accounting
and reporting for acquired goodwill and other intangible assets and supersedes
Accounting Principles Board ("APB") Opinion No. 17, Intangible Assets. These
statements were effective January 1, 2002 and adoption did not have a material
impact on the Company's financial position or results of operations.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 supersedes previous guidance for financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The statement
applies to legal obligations associated with the retirement of long-lived assets
that result from the acquisition, construction, development and/or the normal
operation of a long-lived asset and will be effective on January 1, 2003.

In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or
Disposal of Long-Lived Assets, which provides new accounting and financial
reporting guidance for the impairment or disposal of long-lived assets and the
disposal of segments of a business. This statement was effective January 1, 2002
and its adoption did not have a material impact on the Company's financial
position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. SFAS No. 146 eliminates the definition and requirement for recognition
of exit costs in Emerging Issues Task Force Issue No. 94-3 where a liability for
an exit is recognized at the date of an entity's commitment to an exit plan.
This statement is effective for exit or disposal activities initiated after
December 31, 2002.

The Company does not believe that the adoption of SFAS No. 143 and 146 will have
a material impact on its financial position or results of operations.

22

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

RESULTS OF OPERATIONS

Revenues are calculated in accordance with accounting principles generally
accepted in the United States of America and are presented in a manner
consistent with industry practice. Historically, net distributable profits by
the Indian casinos were computed using a modified cash basis of accounting in
accordance with the management contracts to calculate management fees. Under
this modified cash basis of accounting prescribed by the management contracts,
the write-off of capital equipment and leased assets for the casino operations
was accelerated, which thereby impacted the timing of net distributable profits.

NINE MONTHS ENDED SEPTEMBER 29, 2002 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2001

Revenues

Total revenues were $1.5 million for the nine months ended September 29, 2002
compared to $27.5 million for the same period in the prior year. Revenues in
both years were derived from fees related to the management of Grand Casino
Coushatta. Revenues and earnings for the current year were less than the same
period last year primarily due to the expiration of the management contract with
the Coushatta Tribe of Louisiana for Grand Casino Coushatta on January 16, 2002.
The Company's revenues and earnings will not include contributions from the
Coushatta operation going forward. As of September 29, 2002, the Company has no
other management contracts from which it will derive revenues in 2002.

Costs and Expenses

Total costs and expenses were $14.7 million for the nine months ended September
29, 2002, compared to $9.0 million for the same period in the prior year.
Selling, general and administrative expenses increased from $8.1 million for the
nine months ended September 30, 2001 to $14.4 million for the nine months ended
September 29, 2002. This increase is primarily due to an impairment of the $4.0
million note receivable from Living Benefits Financial Services, LLC, as well as
the $3.0 million additional impairment charge taken on the Polo Plaza and
Travelodge properties during the second quarter of 2002. The impairment charge
is described under "Liquidity and Capital Resources" below. This increase is
partially offset by a decline in rent expense resulting from the purchase of the
corporate office building in January 2002. Fewer costs relating to travel also
partially offset the increase in selling, general and administrative expenses
during the current year period.

Other

Interest income was $1.3 million for the nine months ended September 29, 2002
compared to $1.7 million for the nine months ended September 30, 2001. Equity in
loss of unconsolidated affiliates was $0.3 million and $0.4 million for the nine
months ended September 29, 2002 and September 30, 2001, respectively. Write-down
of unconsolidated affiliates was $0.7 million for the nine months ended
September 30, 2001.

23

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

In June 2001, Lakes entered into an agreement with New Horizon Kids Quest
(NHKQ), pursuant to which NHKQ acquired Lakes' interest in NHKQ. As a result,
Lakes incurred a one-time write-down of $0.7 million before tax. There were no
such write-downs during the current year period.

Earnings per Common Share and Net Earnings

For the nine months ended September 29, 2002, basic and diluted loss per common
share were ($0.84). This compares to basic and diluted earnings per common share
of $1.06 and $1.05, respectively, for the nine months ended September 30, 2001.
Net losses totaled $8.9 million for the nine months ended September 29, 2002
compared to earnings of $11.2 million for the nine months ended September 30,
2001. The decrease in earnings relates primarily to the expiration of the
management contract for Grand Casino Coushatta on January 16, 2002 described
above, as well as the ViatiCare note receivable impairment and impairment on
Polo Plaza and Travelodge properties described above.

