1
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.................... 24
Consolidated Balance Sheets at December 28, 1997 and
December 29, 1996......................................... 25
Consolidated Statements of Operations for the fiscal years
ended December 28, 1997, December 29, 1996 and December
31, 1995.................................................. 26
Consolidated Statements of Shareholders' Equity for the
period from January 1, 1995 to December 28, 1997.......... 27
Consolidated Statements of Cash Flows for the fiscal years
ended December 28, 1997, December 29, 1996 and December
31, 1995.................................................. 28
Notes to Consolidated Financial Statements.................. 30
23
2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Stratosphere Corporation:
We have audited the accompanying consolidated balance sheets of
Stratosphere Corporation (a Delaware corporation) and subsidiaries ("the
Company"), debtors-in-possession, as of December 28, 1997 and December 29, 1996,
and the related consolidated statements of operations, shareholders' equity and
cash flows for the years ended December 28, 1997, December 29, 1996 and December
31, 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Stratosphere
Corporation and subsidiaries as of December 28, 1997 and December 29, 1996, and
the results of their operations and their cash flows for the years ended
December 28, 1997, December 29, 1996 and December 31, 1995, in conformity with
generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company filed for Chapter 11
bankruptcy protection on January 27, 1997. The bankruptcy filing raises
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 10. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
February 6, 1998
24
3
STRATOSPHERE CORPORATION AND SUBSIDIARIES
(DEBTORS IN POSSESSION)
CONSOLIDATED BALANCE SHEETS
DECEMBER 28, DECEMBER 29,
1997 1996
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 20,326,317 $ 22,558,804
Cash and cash equivalents -- restricted................... 471,273 --
Investments -- restricted................................. 3,139,469 2,678,344
Securities available for sale............................. -- 2,000,905
Accounts receivable, net.................................. 2,479,512 4,575,490
Other current assets...................................... 5,753,608 6,127,325
------------- -------------
Total Current Assets........................................ 32,170,179 37,940,868
------------- -------------
Property and Equipment, Net................................. 122,381,979 130,000,000
------------- -------------
Other Assets:
Deferred financing costs -- net........................... 624,156 12,339,097
Related party receivable -- net........................... 800,000 800,000
------------- -------------
Total Other Assets.......................................... 1,424,156 13,139,097
------------- -------------
TOTAL ASSETS................................................ $ 155,976,314 $ 181,079,965
============= =============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Accounts payable-trade.................................... $ 1,124,425 $ 1,250,786
Accounts payable-construction............................. -- 858,665
Current installments of long-term debt.................... 148,017 429,103
Current installments of capital lease obligations......... -- 8,684,360
Accrued interest.......................................... 263,457 18,644,462
Accrued payroll and related expenses...................... 5,778,505 5,005,047
Affiliate payable......................................... -- 1,878,717
Other accrued expenses.................................... 6,156,276 9,231,792
------------- -------------
Total Current Liabilities................................... 13,470,680 45,982,932
------------- -------------
Long-term Liabilities:
Long-term debt -- less current installments............... -- 203,000,000
Long-term note payable -- less current installments....... 296,033 --
Capital lease obligations -- less current installments.... -- 19,539,815
Note payable to affiliate................................. -- 50,000,000
------------- -------------
Total Long-Term Liabilities................................. 296,033 272,539,815
------------- -------------
Liabilities Subject to Compromise........................... 299,208,988 --
------------- -------------
TOTAL LIABILITIES........................................... 312,975,701 318,522,747
------------- -------------
Commitments and Contingencies
Shareholders' Deficit:
Preferred stock, $.01 par value; authorized 10,000,000
shares; no shares issued and outstanding............... -- --
Common stock, $.01 par value; authorized 100,000,000
shares; issued and outstanding 58,393,105 at December
28, 1997 and December 29, 1996......................... 583,931 583,931
Additional paid-in-capital................................ 218,546,069 218,787,643
Accumulated deficit....................................... (376,129,387) (356,814,356)
------------- -------------
Total Shareholders' Deficit................................. (156,999,387) (137,442,782)
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT................. $ 155,976,314 $ 181,079,965
============= =============
See notes to consolidated financial statements.
25
4
STRATOSPHERE CORPORATION AND SUBSIDIARIES
(DEBTORS-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 28, 1997, DECEMBER 29, 1996 AND DECEMBER 31, 1995
1997 1996 1995
---- ---- ----
REVENUES:
Casino...................................... $ 62,981,160 $ 47,901,144 $ --
Hotel....................................... 24,006,537 19,698,730 --
Food and beverage........................... 33,143,254 26,825,729 --
Tower, retail and other income.............. 30,339,898 25,541,729 59,864
------------ ------------- ------------
Gross Revenues................................ 150,470,849 119,967,332 59,864
Less: Promotional allowances................ 12,955,013 11,228,465 --
------------ ------------- ------------
NET REVENUES.................................. 137,515,836 108,738,867 59,864
------------ ------------- ------------
COSTS AND EXPENSES:
Casino...................................... 27,838,121 21,474,255 --
Hotel....................................... 8,554,553 7,082,100 --
Food and beverage........................... 25,552,348 22,416,703 --
Other operating expenses.................... 11,755,549 9,444,697 --
Depreciation and amortization............... 7,843,230 11,477,925 --
Pre-opening costs amortization.............. -- 23,909,146 --
Impairment of long-lived assets............. -- 295,946,633 --
Selling, general and administrative......... 53,166,758 48,153,596 947,008
------------ ------------- ------------
Total Costs and Expenses................. 134,710,559 439,905,055 947,008
------------ ------------- ------------
INCOME (LOSS) FROM OPERATIONS................. 2,805,277 (331,166,188) (887,144)
------------ ------------- ------------
OTHER INCOME (EXPENSE):
Interest income............................. 47,674 3,992,108 8,361,087
Interest expense (Contractual Interest for
fiscal year 1997 estimated at
$42,132,407)............................. (5,491,686) (21,761,565) (11,970,178)
Gain on sale of assets...................... 14,186 93,025 (166,815)
------------ ------------- ------------
Total Other Expense, net................. (5,429,826) (17,676,432) (3,775,906)
------------ ------------- ------------
Loss Before Reorganization Items and Income
Taxes....................................... (2,624,549) (348,842,620) (4,663,050)
------------ ------------- ------------
Reorganization Items:......................... (16,690,482) -- --
Loss Before Income Taxes...................... (19,315,031) (348,842,620) (4,663,050)
------------ ------------- ------------
Income Taxes.................................. -- -- --
------------ ------------- ------------
NET LOSS...................................... $(19,315,031) $(348,842,620) $ (4,663,050)
============ ============= ============
LOSS PER COMMON SHARE......................... $(0.33) $(6.00) $(0.12)
============ ============= ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING.... 58,393,105 58,134,811 37,583,065
============ ============= ============
See notes to consolidated financial statements.
