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, 1996 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. 1-12962 GRAND CASINOS, INC. (Exact name of registrant as specified in its charter) Minnesota 41-1689535 (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) (612) 449-9092 (Registrant's telephone number, including area code) 13705 First Avenue North 55441 Minneapolis, Minnesota (Former Zip Code) (Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report) 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 12, 1996, there were 41,776,386 shares of Common Stock, $0.01 par value per share, outstanding. Page 1 of 29 GRAND CASINOS, INC. AND SUBSIDIARIES INDEX Page of Form 10-Q PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets as of 3 September 29, 1996 and December 31, 1995 Consolidated Statements of Earnings 4 for the three months ended September 29, 1996 and October 1, 1995 Consolidated Statements of Earnings for 5 the nine months ended September 29, 1996 and October 1, 1995. Consolidated Statements of Cash Flows 6 for the nine months ended September 29, 1996 and October 1, 1995 Notes to Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND 14 ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 23 ITEM 3. Defaults Upon Senior Securities 26 ITEM 6. Exhibits and Reports On Form 8-K 27 GRAND CASINOS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) * SEPTEMBER 29, 1996 DECEMBER 31, 1995 ---------- ---------- ASSETS Current Assets: Cash and cash equivalents $ 126,290 $ 334,772 Current installments of notes receivable 11,454 13,750 Accounts receivable 19,611 10,864 Deferred income taxes 7,278 6,747 Other current assets 15,186 13,736 ---------- ---------- Total Current Assets 179,819 379,869 ---------- ---------- Property and Equipment, Net 784,444 542,838 ---------- ---------- Other Assets: Cash and cash equivalents-restricted 6,253 6,902 Securities available for sale 33,559 14,200 Notes receivable, less current installments 36,333 43,594 Investments in and notes from unconsolidated affiliates 147,949 109,413 Debt issuance and deferred licensing costs-net 23,754 20,582 Other long-term assets 18,020 10,710 ---------- ---------- Total Other Assets 265,868 205,401 ---------- ---------- TOTAL ASSETS $1,230,131 $1,128,108 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable-trade $ 7,895 $ 6,252 Accounts payable-construction 18,188 12,517 Current installments of long-term debt and capital leases 11,277 11,562 Accrued interest 15,880 4,030 Accrued payroll and related expenses 18,843 17,157 Other accrued expenses 32,922 16,314 ---------- ---------- Total Current Liabilities 105,005 67,832 ---------- ---------- Long-term Liabilities: Long-term debt-less current installments 468,121 459,070 Deferred income taxes 74,489 75,106 ---------- ---------- Total Long-Term Liabilities 542,610 534,176 ---------- ---------- TOTAL LIABILITIES 647,615 602,008 ---------- ---------- COMMITMENTS AND CONTINGENCIES Shareholders' Equity: Common stock, $.01 par value; authorized 100,000 shares; issued and outstanding 41,768 and 40,988 at September 29, 1996 and December 31, 1995, respectively 418 410 Additional paid-in-capital 412,337 397,298 Net unrealized gains on securities available for sale 2,912 2,102 Retained earnings 166,849 126,290 ---------- ---------- Total Shareholders' Equity 582,516 526,100 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,230,131 $1,128,108 ========== ========== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. * DERIVED FROM AUDITED CONSOLIDATED FINANCIAL STATEMENTS. GRAND CASINOS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) (UNAUDITED) THREE MONTHS ENDED ------------------ SEPTEMBER 29, 1996 OCTOBER 1,1995 ------------------ -------------- REVENUES: Casino $ 109,391 $ 71,157 Hotel 6,516 3,626 Food and beverage 14,941 8,940 Management fee income 22,447 20,991 Retail and other income 3,071 2,524 --------- --------- Gross Revenues 156,366 107,238 Less: Promotional allowances (9,641) (3,828) --------- --------- NET REVENUES 146,725 103,410 --------- --------- COSTS AND EXPENSES: Casino 39,509 23,231 Hotel 1,512 1,026 Food and beverage 8,980 4,021 Other operating expenses 3,111 2,545 Depreciation and amortization 14,930 6,491 Lease expense 4,992 3,991 Selling, general and administrative 40,638 28,042 --------- --------- Total Costs and Expenses 113,672 69,347 --------- --------- EARNINGS FROM OPERATIONS 33,053 34,063 --------- --------- OTHER INCOME (EXPENSE): Interest income 4,063 3,919 Interest expense (11,167) (7,078) Gain on sale of investments/Other (expense) (245) 3,232 Equity in loss of unconsolidated affiliates (10,910) (136) --------- --------- Total other income (expense), net (18,259) (63) --------- --------- Earnings before income taxes and minority interest 14,794 34,000 Provision for income taxes 11,291 13,414 --------- --------- Earnings before minority interest 3,503 20,586 Minority interest 0 897 --------- --------- NET EARNINGS $ 3,503 $ 21,483 ========= ========= EARNINGS PER COMMON SHARE $ 0.08 $ 0.61 ========= ========= WEIGHTED AVERAGE COMMON SHARES AND COMMON STOCK EQUIVALENTS OUTSTANDING 42,827 35,175 ========= ========= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. GRAND CASINOS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) (UNAUDITED) NINE MONTHS ENDED ----------------- SEPTEMBER 29, 1996 OCTOBER 1, 1995 ------------------ --------------- REVENUES: Casino $ 263,991 $ 201,664 Hotel 18,555 6,276 Food and beverage 34,009 25,230 Management fee income 61,539 52,004 Retail and other income 8,406 5,511 --------- --------- Gross Revenues 386,500 290,685 Less: Promotional allowances (22,961) (11,016) --------- --------- NET REVENUES 363,539 279,669 --------- --------- COSTS AND EXPENSES: Casino 90,195 63,881 Hotel 4,561 2,079 Food and beverage 18,500 11,703 Other operating expenses 8,686 5,500 Depreciation and amortization 28,269 16,872 Lease expense 13,164 10,888 Selling, general and administrative 102,487 78,175 --------- --------- Total Costs and Expenses 265,862 189,098 --------- --------- EARNINGS FROM OPERATIONS 97,677 90,571 --------- --------- OTHER INCOME (EXPENSE): Interest income 13,501 10,664 Interest expense (21,733) (19,290) Gain on sale of investment/Other (expense) (245) 4,853 Equity in loss of unconsolidated affiliates (14,749) (406) --------- --------- Total other (expense), net (23,226) (4,179) --------- --------- Earnings before income taxes and minority interest 74,451 86,392 Provision for income taxes 33,892 33,920 --------- --------- Earnings before minority interest $ 40,559 $ 52,472 Minority interest 0 2,353 --------- --------- NET EARNINGS 40,559 54,825 ========= ========= EARNINGS PER COMMON SHARE $ 0.94 $ 1.59 ========= ========= WEIGHTED AVERAGE COMMON SHARES AND COMMON STOCK EQUIVALENTS OUTSTANDING 42,985 34,476 ========= ========= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. GRAND CASINOS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED ----------------- SEPTEMBER 29, 1996 OCTOBER 1, 1995 ------------------ --------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 40,559 $ 54,825 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 26,527 14,318 Amortization of original issue discount and debt issuance costs 1,742 4,743 Gain on sale of investment 0 (4,853) Equity in loss of unconsolidated affiliate 14,749 406 Decrease in minority interest 0 (2,353) Change in deferred income taxes 616 0 Write-off of project note receivables (340) 0 Changes in operating assets and liabilities: Current assets (15,460) (2,446) Accounts payable 7,314 3,458 Accrued expenses and income taxes 34,849 26,085 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 110,556 94,183 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Increase in notes receivable (453) (10,409) Investment in and notes receivable from unconsolidated affiliates (53,664) (20,059) Proceeds from repayment of notes receivable 10,349 17,675 (Increase) decrease in cash and cash equivalents-restricted 649 (162,839) Payments for property and equipment (261,508) (108,234) Purchases of securities available for sale (19,750) 0 Proceeds from sale of investment 0 4,778 Increase in other long-term assets (13,455) (560) --------- --------- NET CASH USED IN INVESTING ACTIVITIES (337,832) (279,648) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Decrease in accounts payable-construction 0 (329) Proceeds from issuance of common stock-net 15,047 1,337 Debt issuance costs and deferred financing costs (5,018) (12,838) Proceeds from issuance of long-term debt 18,429 235,500 Payments on long-term debt and capital lease obligations (9,664) (12,222) Increase in minority interest due to exercise of Stratosphere warrants 0 4,663 Gain on exercise of Stratosphere Corporation warrants 0 6,272 --------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES 18,794 222,383 --------- --------- Net increase (decrease) in cash and cash equivalents (208,482) 36,918 Cash and cash equivalents - beginning of period 334,772 29,797 --------- --------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 126,290 $ 66,715 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest - net of capitalized interest $ 9,883 $ 20,027 Income taxes $ 15,719 $ 26,354 NON-CASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock for debt issuance costs $ 0 $ 4,000 Increase in goodwill due to an increase in ownership of Stratosphere Corporation $ 0 $ 4,185 Increase in minority interest due to an increase in ownership of Stratosphere Corporation $ 0 $ 16,296 Deferred income taxes on gain on exercise of Stratosphere Corporation warrants $ 0 $ 2,200 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS GRAND CASINOS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 29, 1996 (UNAUDITED) NOTE 1 UNAUDITED FINANCIAL STATEMENTS Grand Casinos, Inc. and Subsidiaries, collectively the Company, develop, construct, and manage land-based and dockside casinos and related hotel and entertainment facilities primarily in emerging gaming jurisdictions. The Company owns and operates two dockside casinos on the Mississippi Gulf Coast, one dockside casino in Tunica County, Mississippi, and manages two Indian-owned casinos in Minnesota and two Indian-owned casinos in Louisiana. It is also an owner of approximately 42% of Stratosphere Corporation (Stratosphere), which constructed the Stratosphere project in Las Vegas, Nevada, which opened on April 29, 1996. Related hotel and entertainment facilities at the Grand Casino Biloxi and Grand Casino Tunica projects are currently under construction and will open at various times. The consolidated financial statements include the accounts of Grand Casinos, Inc. and its wholly-owned and majority-owned subsidiaries. The prior year's accompanying consolidated financial statements include the accounts of Stratosphere through December 20, 1995, the date on which the Company owned less than 50% of the voting stock of Stratosphere. Investments in unconsolidated subsidiaries representing between 20% and 50% of voting stock are accounted for on the equity method. All material intercompany balances and transactions have been eliminated in the consolidation. The accompanying unaudited consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles 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 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, 1996, are not necessarily indicative of the results that may be expected for the fiscal year ending December 29, 1996. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended December 31, 1995. NOTE 2 INCOME RECOGNITION The Company recognizes revenues from its owned and operated casinos in accordance with industry practice. Casino revenue is the net win from gaming activities (the difference between gaming wins and losses). Casino revenues are net of accruals for anticipated payouts of progressive and certain other slot machine jackpots. Revenues include the retail value of food and beverage and other items which are provided to customers on a complimentary basis. A corresponding amount is deducted as promotional allowances. The costs of such complimentaries are included in casino costs and expenses in the accompanying Consolidated Statements of Earnings. Revenue from the management of Indian-owned casino gaming facilities is recognized when earned according to the terms of the management contracts. NOTE 3 INVENTORIES Inventories, consisting of food and beverage, retail and operating supplies, are stated at the lower of cost or market. Cost is determined using the first in, first out method. NOTE 4 PREOPENING EXPENSES Preopening expenses incurred prior to opening of Company-owned facilities are capitalized and amortized to expense using the straight-line method over the six months following the opening of the respective facilities. The majority of these costs include payroll, training, and marketing costs incurred prior to commencement of operations. Depreciation and amortization for the nine months ended September 29, 1996 and October 1, 1995 includes approximately $5.6 million and $.6 million of preopening amortization expense, respectively. For the three months ended September 29, 1996 and October 1, 1995, approximately $5.2 million and $.4 million, respectively, of preopening amortization was expensed. NOTE 5 EARNINGS PER COMMON SHARE Earnings per common share was determined by dividing net earnings by the weighted average number of common shares and common stock equivalents outstanding during the nine and three months ended September 29, 1996 and October 1, 1995. NOTE 6 PROPERTY AND EQUIPMENT Property and equipment are stated at cost, except in the case of capitalized lease assets, which are stated at the lower of the present value of the future minimum lease payments or fair market value at the inception of the lease. Expenditures for additions, renewals and improvements are capitalized. Costs of repairs and maintenance are expensed when incurred. Depreciation of property and equipment is computed using the straight-line method over useful lives of three to forty years. Leasehold acquisition costs are amortized over the shorter of the estimated useful life or the term of the respective leases once the assets are placed in service. NOTE 7 AMORTIZATION OF ORIGINAL ISSUE DISCOUNT AND DEBT ISSUANCE COSTS Original issue discounts are amortized using the effective interest method, over the life of the related indebtedness. Debt issuance costs are amortized using the straight-line and effective interest methods, over the life of the related indebtedness. NOTE 8 INTEREST COSTS Interest is capitalized in connection with the construction of major facilities. The capitalized interest is recorded as part of the asset to which it relates and is amortized over the asset's estimated useful life once the asset is placed in service. For the nine months ended September 29, 1996 and October 1, 1995, approximately $14.1 million and $13.6 million, respectively, of interest cost was capitalized. For the three months ended September 29, 1996 and October 1, 1995, approximately $1.0 million and $5.4 million, respectively, of interest cost was capitalized. Capitalized interest for Stratosphere which was included in the consolidated financial statements for the nine and three months ended October 1, 1995 was $7.7 million and $3.9 million, respectively. NOTE 9 NOTES RECEIVABLE Notes receivable consist of the following (in thousands): September 29, 1996 Dec. 31, 1995 ------------------ ------------- Notes from the Coushatta Tribe with interest at a defined reference rate plus 1% (not to exceed 16%), receivable in 84 monthly installments through January 2002 24,386 26,903 Notes from the Tunica-Biloxi Tribe with interest at a defined reference rate plus 1% (not to exceed 16%), receivable in 84 monthly installments through June 2001 13,070 14,529 Notes from the Mille Lacs Band with interest at a defined reference rate plus 1% (not to exceed 16%), receivable in varying installments through October 1997 1,886 3,071 Notes from the Mille Lacs Band, with interest at 9.75%, receivable in 60 monthly installments through December 1997 1,577 2,435 Other 6,868 10,406 ------- ------- $47,787 $57,344 Less current installments of notes receivable 11,454 13,750 ------- ------- Notes receivable-less current installments $36,333 $43,594 ======= ======= NOTE 10 LONG-TERM DEBT On November 30, 1995, the Company completed its public offering of $450.0 million of eight year 10.125% First Mortgage Notes due December 1, 2003, realizing net cash proceeds of approximately $434.5 million after underwriting and other related offering costs. The Company used $132.6 million of net proceeds to extinguish $115.0 million aggregate principal amount of 12.5% First Mortgage Notes due on February 1, 2000 (including accrued interest of $4.8 million and $12.8 million related to a tender offer premium and expenses), and $25.3 million to retire all outstanding principal and interest due under a credit facility with First Interstate Bank of Nevada, N.A. (F.I.B. Note). The balance of net proceeds of approximately $275.7 million is to be used to develop and open Grand Casino Tunica and to construct additional hotel rooms and entertainment and gaming-related amenities at Grand Casino Biloxi and Grand Casino Gulfport. The 10.125% First Mortgage Notes are secured by substantially all the assets of Grand Casino Biloxi and Grand Casino Gulfport, Grand Casino Tunica assets included in Phase 1 development, capital stock owned by the Company in Stratosphere, and certain existing notes receivable due the Company from Tribes. The notes require semi-annual payments of interest only on June 1 and December 1 of each year which commenced June 1, 1996, until December 1, 2003, at which time the entire principal plus accrued interest is due and payable. The notes may be redeemed at the Company's option, in whole or in part, anytime after December 1, 1999, at a premium, declining ratably thereafter to par value on December 1, 2002, to maturity. On May 10, 1996, the Company completed a $120 million Senior Secured Term Loan through BankAmerica Leasing and Capital Group. The five-year Senior Secured Term Loan Facility, with varying interest rates ranging from 1.75% to 2.50% over the LIBO Rate, will be used for the continued development of the Company's