THREE MONTHS ENDED SEPTEMBER 29, 2002 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2001

Revenues

Total revenues were $8.7 million for the three months ended September 30, 2001,
which were derived from fees related to the management of Grand Casino
Coushatta. There were no revenues during the current year quarter due to the
expiration of the management contract with the Coushatta Tribe of Louisiana for
Grand Casino Coushatta on January 16, 2002. The Company's revenues and earnings
will not include contributions from the Coushatta operation going forward. As of
September 29, 2002, the Company has no other management contracts from which it
will derive revenues in 2002.

Costs and Expenses

Total costs and expenses were $2.8 million for the three months ended September
29, 2002, compared to $2.9 million for the same period in the prior year.
Selling, general and administrative expenses increased from $2.5 million for the
three months ended September 30, 2001 to $2.7 million for the three months ended
September 29, 2002. This increase is primarily due to an increase in costs
incurred associated with planned casino developments.

Other

Interest income was $0.1 million for the three months ended September 29, 2002
compared to $0.2 million for the same period in the prior year. Equity in loss
of unconsolidated affiliates was $0.1 million for the three month periods ended
September 29, 2002 and September 30, 2001.

24

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

Earnings per Common Share and Net Earnings

For the three months ended September 29, 2002, basic and diluted loss per common
share were ($0.16). This compares to basic and diluted earnings of $0.33 per
common share, for the three months ended September 30, 2001. Losses totaled $1.7
million for the three months ended September 29, 2002 compared to earnings of
$3.5 million for the three months ended September 30, 2001. The decrease in
earnings relates primarily to the expiration of the management contract for
Grand Casino Coushatta on January 16, 2002 described above.

Outlook

Except for fees earned from the management of Grand Casino Coushatta through
January 16, 2002, it is currently contemplated that there will be no additional
operating revenues for the remainder of 2002. Although none of the existing
casino development projects are expected to produce revenue in 2002, Lakes
continues to evaluate potential new revenue-generating business opportunities.
Lakes continues to closely monitor its operating expenses. Currently, operating
expenses are expected to remain consistent for the remainder of 2002, except for
the non-recurring effect of the Living Benefits note receivable impairment and
impairment on Polo Plaza and Travelodge properties described above. The
Company's cash position is considered adequate to cover expected 2002 operating
expenses.

CAPITAL RESOURCES, CAPITAL SPENDING, AND LIQUIDITY

At September 29, 2002, Lakes had $9.8 million and $14.3 million in restricted
and unrestricted cash and cash equivalents, respectively. The restricted cash
balances are planned to be used to indemnify Grand against costs, expenses and
liabilities incurred in connection with or arising out of certain pending and
threatened claims and legal proceedings to which Grand and certain of its
subsidiaries are likely to be parties as well as for the retirement of a note
payable in the amount of $1.0 million. The remaining $0.5 million in restricted
cash represents a deposit received related to the sale of the Polo Plaza
property in Las Vegas, Nevada and will be transferred to Lakes' unrestricted
cash once it is received from the escrow agent. The unrestricted cash balances
are planned to be used to fund operating expenses and for loans to current joint
venture and tribal partners to develop existing and anticipated Indian casino
operations and for the pursuit of additional business opportunities.

The amount and timing of Lakes' cash outlays for casino development loans will
depend on the timing of the regulatory approval process and the availability of
external financing. When approvals are received, additional financing will be
needed to complete the projects. It is currently planned that this third-party
financing will be obtained by each individual tribe. However, there can be no
assurance that if third-party financing is not available, Lakes will not be
required to finance these projects directly. If Lakes must provide this
financing, Lakes expects to obtain debt or equity financing which it would loan
to the respective tribes as necessary.

25

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

As part of a recently announced investment in World Poker Tour, LLC, a joint
venture, which is currently consolidated by Lakes, formed to televise poker
tournaments, the Company was required to invest $0.1 million for an
approximately 78% ownership position in the joint venture. The Company is also
required to loan up to $3.2 million to the joint venture as needed. As of
September 29, 2002, $1.2 million in advances had been made by Lakes on this
loan.