26
5
STRATOSPHERE CORPORATION AND SUBSIDIARIES
(DEBTORS-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
TOTAL
ADDITIONAL STOCKHOLDERS'
COMMON PREFERRED PAID-IN ACCUMULATED EQUITY
STOCK STOCK CAPITAL DEFICIT (DEFICIT)
------ --------- ---------- ----------- -------------
Balances at December 31, 1994...... $300,000 $ -- $ 41,020,751 $ (3,308,686) $ 38,012,065
Net loss........................... -- -- -- (4,663,050) (4,663,050)
Sale of preferred stock to
parent........................... -- 82 33,524,778 -- 33,524,860
Issuance of common stock in payment
of underwriting fees............. 8,000 -- 3,992,000 -- 4,000,000
Convert preferred to common
stock............................ 82,500 (82) (82,418) -- --
Cost of initial public offering.... -- -- (23,570) -- (23,570)
Adjustment to preferred
distribution for cash received in
lieu of Vegas World equipment.... -- -- 736,116 -- 736,116
Adjustment to preferential
distribution for the net book
value of the gaming equipment
received in excess of purchase
price............................ -- -- 490,725 -- 490,725
Exercise of 26,500 stock options... 265 -- 112,360 -- 112,625
Exercise of 5,874,617 common stock
purchase warrants................ 58,746 -- 34,132,741 -- 34,191,487
Proceeds from secondary stock
offering......................... 112,600 -- 89,199,400 -- 89,312,000
Cost of secondary stock offering... -- -- (4,841,904) -- (4,841,904)
Purchase of land for common
stock............................ 1,500 -- 1,292,250 -- 1,293,750
Unrealized holding gain on
investment....................... -- -- 144,660 -- 144,660
-------- ---- ------------ ------------- -------------
Balances at December 31, 1995...... 563,611 -- 199,697,889 (7,971,736) 192,289,764
Net loss........................... -- -- -- (348,842,620) (348,842,620)
Exercise of 134,833 stock
options.......................... 1,348 -- 571,692 -- 573,040
Exercise of 81,596 common stock
purchase warrants................ 816 -- 722,590 -- 723,406
Cost of secondary stock offering... -- -- (248,047) -- (248,047)
Purchase of land for common
stock............................ 18,156 -- 18,186,604 -- 18,204,760
Unrealized holding loss on
investment....................... -- -- (143,085) -- (143,085)
-------- ---- ------------ ------------- -------------
Balances at December 29, 1996...... 583,931 -- 218,787,643 (356,814,356) (137,442,782)
Net loss........................... -- -- -- (19,315,031) (19,315,031)
Vegas World acquisition (leasehold
settlement) cost................. -- -- (240,000) -- (240,000)
Unrealized holding loss on
investment....................... -- -- (1,574) -- (1,574)
-------- ---- ------------ ------------- -------------
Balances at December 28, 1997...... $583,931 $ -- $218,546,069 $(376,129,387) $(156,999,387)
======== ==== ============ ============= =============
See notes to consolidated financial statements.
27
6
STRATOSPHERE CORPORATION AND SUBSIDIARIES
(DEBTORS-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED DECEMBER 28, 1997, DECEMBER 29, 1996 AND DECEMBER 31, 1995
1997 1996 1995
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(19,315,031) $(348,842,620) $ (4,663,050)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization........................... 8,404,853 13,407,234 1,718,209
Amortization of pre-opening costs....................... -- 23,909,146 --
Reorganization Items:
Write-off of debt issuance costs...................... 11,210,108 -- --
Professional Fees..................................... 5,500,000 -- --
Management Retention Expense.......................... 820,000 -- --
Interest Earned on Accumulated Cash During Chapter 11
Proceedings......................................... (839,626) -- --
Provision for doubtful accounts......................... 272,481 3,166,829 --
Impairment of long-lived assets......................... -- 295,946,633 --
(Gain) loss on sale or disposal of assets............... (14,186) 214,495 166,815
Changes in operating assets and liabilities:
Accounts receivable................................... 1,992,195 (278,951) (4,485,681)
Other current assets.................................. 373,717 (4,070,428) (2,051,650)
Accounts payable--trade (pre-petition)................ (902,924) -- --
Accounts payable--trade (post-petition)............... 1,124,425 912,041 499,630
Other accrued expenses (pre-petition)................. (7,715,597) -- --
Other accrued expenses (post-petition)................ 8,340,789 28,931,755 3,928,575
------------ ------------- ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES BEFORE
REORGANIZATION ITEMS...................................... 9,251,204 13,296,134 (4,887,152)
------------ ------------- ------------
Increases (decreases) to Cash Resulting from
Reorganization Items:
Professional fees paid.................................. (2,679,802) -- --
Management Retention Disbursements...................... 217,250 -- --
Interest Earned on Accumulated Cash During Chapter 11
Proceedings........................................... 839,626 -- --
------------ ------------- ------------
NET CASH PROVIDED BY (USED IN) REORGANIZATION ITEMS......... (1,622,926) -- --
------------ ------------- ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES......... 7,628,278 13,296,134 (4,887,152)
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to stockholder................................... -- -- (4,411,798)
Change in cash and cash equivalents-restricted............ (472,847) 109,913,662 (115,268,775)
Change in investments-restricted.......................... (461,125) 2,678,344 --
Change in securities available for sale................... 2,000,905 3,140,045 (5,140,950)
Payments for property and equipment....................... (1,403,341) (191,301,881) (124,470,643)
Change in construction payables........................... (544,133) (32,664,947) 29,883,865
Pre-opening costs......................................... -- (18,112,284) (5,796,862)
Increase in related party receivable and other............ (168,697) (3,777,687) --
Cash proceeds from sale of property and equipment......... 1,585,827 -- 928,134
------------ ------------- ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES......... 536,589 (130,124,748) (224,277,029)
------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock-net................ -- 1,296,446 84,470,097
Proceeds from exercise of stock options/common stock
purchase warrants....................................... -- -- 34,304,112
Costs of secondary stock offering......................... -- (248,046) --
Debt issuance and deferred financing costs................ (6,250) (760,707) (11,221,825)
Change in prepaid offering costs.......................... -- -- 935,395
Proceeds from issuance of long-term debt.................. -- 1,170,375 216,493,456
Payments on long-term debt................................ (429,103) (741,272) (3,737,763)
Payments on capital lease obligations subject to
compromise.............................................. (10,266,760) (5,000,000) --
Increase in affiliate payable............................. 544,759 1,074,852 --
Proceeds from the issuance of debt to affiliate........... -- 50,000,000 --
Vegas World acquisition (leasehold settlement) costs...... (240,000) -- --
------------ ------------- ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES......... (10,397,354) 46,791,648 321,243,472
------------ ------------- ------------
Net increase (decrease) in cash and cash equivalents........ (2,232,487) (70,036,966) 92,079,291
Cash and cash equivalents -- beginning of period............ 22,558,804 92,595,770 516,479
------------ ------------- ------------
Cash and cash equivalents -- end of period.................. $ 20,326,317 $ 22,558,804 $ 92,595,770
============ ============= ============
See notes to consolidated financial statements.