Grand Casino Tunica project, located in northern Mississippi, just outside of Memphis,Tennessee. Approximately $90 million of the loan will be used for furniture, fixtures and equipment for the 340,000 square foot casino complex. The balance of approximately $30 million will be used to construct a 600-room hotel at Grand Casino Tunica. As of September 29, 1996, $18.4 million had been advanced under the Senior Secured Term Loan Facility. NOTE 11 COMMITMENTS AND CONTINGENCIES STRATOSPHERE CORPORATION On March 9, 1995, the Company converted $33.5 million of outstanding advances to Stratosphere into an aggregate 8.25 million shares of common stock. The Company has agreed to provide credit enhancements, subject to certain limitations, to guarantee completion of construction of the project to a limit of $50.0 million and to purchase up to $20.0 million of additional equity in Stratosphere during each of the first three years (up to $60.0 million total) Stratosphere is operating to the extent Stratosphere's consolidated cash flow does not reach $50.0 million in each of such years. As of September 29, 1996 and October 1, 1996, the Company has loaned $49.4 million and $50.0 million, respectively to Stratosphere pursuant to the Completion Guarantee. On October 24, 1996, Stratosphere announced that it continues to seek additional financing and is discussing restructuring both its existing First Mortgage Note indebtedness and capital lease obligation. Based on Stratosphere's current and projected cash position, Stratosphere does not plan to make the First Mortgage Note interest payment of $14.5 million that is due November 15, 1996. Failure to make such payment will result in an event of default that gives the note holders the right to accelerate such indebtedness. This right does not vest until the expiration of the 30 day right to cure this default by Stratosphere. Stratosphere does not currently have the ability to repay the indebtedness. It is likely that Stratosphere's negotiations with its creditors, whether successful or not at arriving at a restructuring, will involve a bankruptcy filing by Stratosphere as a means of formalizing and approving a consensual or nonconsensual restructuring. Stratosphere has suspended construction of Phase II. If Stratosphere cannot restructure its existing indebtedness, there will be serious doubt as to whether or not Stratosphere will be able to continue as a going concern. Depending upon the terms of any restructuring of Stratosphere, the Company's participation in any such restructuring, and the valuation of the Company's position in Stratosphere following any such restructuring, the Company may be required to write off a substantial portion or all of its previous investment in Stratosphere. Any such write-off would have a material adverse effect on the Company's results of operations and financial position. LOAN GUARANTY AGREEMENTS The Company has guaranteed a loan and security agreement entered into by the Tunica-Biloxi Tribe of Louisiana for $14.1 million for the purpose of financing casino equipment. The agreement extends through 1998, and as of September 29, 1996, the amount outstanding was $7.6 million. In addition, the Company has guaranteed loan and security agreements entered into by the Coushatta Tribe of Louisiana for $22.3 million for the purpose of financing casino equipment. The agreements are for three years and have various maturity dates through 1998, and as of September 29, 1996, the amounts outstanding were $16.1 million. The Company has entered into a master hotel development agreement with Casino Resource Corporation for the hotel adjacent to Grand Casino Hinckley. The Company has guaranteed the mortgage related to the hotel in the amount of $2.8 million as of September 29, 1996. OTHER The Company is a defendant in various pending litigation. In management's opinion, the ultimate outcome of such litigation will not have a material adverse effect on the results of operations or the financial position of the Company. See Part II -- Item 1. Legal Proceedings of this Form 10-Q. GRAND CASINOS, 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 OVERVIEW The Company develops, constructs and manages land-based and dockside casinos primarily in emerging gaming jurisdictions. The Company's revenues are derived from the Company-owned casinos of Grand Casino Biloxi, Grand Casino Gulfport, and Grand Casino Tunica, and from management fee income from Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles, and Grand Casino Coushatta. Pursuant to the Mille Lacs, Hinckley, Avoyelles, and Coushatta management contracts, the Company receives a fee equal to 40% of the net distributable profits generated by Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles, and Grand Casino Coushatta. The Company commenced operations in August 1990, and opened its Company-owned casinos, Grand Casino Gulfport, Grand Casino Biloxi and Grand Casino Tunica in May 1993, January 1994 and June 1996, respectively. Therefore, the Company's limited operating history may not be indicative of the Company's future performance. In addition, a comparison of results from year to year may not be meaningful due to the opening of new facilities during such years. The Company's growth strategy contemplates expanding existing operations and establishing additional gaming operations. The successful implementation of this growth strategy is contingent upon the satisfaction of various conditions and the occurrence of certain events, including obtaining governmental approvals and increased competition, many of which are beyond the control of the Company. The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1995. The casino operations of Grand Casino Tunica opened to the public on June 24, 1996. Accordingly, there are only approximately three months of Grand Casino Tunica's operations included in the results of operations for the nine month period ended September 29, 1996. The Company's long term plan was, and continues to be, to develop Grand Casino Tunica into a destination resort with the development of hotels and other