For the nine months ended September 29, 2002, net cash used in operating
activities totaled $1.4 million. For the nine months ended September 30, 2001,
net cash provided by operating activities totaled $14.9 million. A $20.1 million
reduction in net earnings was partially offset by changes in accounts
receivable, which increased by $3.9 million during the 2001 period and decreased
by $3.5 million during the 2002 period. Also contributing to the variance were
changes in income taxes payable which increased by $5.2 million during the 2001
period and decreased by $4.7 million during the 2002 period, as well as a $3.0
million impairment of land held under contract for sale and a $4.0 million
write-down of related party receivables, both in the 2002 period. For the nine
months ended September 29, 2002 and September 30, 2001, net cash used in
investing activities totaled $20.9 million and $2.7 million, respectively.
Included in these investing activities for the nine months ended September 29,
2002 and September 30, 2001, are proceeds primarily from repayment of notes
receivable from Indian-owned casinos, which amounted to $0.1 million and $9.0
million, respectively. Advances under notes receivable were $15.3 million and
$24.0 million for the nine months ended September 29, 2002 and September 30,
2001, respectively. There was a net decrease in short-term investments of $2.1
million and $29.9 million for the nine months ended September 29, 2002 and
September 30, 2001, respectively.

Also during these periods, payments for land held for development amounted to
$3.7 million and $13.0 million, respectively. Included in the payments for land
held for development of $13.0 million during the nine months ended September 30,
2001 was the purchase of the Shark Club property in Las Vegas, Nevada for
approximately $10.1 million. The remaining decrease in payments made for land
held for development from the prior period to the current year period is the
result of the transfer of title and ownership obligations related to the Polo
Plaza Shopping Center to Metroflag Polo, LLC, and transfer of rights and
obligations related to the Travelodge site to Metroflag BP, LLC, on December 28,
2001.

As a part of the agreements dated as of June 30, 1998, by and among Hilton
Hotels Corporation, Park Place, Gaming Acquisition Corporation, Lakes and Grand,
the Company has agreed to indemnify Grand Casinos, Inc. against all costs,
expenses and liabilities incurred in connection with or arising out of certain
pending and threatened claims and legal proceedings to which Grand and certain
of its subsidiaries are likely to be parties. The Company's indemnification
obligations include the obligation to provide the defense of all claims made in
proceedings against Grand and to pay all related settlements and judgments. See
Part II, Item 1. Legal Proceedings.

26

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

As security to support Lakes' indemnification obligations to Grand, Lakes agreed
to deposit, in trust for the benefit of Grand, as a wholly owned subsidiary of
Park Place, an aggregate of $30 million, consisting of four annual installments
of $7.5 million during the four-year period subsequent to December 31, 1998. Any
surplus proceeds remaining in this trust after all the secured obligations are
indefeasibly paid in full and discharged shall be paid over to Lakes. The
Company made the first deposit of $7.5 million on December 31, 1999.

In 2000, Lakes deposited $18.0 million into an escrow account on behalf of the
recipients in the Stratosphere shareholders' litigation and the Grand Casinos,
Inc. shareholders' litigation. As the $18.0 million was paid out during 2001,
the remaining deposit of $7.5 million is included as restricted cash in the
accompanying condensed consolidated balance sheets as of September 29, 2002 and
December 30, 2001. In January 2001, Lakes also purchased the Shark Club property
in Las Vegas for $10.1 million in settlement of another claim that was subject
to the indemnification obligations.

On December 28, 2001, the Company transferred title and ownership obligations of
the Polo Plaza shopping center property to Metroflag Polo, LLC. In conjunction
with this transaction, Lakes transferred to Metroflag BP, LLC, rights to and
obligations of the adjacent Travelodge property consisting of a long-term land
lease and a motel operation. This transaction was accounted for under the
deposit method of accounting under the requirements of Statement of Financial
Accounting Standards No. 66, Accounting for Sales of Real Estate rather than as
a sale. Therefore, the property is included as land held under contract for sale
in the accompanying condensed consolidated balance sheets as of September 29,
2002 and December 30, 2001. The transaction price for this combined transaction
was approximately $30.9 million. Terms of the transaction include a $1.0 million
down payment, a contractual commitment to pay Lakes $23.3 million by December
29, 2002, and a second contractual commitment to pay Lakes $7.5 million on June
30, 2004.

Lakes' collateral for the two contractual commitments is the property and lease
rights described above which would revert back to Lakes in the event of default
by Metroflag. The transaction was closed subject to certain administrative
post-closing conditions that must be satisfied within six months after the
closing. This post-closing period was extended through September 27, 2002. These
conditions were satisfied as of September 27, 2002.