28
7
STRATOSPHERE CORPORATION AND SUBSIDIARIES
(DEBTORS-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED DECEMBER 28, 1997, DECEMBER 29, 1996 AND DECEMBER 31, 1995
1997 1996 1995
---- ---- ----
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest-net of capitalized interest................ $2,097,540 $ 2,014,243 $ --
Income taxes........................................ $ -- $ -- $ 275,877
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock in purchase of land........ $ -- $18,204,760 $ 1,293,750
Issuance of common stock in payment of underwriting
fees in connection with First Mortgage Notes..... $ -- $ -- $ 4,000,000
Purchase of equipment through capital lease......... $ 444,050 $33,224,175 $ --
Purchase of land, buildings, furniture and equipment
from stockholder (principally Vegas World assets)
as follows:
Purchase price................................. $ -- $ -- $ 1,000,000
Cash paid...................................... -- -- --
---------- ----------- ------------
Note payable to stockholder.................... -- -- 1,000,000
Preferential distribution to stockholder....... (240,000) -- 1,226,841
---------- ----------- ------------
Predecessor cost of assets acquired for
non-cash consideration.................... $ (240,000) $ -- $ 2,226,841
========== =========== ============
Increase in furniture and equipment from reduction
in notes receivable from stockholder............. $ -- $ -- $ 80,000
Offering costs recognized as a reduction in
additional paid-in capital in connection with
initial public offering of common stock.......... $ -- $ -- $ 23,570
Issuance of preferred stock to parent in payment of
notes payable.................................... $ -- $ -- $ 33,524,860
See notes to consolidated financial statements.
29
8
STRATOSPHERE CORPORATION AND SUBSIDIARIES
(DEBTORS-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
The accompanying consolidated financial statements present the financial
position, results of operations and cash flows of Stratosphere Corporation and
its wholly-owned subsidiaries, Stratosphere Gaming Corp., Stratosphere Land
Corporation, Stratosphere Advertising Agency and 2000 Las Vegas Boulevard Retail
Corporation (collectively the "Company"). Stratosphere Corporation was
incorporated in the State of Delaware on January 15, 1993, under the name of
Stratosphere Tower Corporation and on February 8, 1993, a Certificate of
Amendment was filed which changed the name of the Company to Stratosphere
Corporation. The Company is owned 39.4% by Grand Casinos Resorts, Inc. ("Grand")
which is in turn a wholly-owned subsidiary of Grand Casinos, Inc.
The Company was organized for the purpose of completing the development and
construction of, and thereafter owning and operating, the Stratosphere Tower, a
1,149 foot, free-standing observation tower with integrated casino, hotel and
entertainment facilities in Las Vegas, Nevada (the "Tower"). The Company
commenced operations of the resort facility on April 29, 1996.
On January 27, 1997 ("Petition Date"), Stratosphere Corporation and its
wholly-owned subsidiary Stratosphere Gaming Corp. ("SGC" and collectively with
Stratosphere Corporation, the "Debtors") filed voluntary petitions for Chapter
11 Reorganization pursuant to the United States Bankruptcy Code. As of that
date, the United States Bankruptcy Court for the District of Nevada ("Bankruptcy
Court") assumed jurisdiction over the assets of the Debtors. The Debtors are
acting as debtors-in-possession on behalf of their respective bankrupt estates,
and are authorized as such to operate their business subject to Bankruptcy Court
supervision. The fiscal year 1997 consolidated financial statements have been
prepared assuming that the Company will continue as a going concern. These
consolidated financial statements do not include any adjustments that might
result if the Company is unable to successfully emerge from bankruptcy and
continue as a going concern.
BASIS OF PRESENTATION
The consolidated financial statements have been prepared on a going concern
basis, which contemplates continuity of operations, realization of assets and
liquidation of liabilities in the ordinary course of business. While the Chapter
1 cases are in process, Stratosphere Corporation and SGC continue in possession
of their properties and operate and manage their business as a
debtor-in-possession pursuant to the Bankruptcy Code.
In addition, as a result of the restructuring (See Note 10), the Company
has implemented the American Institute of Certified Public Accountants ("AICPA")
Statement of Position 90-7 "Financial Reporting by Entities in Reorganization
Under the Bankruptcy Code" in the preparation of the accompanying December 28,
1997 consolidated financial statements. The Company has not separately reported
financial statements of the non-debtor subsidiaries as it has determined such
disclosure is not material to the consolidated financial statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Stratosphere
Corporation and all subsidiaries. All material intercompany balances and
transactions have been eliminated in consolidation.
30
9
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REVENUES AND EXPENSES
The Company recognizes revenues 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 rooms, food and beverage and other items that are provided
to customers on a complimentary basis. A corresponding amount is deducted as
promotional allowances. The cost of such complimentaries included as casino
expenses is as follows (in thousands):
1997 1996
---- ----
Food and Beverage.......................................... $4,795 $3,339
Rooms...................................................... 1,220 458
Other...................................................... 358 59
------ ------
$6,373 $3,856
====== ======
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and in banks, interest
bearing deposits, money market funds and investments purchased with an original
maturity of 90 days or less. Cash and cash equivalents restricted as of December
28, 1997, consist primarily of funds escrowed pursuant to the Management
Retention Agreements.
INVESTMENTS RESTRICTED
Investments restricted in fiscal years 1997 and 1996 consist primarily of
funds pledged for workers' compensation benefits.
SECURITIES AVAILABLE FOR SALE
The Company invested a portion of its Restricted Investments in short term
bond mutual funds which are classified as available for sale and valued at
market in the accompanying balance sheet. The cost of such investments at
December 29, 1996, was $2,000,905, while the market value was $2,002,480. There
were no such investments as of December 28, 1997.