amenities over the next several months. A 188 room hotel opened on September 22, 1996 and 1,200 additional rooms are currently under development. Until such time that such hotels and other amenities are fully operational, Grand Casino Tunica will be dependent on the highly competitive day trip market. Although Grand Casino Tunica has only been open for a short period of time, gaming revenue for the period of time since opening is below expectations. The Company believes that the addition of hotels and other amenities will improve Grand Casino Tunica's performance. However, there can be no assurance that results will improve as such additional amenities are added. Revenues from owned and operated casinos are calculated in accordance with generally accepted accounting principles and are presented in a manner consistent with industry practice. Net distributable profits from Grand Casino Mille Lacs, Grand Casino Hinckley, Grand Casino Avoyelles, and Grand Casino Coushatta are computed using a modified cash basis of accounting in accordance with the management contracts. The effect of the use of the modified cash basis of accounting is to accelerate the write-off of capital equipment and leased assets, which thereby impacts the timing of net distributable profits. RESULTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 29, 1996 COMPARED TO THE NINE MONTHS ENDED OCTOBER 1, 1995 Earnings Per Common Share and Net Earnings Earnings per common share for the nine months ended September 29, 1996 were $.94 versus $1.59 for the prior year's comparable period based upon weighted average common shares outstanding of 43.0 million and 34.5 million for the nine month periods ended September 29, 1996 and October 1, 1995, respectively. The increase in the weighted average common shares outstanding was primarily a result of the acquisition of Gaming Corporation of America and Grand Gaming Corp. on November 30, 1995 in which 7.3 million shares of common stock were issued. Net earnings decreased $14.3 million to $40.6 million for the nine months ended September 29, 1996 compared to the prior year. Net earnings were negatively impacted by pre-opening costs from Grand Casino Tunica in the amount of $5.2 million. Earnings were also impacted by Grand's 42% equity share in the Stratosphere loss in the amount of $14.8 million during the period. Net Revenues Net revenues for the Company increased $83.9 million for the nine months ended September 29, 1996 compared to the same period in the prior year. The increase in net revenues is primarily due to increased revenues at Company owned facilities on the Gulf Coast of Mississippi and Tunica County, Mississippi in the amount of $39.7 million and $35.1 million, respectively, and increased management fee income from Indian-owned casinos in the amount of $9.5 million. Grand Casino Tunica opened on June 24, 1996. Accordingly, only three months of Grand Casino Tunica's operations are included in the results for the nine months ended September 29, 1996. Grand Casino Biloxi, Grand Casino Gulfport and Grand Casino Tunica generated $264.0 million in gross casino revenue and $61.0 million in gross hotel, food, beverage, retail, and entertainment revenue during the nine months ended September 29, 1996. During the nine months ended October 1, 1995, Grand Casino Biloxi and Grand Casino Gulfport generated $201.7 million in gross casino revenue and $37.0 million in gross hotel, food, beverage and retail revenue. The increase in gross revenue is primarily a result of hotels opened at both Grand Casino Biloxi and Grand Casino Gulfport for the entire nine months ended September 29, 1996 and Grand Casino Tunica being open for approximately three months. The Biloxi Hotel and Gulfport Hotel opened in April 1995 and October 1995, respectively. Costs and Expenses Total costs and expenses increased $76.8 million from $189.1 million for the nine months ended October 1, 1995 to $265.9 million for the nine month period ended September 29, 1996. Casino expenses were $90.2 million for the nine month period ended September 29, 1996 compared to $63.9 million for the comparable period. This casino expense increase is principally related to the increase of $39.7 million in casino revenues at Biloxi and Gulfport and the opening of Grand Casino Tunica. As a result of additional overnight guests at Grand Casino Biloxi and Grand Casino Gulfport, additional casino expenses in the form of complimentary rooms and entertainment have increased casino expenses. Food and beverage expenses increased $6.8 million to $18.5 million for the nine month period ended September 29, 1996, of which $3.7 million was a result of the opening of Grand Casino Tunica. Increases in selling, general and administrative expenses in the amount of $24.3 million are primarily attributable to increases in marketing expenses in the amount of $7.2 million for the Biloxi and Gulfport properties as a result of air charter programs and additional promotions, marketing expenses for Grand Casino Tunica in the amount of $4.4 million, increases in indirect expenses associated with the Biloxi and Gulfport Hotels, as well as additional costs relating to the opening of Grand Casino Tunica in the amount of $7.6 million. Other Interest income increased by $2.8 million to $13.5 million for the nine months ended September 29, 1996. This increase is primarily attributable to interest income earned on the proceeds of the Company's $450.0 million First Mortgage Note offering that closed on November 30, 1995. In addition, interest expense increased by $2.4 million to $21.7 million for the nine months ended September 29, 1996 compared to $19.3 million for the nine months ended October 1, 1995. The increase is the result of increased interest due to $450 million First Mortgage Notes and advances under $120 million Senior Secured Term Loan. THREE MONTHS ENDED SEPTEMBER 29, 1996 COMPARED TO THE THREE MONTHS ENDED OCTOBER 1, 1995 Earnings Per Common Share and Net Earnings Earnings per common share for the three months ended September 29, 1996 were $.08 versus $.61 for the prior year's comparable