Lakes and Metroflag have restructured the terms of the Polo Plaza and Travelodge
property transactions due to deteriorating economic conditions. The parties have
reduced the purchase price of the Polo Plaza property from $23.3 million to
$21.3 million. On the payment date, which is scheduled to be no later than
January 31, 2003, $17.3 million of the purchase price is payable to Lakes in
cash and $4.0 million is payable through the issuance to Lakes of a preferred
membership interest in Metroflag. On or before December 24, 2003, Metroflag Polo
may elect to distribute to Lakes $3.0 million in cash as full return of Lakes'
preferred interest.

27

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

If Lakes' preferred interest remains outstanding at any time on or after
December 24, 2006, Lakes can require Metroflag to repurchase the preferred
interest for $4.0 million plus a priority return of eight percent (8%) per
annum. Effective June 30, 2002, Lakes recorded a $3.0 million impairment charge
for these properties relating to the adjustment in the purchase price and the
potential discount on the return of Lakes' preferred interest.

Lakes continues to own the Shark Club property, which is an approximate 3.5 acre
undeveloped site adjacent to the Polo Plaza shopping center and Travelodge
sites.

During August 2002, Lakes formed a joint venture with Diamond Resorts, LLC, a
Nevada limited liability company and experienced time-share developer for the
purpose of developing the Shark Club parcel as an upscale time-share project.
The terms of this joint venture agreement require that Diamond and Lakes each
make an initial working capital contribution of $250,000. Subject to Diamond
obtaining a financing commitment for a construction loan sufficient to fund at
least the first phase of the building improvements contemplated by the
time-share project, the joint venture agreement will require Lakes to contribute
the relevant portion of the Shark Club parcel, valued at $16 million. Diamond
has agreed to perform sales, marketing, administrative and managerial services
for the project. The terms of the agreement provide for the repayment to Lakes
of its contribution of property in cash based on the joint venture's cash flow
and time-share unit sales. It is contemplated that Lakes will be required to
make no other material contributions of cash or property to the project.

On October 2, 2002, Lakes loaned $1.0 million to the joint venture. Interest
will accrue at a rate of 10.0% per annum. The loan is due and payable from first
available cash flow of the joint venture (excluding any required capital
contribution from a member) and no later than October 1, 2004.

Lakes has approximately $68.0 million in notes receivable from Indian tribes and
other parties. Most of these amounts are advances made to the tribes for the
development of gaming properties managed by Lakes. See Note 4 to the condensed
consolidated financial statements included in Item 1.

Notes receivable from the Coushatta Tribe of Louisiana were $0.1 million at
December 30, 2001. The outstanding balance was repaid at the conclusion of the
management agreement on January 16, 2002. In addition, Lakes was previously the
guarantor of a loan agreement entered into by the Coushatta Tribe in the amount
of $25.0 million, with a balance of $6.8 million outstanding at December 30,
2001. Lakes was released from the guaranty agreement on January 16, 2002.

On January 2, 2002, the Company completed the purchase of its corporate office
building in Minnetonka, Minnesota for $6.4 million, including transaction
expenses. This transaction resulted in the extinguishment of the Company's
capital lease obligation related to the building.

28

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

OBLIGATIONS

The Company currently has one note payable with a third party. This note is
collateralized by certificates of deposit, with $1.0 million outstanding at
September 29, 2002 and December 30, 2001. Interest is compounded and paid on a
quarterly basis at 10%. The principal and any unpaid interest are due December
22, 2002. A second note which was collateralized by property with $0.4 million
outstanding at June 20, 2002 and December 30, 2001, was repaid on June 20, 2002.

Pursuant to the terms of the Distribution Agreement, Grand assigned to Lakes,
and Lakes assumed, a lease agreement dated February 1, 1996 covering Lakes'
current corporate office space of approximately 65,000 square feet with a lease
term of fifteen years. The lease commenced on October 14, 1996. During 2001,
also pursuant to the terms of the Distribution Agreement, Lakes entered into a
capital lease arrangement for the corporate office space at which time the
operating lease was cancelled. Accordingly, Lakes recorded a capital leased
asset and liability in the amount of approximately $5.8 million. These amounts
are included in the accompanying condensed consolidated balance sheet as of
December 30, 2001. On January 2, 2002, as per the agreement with Grand Casinos,
Lakes purchased the building as discussed above.

SEASONALITY

The Company believes that the operations of all casinos to be managed by the
Company will be affected by seasonal factors, including holidays, weather and
travel conditions.