INVENTORIES
Inventories, consisting primarily 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.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost (See Note 4), 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
and depreciated over their useful lives. Costs of repairs and maintenance are
expensed when incurred. Leasehold acquisition costs are amortized over the
shorter of their estimated useful lives or the term of the respective leases
once the assets are placed in service.
31
10
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Depreciation and amortization of property and equipment is computed using
the straight-line method over the following useful lives:
Buildings and improvements.................................. 39 years
Furniture, fixtures and equipment........................... 3-15 years
Land improvements........................................... 15 years
The Company's policy is to capitalize interest incurred on debt during the
course of qualifying construction projects. Such costs are amortized over the
related assets' estimated useful lives. Capitalized interest totaled $13,954,854
and $13,223,121 during the fiscal years 1996 and 1995 respectively. There was no
capitalized interest during fiscal year 1997.
RECOVERABILITY OF LONG-LIVED ASSETS TO BE HELD AND USED IN THE BUSINESS
In 1996 the Company adopted Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" ("SFAS 121)". Pursuant to SFAS 121, the Company
reviews its long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset or a group of assets
may not be recoverable. The Company considered its default on its required debt
service payment and significant operating losses to be its primary indicator of
potential impairment (See Note 4). Assets are grouped and evaluated for
impairment at the lowest level for which there are identifiable cash flows that
are largely independent of the cash flows of other groups of assets. The Company
deems an asset to be impaired if a forecast of undiscounted future operating
cash flows directly related to the asset, including disposal value if any, is
less than its carrying amount. If an asset is determined to be impaired, the
loss is measured as the amount by which the carrying amount of the asset exceeds
fair value. The Company generally measures value by discounting estimated cash
flows. Considerable management judgment is necessary to estimate discounted
future cash flows. Accordingly, actual results could vary significantly from
such estimates.
DEBT ISSUANCE COSTS
Deferred debt issuance costs represent direct costs and expenses of
$15,205,738 that were incurred in connection with the Company's offering of
$203,000,000 14 1/4% First Mortgage Notes. Prior to the Petition Date such
amount was amortized using the straight line method over the term of the First
Mortgage Notes. For the fiscal years ended December 29, 1996, and December 31,
1995, $2,113,383 and $1,718,209 of debt issuance cost was amortized. There was
no amortization of deferred debt issuance costs for the fiscal year ended
December 31, 1994. On the Petition Date the Company expensed unamortized
deferred debt issuance costs. The total write-off classified as "Reorganization
Items" on the consolidated statement of operations was $11.2 million or $0.19
per common share.
PRE-OPENING COSTS
Pre-opening costs incurred prior to the opening were capitalized and
amortized to expense using the straight line method over the six months
following the opening. These costs include payroll, training and marketing costs
incurred prior to commencement of operations. Amortization of pre-opening costs
totaled $23,909,146 for fiscal year ended December 29, 1996. There was no
amortization of pre-opening costs for the year ended December 28, 1997 or any
fiscal years ending prior to December 29, 1996.
INCOME TAXES
In February 1992 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income
Taxes." SFAS 109 requires a change from the deferred method of accounting for
income taxes of APB Opinion 11 to the asset and liability method of
32
11
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accounting for income taxes. Under the asset and liability method of SFAS 109,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Under SFAS 109, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. Effective January 1, 1993, the Company adopted SFAS
109.
As the Company is a less than 80% owned subsidiary, its operations are not
included in the consolidated federal income tax return of Grand Casinos, Inc.
Accordingly, the Company files a separate federal income tax return.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Based on the application of significant judgment, actual
results could differ from those estimates.
EARNINGS PER SHARE ("EPS")
The Company adopted Statement of Financial Accounting Standards No. 128
("SFAS 128") in 1997. However, there is no effect on the EPS calculation as all
Common Stock equivalents are anti-dilutive. Under the Restated Second Amended
Plan, all existing equity interests (including Common Stock, options, and
warrants) would be canceled.
RECLASSIFICATIONS
Certain reclassifications, having no effect on net losses, have been made
to the prior years consolidated financial statements to conform with the current
fiscal year presentation.
FISCAL YEAR-END
The Company has adopted a 52- or 53-week accounting period.
(2) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following as of December 28, 1997 and
December 29, 1996 (in thousands):
1997 1996
---- ----
Hotel and related........................................... $ 664 $3,691
Gaming...................................................... 947 554
Other....................................................... 1,162 519
------ ------
Total....................................................... 2,773 4,764
Less allowance for doubtful accounts........................ (293) (189)
------ ------
$2,480 $4,575
====== ======
33
12
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) OTHER CURRENT ASSETS
Other current assets consists of the following as of December 28, 1997 and
December 29, 1996 (in thousands):
1997 1996
---- ----
Inventory................................................... $2,781 $3,270
Prepaid expenses............................................ 2,973 2,408
Other....................................................... -- 449
------ ------
$5,754 $6,127
====== ======
(4) PROPERTY AND EQUIPMENT -- NET
Property and equipment consist of the following as of December 28, 1997 and
December 29, 1996 (in thousands):
1997 1996
---- ----
Land and improvement, including land held for
development............................................ $ 21,427 $ 21,128
Building and improvements................................ 66,717 66,673
Furniture, fixtures and equipment........................ 36,732 37,717
Construction in progress................................. 16,263 15,919
-------- --------
141,139 141,437
Less accumulated depreciation............................ (18,757) (11,437)
-------- --------
$122,382 $130,000
======== ========
Included in property and equipment at December 28, 1997 and December 29,
1996, are assets recorded under capital leases of $31.4 million and $33.5,
respectively. Accumulated depreciation and amortization at December 28, 1997 and
December 29, 1996, includes amounts recorded for capital leases of $6,547,165
and $3,073,185, respectively.
In connection with the adoption of SFAS 121, the Company recorded a
non-cash impairment loss of $295.9 million or $5.09 loss per weighted average
common share on December 29, 1996. The impairment loss was measured as the
amount by which the carrying value of the long-lived assets exceeded their
estimated fair market value. Management made an assessment of the fair market
value of each long-lived asset category to reflect the impairment loss. As a
result of the reduced carrying amount of the impaired assets, depreciation and
amortization expense has been reduced for future periods. Based on management's
assessment of the estimated fair market value of each long-lived asset category,
as of December 28, 1997, there was no impairment losses realized during fiscal
year 1997 pursuant to SFAS 121.
Future adjustment of asset carry amounts is likely with the anticipated
adoption of "Fresh-Start Reporting" upon the effective date of a plan of
reorganization confirmed by the Bankruptcy Court.