period based upon weighted average common shares outstanding of 42.8 million and 35.2 million for the three month periods ended September 29, 1996 and October 1, 1995, respectively. The increase in the weighted average common shares outstanding was primarily a result of the acquisition of Gaming Corporation of America and Grand Gaming Corp. on November 30, 1995 in which 7.3 million shares of common stock were issued. Net earnings decreased $18.0 million to $3.5 million for the three months ended September 29, 1996 compared to the prior year. Net earnings per share were negatively impacted by pre-opening costs from Grand Casino Tunica and Grand's 42% share of Stratosphere preopening costs in the amount of $5.2 and $5.1 million, respectively. In addition, earnings includes a $4.3 million net loss from operations at Tunica and Grand's 42% equity share in the Stratosphere loss in the amount of $8.8 million during the period. Net Revenues Net revenues for the Company increased $43.3 million for the three months ended September 29, 1996 compared to the same period in the prior year. The increase in net revenues is primarily due to increased revenues at Company owned facilities Grand Casino Biloxi, Grand Casino Gulfport and Grand Casino Tunica and increased management fee income from Indian owned casinos. Grand Casino Biloxi and Grand Casino Gulfport generated net revenues of $94.0 million during the three months ended September 29, 1996, an increase of $11.7 million compared to the comparable period in the prior year and Grand Casino Tunica generated $30.3 million net revenues for the quarter. Management fee income from Indian owned casinos increased by $1.5 million during the three month period ended September 29, 1996 compared to the comparable period. Grand Casino Biloxi, Grand Casino Gulfport and Grand Casino Tunica generated $109.4 million in gross casino revenue and $24.5 million in gross hotel, food, beverage, retail and entertainment revenue during the three months ended September 29, 1996. During the three months ended October 1, 1995, Grand Casino Biloxi and Grand Casino Gulfport generated $71.2 million in gross casino revenue and $14.9 million in gross hotel, food, beverage and retail revenue. The increase in gross revenue is primarily a result of hotels opened at both Grand Casino Biloxi and Grand Casino Gulfport for the entire three months ended September 29, 1996, whereas, only the Biloxi Hotel was open during the three months ended October 1, 1995. In addition, Grand Casino Tunica revenues were included for the entire three months ended September 29, 1996. Costs and Expenses Total costs and expenses increased $44.3 million from $69.3 million for the three months ended October 1, 1995 to $113.7 million for the three month period ended September 29, 1996. Casino expenses were $39.5 million for the three month period ended September 29, 1996 compared to $23.2 million for the comparable period, principally due to the increase of $38.2 million in casino revenues. As a result of additional overnight guests at Biloxi and Gulfport, additional casino expenses in the form of complimentary rooms and entertainment have increased casino expenses. Food and beverage expenses increased $5.0 million to $9.0 million for the three month period ended September 29, 1996, of which Grand Casino Tunica accounted for $3.4 million of the increase. Increases in selling, general and administrative expenses in the amount of $12.6 million are primarily attributable to increases in marketing expenses in the amount of $1.0 million for the Biloxi and Gulfport properties, marketing expenses in the amount of $4.3 million for Grand Casino Tunica, and indirect expenses for Grand Casino Tunica in the amount of $6.8 million. Other Interest expense increased by $4.1 million to $11.2 million for the three months ended September 29, 1996 compared to $7.1 million for the three months ended October 1, 1995. The increase is the result of increased interest due to $450 million First Mortgage Notes and advances under the $120 million Senior Secured Term Loan. CAPITAL RESOURCES AND LIQUIDITY As of September 29, 1996, the company had cash and cash equivalents of $126.3 million. For the nine months ended September 29, 1996, capital expenditures were $261.5 million compared to $108.2 million for the comparable period in the prior year. The majority of expenditures, $242.9 million for the nine months ended September 29, 1996, related to construction of Grand Casino Tunica. Based upon current construction plans, the Company expects that development, construction, equipping and furnishing Grand Casino Tunica will require an aggregate of approximately $490 million, of which $342.4 million was expended as of September 29, 1996. The Company secured $120.0 million in Senior Secured Term Loan Facility for the Grand Casino Tunica project. Based on the current construction plans, the continued development of Grand Casino Tunica will require $147.6 million of additional capital, of which $101.6 million is anticipated to be funded through the Senior Secured Term Loan Facility for the Grand Casino Tunica project. These estimates are based upon current construction plans, which are subject to change, and the scope and cost of each of the Company's projects may vary significantly from that which is currently anticipated. The Company, in conjunction with the closing of Stratosphere Corporation's First Mortgage Notes, agreed to provide credit enhancements, subject to certain limitations, to guarantee completion of construction of the Stratosphere project up to a limit of $50.0 million and to purchase up to $20.0 million of additional equity in Stratosphere Corporation during each of the first three years (up to $60.0 million total) after Stratosphere Corporation commences operations to the extent Stratosphere's consolidated cash flow does not reach $50.0 million in each of such years. As of October 1, 1996, the Company has loaned $50.0 million to Stratosphere pursuant to the Completion Guarantee. Based on Stratosphere's net loss reported for the third quarter of 1996 in the