REGULATION AND TAXES

The Company is subject to extensive regulation by state gaming authorities. The
Company will also be subject to regulation, which may or may not be similar to
current state regulations, by the appropriate authorities in any other
jurisdiction where it may conduct gaming activities in the future. Changes in
applicable laws or regulations could have an adverse effect on the Company.

The gaming industry represents a significant source of tax revenues. 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 the Company's results of operations and financial results.

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 integrated
Quarterly Report on Form 10-Q and other materials filed or to be filed by the
Company with the Securities and Exchange Commission (as well as information
included in oral statements or other written statements made or to be made by
the Company) 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 and the effects of
regulation (including gaming and tax regulation) and competition.

29

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

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 the Company.

These risks and uncertainties include, but are not limited to, those relating to
possible delays in completion of Lakes' casino projects, including various
regulatory approvals and numerous other conditions which must be satisfied
before completion of these projects; possible termination or adverse
modification of management contracts; continued indemnification obligations to
Grand; highly competitive industry; possible changes in regulations; reliance on
continued positive relationships with Indian tribes; possible impairment of
notes receivable of Indian tribes held by Lakes, which represent a large portion
of Lakes' assets; possible need for future financing to meet Lakes' expansion
goals; risks of entry into new businesses; and reliance on Lakes' management.
For further information regarding the risks and uncertainties, see the "Business
- -- Risk Factors" section of the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 30, 2001.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's financial instruments include cash and cash equivalents,
marketable securities and long-term debt. The Company's main investment
objectives are the preservation of investment capital and the maximization of
after-tax returns on its investment portfolio. Consequently, the Company invests
with only high-credit-quality issuers and limits the amount of credit exposure
to any one issuer. The Company does not use derivative instruments for
speculative or investment purposes.

The Company's cash and cash equivalents are not subject to significant interest
rate risk due to the short maturities of these instruments. As of September 29,
2002, the carrying value of the Company's cash and cash equivalents approximates
fair value. The Company's marketable debt securities (principally consisting of
commercial paper, corporate bonds, and government securities) have a weighted
average duration of one year or less. Consequently such securities are not
subject to significant interest rate risk.

The Company's primary exposure to market risk associated with changes in
interest rates involves the Company's notes receivable related to loans for the
development and construction of Native American owned casinos. The loans and
related note balances earn various interest rates based upon a defined reference
rate. The floating rate receivables will generate more or less interest income
if interest rates rise or fall. As of September 29, 2002, Lakes had $68.0
million of floating rate notes receivable. Based on the applicable current
reference rates and assuming all other factors remain constant, deferred
interest income for a twelve month period would be $4.2 million. A reference
rate increase of 100 basis points would result in an increase in deferred
interest income of $0.7 million. A 100 basis point decrease in the reference
rate would result in a decrease of $0.7 million in deferred interest income over
the same twelve month period.

30

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
(UNAUDITED)

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
under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), within 90 days of the filing date of this report.
Based on their evaluation, our chief executive officer and chief financial
officer concluded that Lakes Entertainment, Inc.'s disclosure controls and
procedures are effective.

There have been no significant changes (including corrective actions with regard
to significant deficiencies or material weaknesses) in our internal controls or
in other factors that could significantly affect these controls subsequent to
the date of the evaluation referenced above.

31

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The following summaries describe certain known legal proceedings to which Grand
is a party which Lakes has assumed, or with respect to which Lakes may have
agreed to indemnify Grand, in connection with the Distribution.

SLOT MACHINE LITIGATION

In April 1994, William H. Poulos brought an action in the U.S. District Court
for the Middle District of Florida, Orlando Division -- William H. Poulos, et al
v. Caesars World, Inc. et al -- Case No. 39-478-CIV-ORL-22 -- in which various
parties (including Grand) alleged to operate casinos or be slot machine
manufacturers were named as defendants. The plaintiff sought to have the action
certified as a class action.

A subsequently filed Action -- William Ahearn, et al v. Caesars World, Inc. et
al -- Case No. 94-532-CIV-ORL-22 -- made similar allegations and was
consolidated with the Poulos action.

Both actions included claims under the federal Racketeering-Influenced and
Corrupt Organizations Act and under state law, and sought compensatory and
punitive damages. The plaintiffs claimed that the defendants are involved in a
scheme to induce people to play electronic video poker and slot machines based
on false beliefs regarding how such machines operate and the extent to which a
player is likely to win on any given play.