34
13
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) OTHER ACCRUED EXPENSES
Other accrued expenses, exclusive of pre-petition liabilities subject to
compromise for fiscal year 1997, consisted of the following (in thousands):
1997 1996
---- ----
Accrued liabilities......................................... $4,278 $5,147
Deposits.................................................... 506 444
Accrued taxes............................................... 710 1,437
Other....................................................... 662 2,204
------ ------
$6,156 $9,232
====== ======
(6) LONG TERM DEBT
A summary of debt outstanding, exclusive of amounts classified to
"Liabilities subject to compromise" for fiscal year 1997, is as follows (in
thousands):
1997 1996
---- ----
14 1/4% First Mortgage Notes due April 1, 2002 (see
description following).................................... $ -- $203,000
Other....................................................... 444 429
----- --------
444 203,429
Less current portion........................................ (148) (429)
----- --------
Long-term debt-less current portion......................... $ 296 $203,000
===== ========
The prime rate of interest was 8.5% and 8.25% at December 28, 1997 and
December 29, 1996, respectively.
14 1/4% FIRST MORTGAGE NOTES
On March 9, 1995, the Company closed on its offering of $203,000,000
14 1/4% First Mortgage Notes due 2002 with Contingent Interest; Contingent
Interest is equal to 10.8% of the Company's Consolidated Cash Flow, up to a
limit of $100 million during any two consecutive semi-annual periods (as defined
in the Indenture) ending March 31, once operational. The fair market value of
the First Mortgage Notes at December 29, 1996, was $188,790,000. The indenture
relating to the First Mortgage Notes (the "Indenture") contains covenants that
include a requirement that the Company maintain certain financial ratios. As of
December 28, 1997 and December 29, 1996, the Company was in default of the
Indenture covenants. The First Mortgage Notes are collateralized by
substantially all of the Company's real property. The proceeds of the offering
were used to develop and construct Phase I, an integrated casino/hotel and
entertainment complex. The Company did not make the required November 15, 1996,
interest payment of $14.5 million. As of December 29, 1996, the Company accrued
$18,251,244 of interest expense related to these notes.
On January 27, 1997, the Company and its wholly-owned subsidiary
Stratosphere Gaming Corporation ("SGC") filed voluntary petitions for Chapter 11
Reorganization pursuant to the United States Bankruptcy Code. As of that date,
the principal balance and accrued interest was $203,000,000 and $20,661,467,
respectively. Since the Petition Date, both principal and interest have been
reclassified to "Liabilities subject to compromise" on the consolidated balance
sheet (See Note 9). As of December 28, 1997, the Company accrued interest of
$20,661,467 and the fair market value of the First Mortgage Notes was
approximately $113,680,000.
35
14
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The future aggregate annual maturities of non-affiliate long-term debt at
December 28, 1997, are as follows (in thousands):
1998........................................................ $148
1999........................................................ 148
2000........................................................ 148
2001........................................................ --
2002........................................................ --
Thereafter.................................................. --
----
Total.................................................. $444
====
(7) LEASES AND CAPITAL LEASE OBLIGATIONS
The Company consummated a $37.5 million capital lease transaction on May 3,
1996. On October 30, 1996, the Company executed a Standstill Agreement as the
Company was in default with the terms of the lease agreement based on its
failure to meet certain financial covenants. Pursuant to the agreement, the
Company reduced the principal by $4.2 million on a pro rata basis with funds
held in an escrow account. On July 17, 1997, the Company reduced its capital
lease obligations by an additional $1.6 million. The funds were generated by the
sale of 410 warehoused slot machines and the net proceeds were applied to future
principal payments on a pro rata basis pursuant to the terms of the lease
agreement.
Since the Petition Date, the capital lease obligation has been classified
to "Liabilities subject to compromise." The Company anticipates the continuation
of payments on its capital lease obligations pursuant to the pre-petition
Standstill Agreement and an order entered by the Bankruptcy Court on March 4,
1997 approving a stipulation for adequate protection (See Note 9).
Future minimum lease payments, excluding contingent rentals, due under
non-cancelable operating and capital leases for the five years subsequent to
December 28, 1997, are as follows (in thousands):
CAPITAL OPERATING
FISCAL YEAR LEASES LEASES
----------- ------- ---------
1998....................................................... $ 9,922 $1,818
1999....................................................... 9,616 826
2000....................................................... -- 164
2001....................................................... -- 55
2002....................................................... -- --
Thereafter................................................. -- --
-------
Total minimum lease payments............................... 19,538
Less: amounts representing interest @ 8.38%................ (1,580)
Present value of minimum capital lease payments............ 17,958
Less: current installment.................................. (8,684)
-------
Obligations under capital leases $ 9,274
=======
Rent expense from the operating leases was $2,131,440, $1,298,569, and $0
in fiscal years 1997, 1996 and 1995, respectively.
36
15
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) MINIMUM LEASE INCOME
The Company has entered into a number of operating leases in relation to
food and beverage and retail outlets. The future minimum lease income receivable
under these leases for the five years subsequent to December 28, 1997, consisted
of the following (in thousands):
1998........................................................ $ 1,023
1999........................................................ 1,000
2000........................................................ 1,000
2001........................................................ 1,000
2002........................................................ 1,000
Thereafter.................................................. 13,333
-------
$18,356
=======
(9) LIABILITIES SUBJECT TO COMPROMISE
Liabilities subject to compromise under reorganization proceedings consist
of the following as of December 28, 1997 (in thousands):
1997
----
Accounts payable trade...................................... $ 348
Accrued payroll and related expenses........................ 58
Affiliate payable........................................... 2,423
Other accrued expenses...................................... 4,761
Capital lease obligations................................... 17,958
14 1/4% First Mortgage Notes -- including accrued interest
through 1/27/97........................................... 223,661
Notes payable to affiliate.................................. 50,000
--------
$299,209
========
The Company ceased accruing interest on the 14 1/4% First Mortgage Notes
and the note payable to affiliate as of the Petition Date. Although classified
to "Liabilities subject to compromise," the Company anticipates the continuation
of payments on its capital lease obligations pursuant to a pre-petition
Standstill Agreement and an order entered by the Bankruptcy Court on March 4,
1997, approving a stipulation for adequate protection. The December 28, 1997,
consolidated balance sheet does not reflect as liabilities the total amount of
the claims as filed against the Debtors in the bankruptcy proceedings since a
reasonable estimate of additional bankruptcy claims and pre-petition liabilities
and the settlement value of certain contingent and/or disputed bankruptcy claims
could not be made at December 28, 1997. No liabilities were classified as
subject to compromise as of December 29, 1996.