amount of $26.0 million and the factors discussed below, there can be no assurance that Stratosphere will generate sufficient cash flow to service this debt. Pursuant to the terms of the Completion Guarantee, Stratosphere is permitted to defer the payment of interest and principal on such indebtedness. Stratosphere has announced that its cash on hand and projected internally generated funds will not be sufficient to fund Stratosphere's cash requirements for existing operations, including debt service. The Company is not obligated to provide funds to Stratosphere other than as noted above. Stratosphere has announced that its cash on hand and internally generated funds will not be sufficient to fund the cash requirements of its existing operations, current trade and construction payables and debt service. Stratosphere has also announced that it does not plan to make its regularly scheduled interest payment on its First Mortgage Notes due on November 15, 1996, of $14.5 million. Failure of Stratosphere to service debt will result in an event of default under Stratosphere's First Mortgage Note Indenture that gives the Stratosphere note holders the right to accelerate such indebtedness. This right does not vest until the expiration of the 30 day right to cure this default by Stratosphere. It is likely that Stratosphere's negotiations with its creditors, whether successful or not at arriving at a restructuring, will involve a bankruptcy filing by Stratosphere as a means of formalizing and approving a consensual or nonconsensual restructuring. If Stratosphere cannot restructure its existing indebtedness, there will be serious doubt as to whether or not Stratosphere will be able to continue as a going concern. Depending upon the terms of any restructuring of Stratosphere, the Company's participation in any such restructuring, and the valuation of the Company's position in Stratosphere following any such restructuring, the Company may be required to write off a substantial portion or all of its previous investment in Stratosphere. Any such write-off would have a material adverse effect on the Company's results of operations and financial position. On October 10, 1996, Stratosphere paid $2.3 million to the Company pursuant to the Management and Development Agreement entered into on July 1, 1994. The Company has agreed to either refund the $2.3 million to Stratosphere or advance the amount as a loan by November 5, 1996. As of November 13, 1996, such amount has not been paid to Stratosphere. In addition, Stratosphere has purchased certain equipment from a wholly-owned subsidiary of the Company in the approximate amount of $3.7 million. As of November 13, 1996, approximately $2.5 million of such amount remained unpaid. Stratosphere has advised the Company that is has accrued this cost and intends to pay such amount as part of the final funding of Phase I. Pursuant to the Company's covenants related to the $450.0 million First Mortgage Notes, the Company is restricted from paying cash dividends and from transferring funds from certain subsidiaries to the Company. Because of such restrictions and to provide funds for the growth of the Company, no cash dividends are expected to be paid on common shares in the foreseeable future. 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 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) contains statements that are forward-looking, such as statements relating to plans for future expansion and other busines development activities as well as other capital spending, financing sources and the effects of regulation (including gaming and tax regulation) and competition. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ 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 development and construction activities, dependence on existing management, leverage and debt service (including sensitivity to fluctuations in interest rates), domestic or global economic conditions, changes in federal or state tax laws or the administration of such laws and changes in gaming laws or regulations (including the legalization of gaming in certain jurisdictions). GRAND CASINOS, INC. AND SUBSIDIARIES PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 1. Stratosphere Shareholders Lawsuits - Federal Court The Company's Quarterly Report Form on Form 10-Q for the fiscal quarter ended June 30, 1996 described a lawsuit (the `Ceasar Lawsuit') entitled Michael Ceasar, et al v. Stratosphere Corporation, et al which was filed on August 5, 1996 in the United States District Court for the District of Nevada. The Ceasar Lawsuit involves claims against Stratosphere Corporation, the Company, Bob Stupak (a former officer and director of Stratosphere), David R. Wirshing (a former officer and director of Stratosphere), Lyle A. Berman (an officer and director of the Company and an officer and director of Stratosphere), Thomas A. Lettero (an officer of Stratosphere), Andrew S. Blumen (an officer and director of Stratosphere), Bob Stupak Enterprises and Thomas G. Bell (a director of Stratosphere). The complaint in the Ceasar Lawsuit purports to seek relief on behalf of a class of plaintiffs who purchased Stratosphere common stock during the period from December 19, 1995 through and including July 22, 1996. That complaint alleges that the defendants made misrepresentations and engaged in other wrongdoing. In August, September and October 1996, complaints in the following lawsuits were filed in the United States District Court for the District of Nevada against the defendants in the Ceasar Lawsuit (and in one instance also against Stanley Taube - an officer and director of the Company and a director of Stratosphere) alleging, in a manner nearly identical to the complaint in the Ceasar Lawsuit, that the defendants made misrepresentations and engaged in other wrongdoing: Name of Lawsuit Date Filed Regina Peltz, et al v. Stratosphere Corporation August 13, 1996 Grand Casinos, Inc., Bob Stupak, David R. Wirshing, Lyle A. Berman, Thomas A. Lettero Andrew Blumen, Bob Stupak Enterprises and Thomas G. Bell Robert Stengel, et al v. Stratosphere