In December 1994, the consolidated actions were transferred to the U.S. District
Court for the District of Nevada.

In September 1995, Larry Schreier brought an action in the U.S. District Court
for the District of Nevada -- Larry Schreier, et al v. Caesars World, Inc. et al
- -- Case No. CV-95-00923-DWH(RJJ). The plaintiffs' allegations in the Schreier
action were similar to those made by the plaintiffs in the Poulos and Ahearn
actions, except that Schreier claimed to represent a more precisely defined
class of plaintiffs than Poulos or Ahearn.

In December 1996, the court ordered the Poulos, Ahearn and Schreier actions
consolidated under the title William H. Poulos, et al v. Caesars World, Inc., et
al -- Case No. CV-S-94-11236-DAE(RJJ) -- (Base File), and required the
plaintiffs to file a consolidated and amended complaint. In February 1997, the
plaintiffs filed a consolidated and amended complaint.

In March 1997, various defendants (including Grand) filed motions to dismiss or
stay the consolidated action until the plaintiffs submitted their claims to
gaming authorities and those authorities considered the claims submitted by the
plaintiffs.

32

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)

In December 1997, the court denied all of the motions submitted by the
defendants, and ordered the plaintiffs to file a new consolidated and amended
complaint. That complaint has been filed. Grand has filed its answer to the new
complaint.

The plaintiffs have filed a motion seeking an order certifying the action as a
class action. Grand and certain of the defendants have opposed the motion. The
Court has not ruled on the motion.

STANDBY EQUITY COMMITMENT LITIGATION

In September 1997, the Stratosphere Trustee under the indenture pursuant to
which Stratosphere issued its first mortgage notes filed a complaint in the U.S.
District Court for the District of Nevada -- IBJ Schroeder Bank & Trust Company,
Inc. v. Grand Casinos, Inc. -- File No. CV-S-97-01252-DWH (RJJ) -- naming Grand
as defendant.

The complaint alleges that Grand failed to perform under the Standby Equity
Commitment entered into between Stratosphere and Grand in connection with
Stratosphere's issuance of such first mortgage notes in March 1995. The
complaint seeks an order compelling specific performance of what the Trustee
claims are Grand's obligations under the Standby Equity Commitment.

The Stratosphere Trustee filed the complaint in its alleged capacity as a third
party beneficiary under the Standby Equity Commitment. Pursuant to the Second
Amended Plan, a new limited liability company (the "Stratosphere LLC") was
formed to pursue certain alleged claims and causes of action that Stratosphere
and other parties may have against numerous third parties, including Grand
and/or officers and/or directors of Grand. The Stratosphere LLC has been
substituted for IBJ Schroeder Bank & Trust Company, Inc. in this proceeding.

In August 2000, the Court and the parties agreed to try the action upon an
amended joint pre-trial order and a series of post-trial briefs. Post-trial
briefing concluded on December 12, 2000 and oral argument was held on January
22, 2001. On April 4, 2001, the Court entered judgment in favor of Grand and
issued its findings of fact and conclusions of law.

The plaintiff filed an appeal with the Ninth Circuit Court of Appeals on May 4,
2001, Case No. 01-15947. On August 13, 2002, the Ninth Circuit affirmed the
prior ruling in favor of Grand.

STRATOSPHERE PREFERENCE ACTION

In April 1998, Stratosphere served on Grand and Grand Media & Electronics
Distributing, Inc., a wholly owned subsidiary of Grand ("Grand Media"), a
complaint in the Stratosphere bankruptcy case seeking recovery of certain
amounts paid by Stratosphere to (i) Grand as management fees and for costs and
expenses under a management agreement between Stratosphere and Grand, and (ii)
Grand Media for electronic equipment purchased by Stratosphere from Grand Media.

33

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)

Stratosphere claims in its complaint that such amounts are recoverable by
Stratosphere as preferential payments under bankruptcy law. In May 1998, Grand
responded to Stratosphere's complaint denying that Stratosphere is entitled to
recover the amounts described in the complaint. Discovery was completed on
December 31, 2001 and the case proceeded to trial before the United States
Bankruptcy Court for the District of Nevada on June 20, 2002. A decision has not
yet been issued.