(10) RESTRUCTURING
On January 27, 1997, Stratosphere Corporation and its wholly-owned
subsidiary Stratosphere Gaming Corp. filed voluntary petitions for Chapter 11
Reorganization pursuant to the United States Bankruptcy Code. As of that date,
the United States Bankruptcy Court for the District of Nevada assumed
jurisdiction over the assets of the Debtors. The Debtors are acting as
debtors-in-possession on behalf of their respective bankrupt estates, and are
authorized to operate their business subject to Bankruptcy Court supervision.
The Debtors and Grand Casinos, Inc. ("Grand") filed a Joint Plan of
Reorganization (the "Plan") on January 27, 1997.
The Plan and the various underlying agreements upon which it was
predicated, included several conditions for it to become effective, some of
which the Debtors could not ultimately satisfy. Because certain
37
16
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
closing conditions could not be satisfied, the Debtors and Grand commenced
discussions in early May 1997 regarding possible alternatives to the Plan. Grand
and the Debtors ultimately agreed upon the terms of an alternative restructuring
plan. On June 20, 1997, the Debtors filed their First Amended Plan of
Reorganization ("First Amended Plan") to implement the terms of this agreement.
The First Amended Plan reserved the right for the Company's Board of
Directors to entertain and accept competing proposals which would be
economically more advantageous to the creditors of the Debtors' estates. On or
about July 15, 1997, the Debtors received a competing restructuring proposal
from High River Limited Partnership and American Real Estate Partners, L.P.
(collectively "High River"), holders of a substantial portion of the Company's
First Mortgage Notes. High River is controlled by New York financier, Carl
Icahn. After analyzing the High River proposal and negotiating certain
modifications thereto, the independent members of the Company's Board of
Directors preliminarily concluded that the High River proposal was preferable to
the First Amended Plan and thereafter determined not to proceed with the First
Amended Plan. On November 7, 1997, the Debtors filed their Second Amended Plan
of Reorganization ("Second Amended Plan"). The filing of the Second Amended Plan
followed substantial negotiation among the Debtors, High River and Grace
Brothers, Ltd. (the remaining representative of the official committee of First
Mortgage Note Holders). High River and Grace Brothers, Ltd. could not reach
agreement amongst themselves on the terms of a plan of reorganization which they
would find to be mutually acceptable. Rather than wait for the outcome of
protracted negotiations between High River and Grace Brothers, Ltd., with no
guarantee that such negotiations would result in a proposal acceptable to such
parties and to the Debtors, the Debtors filed the Second Amended Plan. On
February 13, 1998, the Debtors filed their Restated Second Amended Plan of
Reorganization ("Restated Second Amended Plan") which included the results of
subsequent negotiations between High River and Grace Brothers, Ltd. Among other
things, under the Restated Second Amended Plan, the secured portion of the
Company's First Mortgage Notes (estimated at $120.0 million) would be converted
into one hundred percent (100%) of the equity of reorganized Stratosphere
Corporation, and all currently outstanding Common Stock of the Company and all
other existing equity interests (including stock options and warrants) of the
Company would be canceled. The remaining portion of the First Mortgage Notes
claim (approximately $104.0 million) would be treated as a general unsecured
claim. In addition to the deficiency claim arising from the First Mortgage
Notes, the general unsecured class of claims would include the balance of the
Grand note (approximately at $52.4 million) and other general unsecured claims.
The Restated Second Amended Plan assumes that the general unsecured class of
claims would participate in a pro rata share of approximately $6.0 million in
full settlement of their related claims. In addition, the Restated Second
Amended Plan assumes that the reorganized Stratosphere Corporation will continue
to make payments pursuant to its capital lease and operating lease agreements. A
copy of the Restated Second Amended Plan and disclosure statement is included
herein as an exhibit. The disclosure statement accompanying the Restated Second
Amended Plan was approved, with certain modifications, by the Bankruptcy Court
on February 26, 1998, and a confirmation hearing has been scheduled on May 15,
1998. There can be no assurance that the Restated Second Amended Plan will be
confirmed by the Bankruptcy Court. In the event a plan of reorganization cannot
be confirmed, the Company may be forced to liquidate its assets.
The Company has implemented the guidance provided by AICPA Statement of
Position 90-7 "Financial Reporting By Entities In Reorganization Under The
Bankruptcy Code" and, accordingly, expenses reorganization items as incurred
(See Note 11). These items include professional fees, management retention
compensation, interest income earned and any other costs and expenses deemed to
have resulted from reorganization efforts since the Petition Date. All
professional fees require approval by the Bankruptcy Court prior to the Company
making payment in respect thereof.
Under Chapter 11 Reorganization, actions to enforce claims against the
Debtors or Debtors' property are stayed pending further order of the Bankruptcy
Court if those claims arose, or are based on events that occurred, on or before
the Petition Date, and such claims can not be paid or restructured prior to the
38
17
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
conclusion of the Chapter 11 proceedings or approval of the Bankruptcy Court.
Other liabilities may arise or be subject to compromise as a result of rejection
of executory contracts, including leases, or the Bankruptcy Court's resolution
of claims for contingencies and other disputed amounts. Liabilities subject to
compromise, included in the accompanying consolidated balance sheets, represent
the Company's estimate of the Debtors' pre-petition liabilities which are
subject to compromise (See Note 9).
(11) REORGANIZATION ITEMS
Reorganization items consisted of the following for the twelve month period
ended December 28, 1997 (in thousands):
1997
----
Write-off of debt issuance costs............................ $11,210
Professional fees........................................... 5,500
Interest earned on accumulated cash during Chapter 11
proceedings............................................... (840)
Management retention compensation........................... 820
-------
$16,690
=======
Costs and expenses related to the reorganization of the Company have been
classified as Reorganization items in the consolidated statement of operations
since the Petition Date. Prior to the Petition Date, such costs and expenses
were classified as selling, general and administrative in the consolidated
statement of operations. Such expenses totaled approximately $1.0 million during
fiscal year 1996.
(12) SHAREHOLDERS' DEFICIT
CAPITAL CONTRIBUTIONS AND INITIAL PUBLIC OFFERING
On February 23, 1994, the Company consummated an Initial Public Offering
("IPO") of 11,700,000 Units (each $5.00 Unit consisting of one share of Common
Stock and a redeemable warrant to purchase one share of Common Stock). The
redeemable warrants, exercisable for a period of five years, had an exercise
price of $5.83 per share and could be redeemed by the Company for $.01 per
warrant upon 30 days' prior written notice in the event the closing bid price of
the Company's Common Stock equaled or exceeded $7.375 per share for 10
consecutive trading days ending not more than 30 days preceding the date of the
notice of redemption. The Company received proceeds of $53,913,175 from the IPO,
net of commission and escrow fees but prior to other offering related expenses
of $2,519,156.