Corporation August 13, 1996 Corporation, Grand Casinos, Inc., Bob Stupak, David R. Wirshing, Lyle A. Berman, Thomas A. Lettero, Andrew S. Blumen, Bob Stupak Enterprises and Thomas G. Bell Robert Johnson, et al v. Stratosphere Corporation, Sept. 19, 1996 Grand Casinos, Inc., David R. Wirshing, Lyle A. Berman, Thomas A. Lettero, Andrew S. Blumen, Bob Stupak Enterprises and Thomas G. Bell David Vallee, et al v. Stratosphere Corporation, Sept. 25, 1996 Grand Casinos, Inc., Bob Stupak, David R. Wirshing, Lyle A. Berman, Thomas A. Lettero, Andrew S. Blumen, Bob Stupak Enterprises and Thomas G. Bell Anthony L. Poli, et al v. Stratosphere Corporation, Sept. 25, 1996 Grand Casinos, Inc., Bob Stupak, David R. Wirshing, Lyle A. Berman, Thomas A. Lettero, Bob Stupak Enterprises, Thomas G. Bell and Stanley M. Taube Darrell Russell and Gail Russell, et al v. October 7, 1996 Stratosphere Corporation, Grand Casinos, Inc., Bob Stupak, David R. Wirshing, Lyle A. Berman, Thomas A. Lettero, Andrew S. Blumen, Bob Stupak Enterprises and Thomas G. Bell Mitchell Gordon, et al v. Stratosphere October 7, 1996 Corporation, Grand Casinos, Inc., Bob Stupak, David R. Wirshing, Lyle A. Berman, Thomas A. Lettero, Andrew S. Blumen, Bob Stupak Enterprises and Thomas G. Bell The Company believes that the claims made in the complaint in each of the above lawsuits are without merit and plans to vigorously defend such claims. 2. Stratosphere Shareholders Lawsuit - State Action On August 16, 1996, a complaint was filed in the District Court for Clark County, Nevada (Victor M. Opitz, et al v. Robert E. Stupak, et al) against Robert E. Stupak (a former officer and director of Stratosphere), Lyle A. Berman (an officer and director of the Company and an officer and director of Stratosphere), Patrick R. Cruzen (a former officer and director of Stratosphere), Timothy J. Cope (an officer of the Company) and Stanley M. Taube (an officer and director of the Company and a director of Stratosphere). The complaint purports to seek relief on behalf of a class of plaintiffs who purchased Stratosphere common stock during the period from December 19, 1995 through July 22, 1996. The complaint alleges that the defendants made representations and engaged in other wrongdoing. The Company believes that the claims made in the Victor M. Opitz, et al v. Stratosphere Corp., et al complaint are without merit and plans to vigorously defend such claims. 3. Grand Shareholders Lawsuits - Federal Court The following complaints have been filed in the United States District Court for the District of Minnesota against the Company, Lyle A. Berman (an officer and director of the Company), Patrick R. Cruzen (a former officer and director of the Company), Timothy J. Cope (an officer of the Company) and Stanley M. Taube (an officer and director of the Company): Name of Lawsuit Date Filed Joel Blake v. Grand Casinos, Inc., Lyle A. September 9, 1996 Berman, Patrick R. Cruzen, Timothy J. Cope and Stanley M. Taube Robert D. Marcus v. Grand Casinos, Inc., October 25, 1996 Lyle A. Berman, Patrick R. Cruzen, Timothy J. Cope and Stanley M. Taube. The complaint in each of the above lawsuits purports to seek relief on behalf of a class of plaintiffs who purchased common stock of the Company during the period from December 19, 1995 through July 22, 1996. The complaint in each of the above actions makes nearly identical allegations and alleges that the defendants made misrepresentations and engaged in other wrongdoing. The Company believes that the claims made in each of the above lawsuits are without merit and plans to vigorously defend such claims. See the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 and the Company's Quarterly Reports on Form 10-Q for the fiscal quarter ended March 31, 1996 and June 30, 1996 for information regarding other pending legal proceedings. ITEM 3. DEFAULTS UPON SENIOR SECURITIES - STRATOSPHERE CORPORATION The Company is the owner of approximately 42% of Stratosphere Corporation (Stratosphere) and has an investment in and advances due from Stratosphere in the amount of $145.6 million as of September 29, 1996. Based upon Stratosphere's third quarter results, Stratosphere determined that it would not meet certain financial covenants which would constitute an event of default under Stratosphere's capital lease that would give the lender the right to accelerate maturity. On October 30, 1996, Stratosphere entered into a Standstill Agreement with the lenders that will remain in effect until the earlier of the bankruptcy filing or payment default. Pursuant to the agreement, Stratosphere made its scheduled payment on October 31, 1996, of $3.2 million. In addition, the agreement required the return of $4.2 million (including interest) remaining in the escrow account to the lenders to be applied to the principal balance on a pro rata basis. The amount was applied to the principal balance on October 30, 1996, reducing it to a total of $28.3 million. In the event the Standstill Agreement is terminated for reasons mentioned and the lenders accelerate Stratosphere's capital lease indebtedness, Stratosphere would not have the ability to repay such indebtedness. The acceleration of Stratosphere's capital lease indebtedness would also constitute an event of default under Stratosphere's First Mortgage Note Indenture by reason of a cross default provision included in such Indenture. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit Number 10.01 - Funding Agreement dated as of September 27, 1996 by and among Grand Casinos, Inc. and Stratosphere Corporation Exhibit Number 10.02 - Letter Agreement dated as of September 27, 1996 by and among Grand Casinos, Inc., Stratosphere Corporation and Stratosphere Gaming Corp. Exhibit Number 27 - Financial Data Schedule (b) No reports on Form 8-K were filed during the quarterly period ended September 29, 1996. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: November 13, 1996 GRAND CASINOS, INC. ------------------- Registrant By/ S /THOMAS J. BROSIG Thomas J. Brosig, President / S / TIMOTHY J. COPE Timothy J. Cope, Chief Financial Officer