OTHER LITIGATION

The Company has recorded a reserve assessment related to various of the above
items based on management's best estimate. The reserve is reflected as a
litigation and claims accrual on the accompanying condensed consolidated balance
sheet as of September 29, 2002 and December 30, 2001.

Grand and Lakes 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 is not likely to have a material adverse effect upon Grand's or the
Company's consolidated financial position or results of operations.

34

LAKES ENTERTAINMENT, INC. AND SUBSIDIARIES
PART II
OTHER INFORMATION (CONTINUED)

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

10.1 Amendment to Purchase Agreement, dated September 27, 2002, and
effective July 1, 2002, by and among Grand Casinos Nevada I,
Inc., a Minnesota corporation, and Metroflag Polo, LLC, a
Nevada limited liability company.

10.2 Amended and Restated Note Secured by Deed of Trust, dated
December 28, 2001, and amended and restated as of July 1,
2002, by and among Metroflag Polo, LLC, a Nevada limited
liability company, and Grand Casinos Nevada I, Inc., a
Minnesota corporation.

10.3 Amendment to Purchase Agreement, dated September 27, 2002, and
effective July 1, 2002, by and among Grand Casinos Nevada I,
Inc., a Minnesota corporation, and Metroflag BP, LLC, a Nevada
limited liability company.

10.4 Amended and Restated Note Secured by Deed of Trust, dated
December 28, 2001, and amended and restated as of July 1,
2002, by and among Metroflag BP, LLC, a Nevada limited
liability company, and Grand Casinos Nevada I, Inc., a
Minnesota corporation.

10.5 Operating Agreement of The Chateaux, LLC dated as of September
26, 2002 by and between Grand Casinos Nevada I, Inc. and
Diamond Resorts, LLC.

10.6 Loan Agreement dated as of September 25, 2002 by and between
Grand Casinos Nevada I, Inc. and The Chateaux, LLC.

10.7 Promissory Note of The Chateaux, LLC dated as of September 25,
2002.

99.1 Certification of Chief Executive Officer

99.2 Certification of Chief Financial Officer

(b) Reports on Form 8-K

(i) A Form 8-K, Item 5. Other Events, was filed on August 7, 2002.

(ii) A Form 8-K, Item 5. Other Events, was filed on August 23,
2002.

(iii) A Form 8-K, Item 5. Other Events, was filed on September 10,
2002.

35

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.

Dated: November 13, 2002 LAKES ENTERTAINMENT, INC.
-------------------------
Registrant

/s/ Lyle Berman
---------------------------------------
Lyle Berman
Chairman of the Board,
Chief Executive Officer and
President

CERTIFICATIONS

I, Lyle Berman, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Lakes Entertainment,
Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statement made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Lakes
Entertainment, Inc., and have:

a. designed such disclosure controls and procedures to ensure that
material information relating to Lakes Entertainment, Inc., including
its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this quarterly
report is being prepared;

b. evaluated the effectiveness of Lakes Entertainment, Inc.'s disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and

36

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. I have disclosed, based on our most recent evaluation, to Lakes
Entertainment, Inc.'s auditors and the audit committee of Lakes
Entertainment, Inc.'s board of directors:

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect Lakes Entertainment, Inc.'s
ability to record, process, summarize and report financial date and
have identified for Lakes Entertainment, Inc.'s auditors any material
weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or other
employees who have a significant role in Lakes Entertainment, Inc.'s
internal controls; and

6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: November 13, 2002 /s/ Lyle Berman
-------------------- ---------------------------
Lyle Berman
Chief Executive Officer

CERTIFICATIONS

I, Timothy J. Cope, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Lakes Entertainment,
Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statement made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Lakes
Entertainment, Inc., and have:

a. designed such disclosure controls and procedures to ensure that
material information relating to Lakes Entertainment, Inc., including
its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this quarterly
report is being prepared;

37

b. evaluated the effectiveness of Lakes Entertainment, Inc.'s disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. I have disclosed, based on our most recent evaluation, to Lakes
Entertainment, Inc.'s auditors and the audit committee of Lakes
Entertainment, Inc.'s board of directors:

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect Lakes Entertainment, Inc.'s
ability to record, process, summarize and report financial date and
have identified for Lakes Entertainment, Inc.'s auditors any material
weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or other
employees who have a significant role in Lakes Entertainment, Inc.'s
internal controls; and

6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: November 13, 2002 /s/ Timothy J. Cope
-------------------- -----------------------------------
Timothy J. Cope
Chief Financial Officer

38