Prior to receipt of the net proceeds from the IPO, the Company met its
capital requirements through capital contributions and loans from Bob Stupak
Enterprises ("BSE") or its affiliates, loans from Grand and mortgage financing.
The Company used $12,465,700 of the proceeds to repay amounts borrowed from BSE
and Grand (See Note 13).
On February 17, 1994, BSE transferred certain assets and services to the
Company with a historical cost of $15,689,347 representing a capital
contribution of $8,001,000 (18,299,000 shares of Common Stock) and a loan for
$7,688,347. The transfers made by BSE consisted principally of the following:
(i) real estate comprised of land upon which the Stratosphere Tower was
constructed and additional real estate, including certain existing rental
properties, upon which additional attractions and possible future projects will
be constructed; (ii) all plans, designs, contracts, concepts and construction in
progress relating to the Stratosphere Tower and (iii) certain direct costs and
expenses incurred in connection with the IPO and certain other reimbursable
expenses directly associated with the Stratosphere Tower project. In addition,
through February 17, 1994, BSE or its affiliates (principally Vegas World)
contributed services to the Company aggregating $2,134,887. These expenses
represent an allocation of expenses incurred by those affiliates on behalf of
the Company and management's estimate of other expenses that would have been
incurred had the Company
39
18
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operated on a stand alone basis during the periods presented. For purposes of
the accompanying consolidated financial statements, the aforementioned capital
contributions and loans made by BSE or its affiliates are reflected in the
periods the underlying assets were acquired and services rendered.
In connection with the IPO, the Company, BSE, Stupak and Grand entered into
various agreements pursuant to which:
- Grand purchased 5,750,000 of the 11,700,000 Units sold in the IPO for
$26,915,750.
- At the close of the IPO, Grand acquired 5,357,132 shares of Common Stock
from BSE at BSE's cost of approximately $.44 per share.
- Grand was granted the option to purchase certain assets of Vegas World
(See Note 13).
- At the close of the IPO, BSE deposited into escrow an additional
4,119,572 shares of the Company's Common Stock then owned by BSE ("BSE
Escrow Shares"). Subsequent to the exercise of an option by the Company
to purchase certain assets of Vegas World (See Note 13), Grand acquired
the BSE Escrow Shares in August 1994 at BSE's cost of approximately $.44
per share.
Concurrent with the closing of the First Mortgage Notes Offering, Grand
invested approximately $33.5 million in the Company by purchasing 8,250
unregistered shares of the Company's Series A Convertible Non-Voting Preferred
Stock for $4,063 per share (the "Series A Preferred Stock"). Each share of
Series A Preferred Stock was convertible into 1,000 shares of the Company's
Common Stock. At the Company's annual meeting of stockholders on May 19, 1995,
the Company's stockholders approved Grand's conversion of the Series A Preferred
Stock into the Common Stock.
Subsequently, Grand has converted the Series A Preferred Stock into
8,250,000 shares of the Common Stock. The shares of Common Stock issued upon
conversion of the Series A preferred Stock are not transferable for a period of
five years from March 9, 1995. Grand also agreed that it would not transfer or
exercise the 5,750,000 Redeemable Warrants beneficially owned by Grand.
On September 7, 1995, the Company called for redemption on October 10,
1995, all of the outstanding Redeemable Warrants at a price of $0.01 per
Redeemable Warrant, for a total redemption price of $117,000. Each Redeemable
Warrant entitled the registered holder thereof to purchase one share of Common
Stock at $5.83 per share. The Company received approximately $34.2 million in
net proceeds from the issuance of the Common Stock upon exercise of all the
Redeemable Warrants (excluding those held by Grand). In addition, the Company
received $112,625 from the exercise of 26,500 Stock Options.
On December 22, 1995, the Company closed an offering (the "First Offering")
of 10,000,000 shares of the Common Stock, resulting in proceeds to the Company
of $75,200,000. Of these shares, 8,400,000 shares were sold at $8.00 per share
in an underwritten public offering (the "Public Offering"), resulting in net
proceeds to the Company after underwriting discounts of $7.52 per share. The
remaining 1,600,000 shares (the "Direct Shares") of the First Offering were sold
directly by the Company for $7.52 per share to affiliates of the Company. Of the
Direct Shares, 1,000,000 were sold to Grand, 500,000 shares were sold to Lyle
Berman, former Chief Executive Officer and a former director of the Company and
Chief Executive Officer and Chairman of the Board of Grand and 100,000 shares
were sold to Stanley Taube, a former director of the Company and a former Vice
President and a director of Grand. On December 29, 1995, the Company closed on
the offering (the "Second Offering," together with the First Offering, the
"Equity Offerings"), of 1,260,000 shares granted in an option to the
underwriters of the Equity Offerings. Proceeds to the Company from the Second
Offering were $9,475,200.
On January 11, 1996 the Company purchased approximately 3.5 acres across
the street from its property. The property is used to facilitate a 500-car
parking lot. The Company issued 1,050,000 shares of Common
40
19
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock for the purchase of which 500,000 shares went directly to the owner of the
land, 500,000 shares were sold to an unrelated third party and 50,000 shares
were paid as a fee to the broker of the transaction.
During March 1996 the Company acquired approximately two acres through the
issuance of 765,559 shares to an unrelated third party. The property has been
used to stage Phase II construction materials and equipment, and may be used to
provide future additional parking.
On May 6, 1996 the Company received proceeds of $723,406 through the
exercise of 81,596 sales agent warrants that were issued in connection with the
IPO.
There were no additional issuances of Common Stock or other equity during
1997. As of December 28, 1997, the Company had 58,393,105 shares of Common Stock
issued and outstanding. Under the terms and conditions of the Restated Second
Amended Plan, all currently outstanding Common Stock and all other existing
equity interests of the Company would be canceled.
STOCK OPTION PLANS
The Company has reserved for issuance of an aggregate of 3,125,000 shares
of Common Stock under the 1993 Stock Option Plan ("Stock Option Plan") and the
1993 Non-Employee Directors' Plan ("Directors Plan"). The Company does not plan
to issue additional stock options under either plan since all outstanding stock
is anticipated to be canceled upon Bankruptcy Court confirmation of a plan of
reorganization.
1993 STOCK OPTION PLAN
Officers (including officers who are members of the Board of Directors),
directors (other than members of the Stock Option Committee (the "Committee") to
be established to administer the Stock Option Plan and the Director' Plan) and
other employees of, and consultants to, the Company and its subsidiaries will be
eligible to receive options under the Stock Option Plan. The Committee will
administer the Stock Option Plan and will determine those persons to whom
options will be granted, the number of options to be granted, the provisions
applicable to each grant and the time periods during which the options may be
exercised. No options may be granted more than ten years after the date of the
adoption of the Stock Option Plan.
Unless the Committee, in its discretion, determines otherwise,
non-qualified stock options will be granted with an option price equal to the
fair market value of the shares of Common Stock on the date of grant. In no
event may the option price, with respect to an incentive stock option granted
under the Stock Option Plan, be less than the fair market value of such Common
Stock on the date of grant.
Options granted under the Stock Option Plan will be exercisable for a term
of not more than ten years after the date of grant. Certain other restrictions
will apply. In the event of a change of control (as defined in the Stock Option
Plan), the date on which all options outstanding under the Stock Option Plan may
first be exercised will be accelerated. Generally, all options terminate 90 days
after a change of control.
At December 28, 1997, 1,083,000 shares were available for granting further
options and options for 1,542,167 shares were outstanding at $4.00 to $8.00 per
share, of which options for 1,040,167 were exercisable. During 1997 10,000
shares became void upon employee separations. There was no exercises of stock
options during fiscal year 1997. During fiscal year 1996, 134,833 shares were
exercised at $4.25 per share and options for 527,500 shares became void upon
employee separations. There were no exercises of stock options during fiscal
years 1995 and 1994. The Company anticipates that all options will be canceled
upon Bankruptcy Court confirmation of a plan of reorganization. The Company does
not expect any issuance or exercise of additional stock options.
41
20
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NON-EMPLOYEE DIRECTORS' PLAN
The Directors' Plan provides for the grant of stock options to the persons
who are members of the Board of Directors and who at the time they joined the
Board of Directors were not employees of the Company or any of its affiliates
("Non-Employee Directors"). The Committee will administer the Directors' Plan.
Each of the Non-Employee Directors will receive an option to purchase 37,500
shares of Common Stock, provided that in the case of one director, the Company
has committed to grant options for the purchase of 75,000 shares. Such options
will vest in three equal annual installments commencing on the first anniversary
of such Non-Employee Director's election. The options of Non-Employee Directors
who joined the Board prior to completion of the IPO are exercisable at $4.25 per
share, the fair market value of the Common Stock on the date of grant and of
those non-employee directors elected after the IPO are exercisable at the fair
market value of the Common Stock on the date of grant. Options granted under the
Director's Plan may not be exercised more than ten years after the date of
adoption of the Director' Plan. In the event of a change of control (as defined
in the Directors' Plan), the date on which all options outstanding under the
Directors' Plan may first be exercised is accelerated.
At December 28, 1997, 1,083,000 shares were available for granting further
options and options for 340,000 shares were outstanding at $2.00 to $4.625 per
share, of which options for 180,000 were exercisable. No options were exercised
during 1997. Options for 10,000 shares were exercised during fiscal year 1996
and no options were exercised during fiscal years 1995 and 1994. The Company
anticipates that all options will be canceled upon Bankruptcy Court confirmation
of a plan of reorganization. The Company does not expect any issuance or
exercise of additional stock options prior to plan confirmation.
ACCOUNTING FOR STOCK-BASED COMPENSATION
In accordance with the anticipated cancellation of all stock options
pursuant to the restructuring described in Note 10, no Financial Accounting
Standards Board No. 123 "Accounting for Stock-Based Compensation" pro forma
disclosures have been made.
(13) PURCHASE OF VEGAS WORLD HOTEL & CASINO ASSETS
On June 1, 1994, Grand assigned to the Company and the Company then
exercised an option to acquire for $50.8 million ("Purchase Price") certain
assets ("Vegas World Assets") of Vegas World, principally land, buildings,
furniture and equipment. On November 4, 1994, the Company closed on the purchase
of Vegas World Assets. The Vegas World Assets were then leased back to Stupak
under a triple net lease. Rental payments under the lease, which expired upon
the closing of Vegas World, were de minimis. The Vegas World Assets were
recorded at the closing of the purchase of Vegas World's net book values. In
addition to the Vegas World Asset purchase, on November 4, 1994, the Company
purchased $1,725,000 in additional land and buildings from Stupak. The excess of
the purchase prices over the net book values of the assets acquired, which
amounted to $19,222,963, was recorded as a preferential distribution to Stupak.
The Vegas World Assets purchased as described above, included certain gaming
equipment that was not transferred at the time of sale. A portion of this
equipment and cash received in lieu of the equipment was reflected in the
consolidated financial statements as a reduction in the preferential
distribution to Stupak.
In connection with the closing of the Vegas World Assets purchase, $5.1
million was disbursed for closing costs and to pay off existing mortgages and
the Company issued non-interest bearing promissory notes to Stupak in the amount
of $46,728,484. The consolidated financial statements reflect the offset of the
Stupak advances and the non-interest bearing promissory notes.
The liabilities retained by Stupak in connection with the Vegas World Asset
purchase were principally comprised of accounts payable and accrued expenses and
certain obligations for presold vacation packages
42
21
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
consisting of goods and services (cash, casino action, hotel room nights,
beverages at casino bars, show tickets, admissions to the Tower upon opening and
certain other goods and services), to be provided in the future.
Pursuant to an escrow agreement mandated by the Nevada Gaming Authorities,
to the extent that Stupak's assumed obligations to the vacation package holders
were not satisfied by the date of the closing of Vegas World (either through
use, refund or expiration), an amount equal to 100% of the obligation in cash
and, to the extent not covered in cash, 150% of the remaining obligation in
Company's Common Stock owned by Stupak is required to be placed in escrow by
Stupak.
The Company had agreed to provide the goods and services to customers
holding unused vacation packages upon the opening of the Tower project so long
as the escrow remains in good standing. The arrangement anticipated the Company
invoicing and being reimbursed by the escrow fund for "one visit" vacation
packages at an agreed upon fixed cost, which may be more or less than the
Company's actual cost to provide such facilities and services. The escrow will
further be charged the actual cost of providing goods and services for "multiple
visit" vacation packages. Certain goods and services (agreed upon numbers of
hotel room nights, admissions to the Tower and beverages at casino bars) were
provided by Stratosphere without reimbursement. In conjunction with Stupak
providing all other benefits relating to these vacation packages. The cost of
providing these services was not expected to be material to the Company's
results of operations in the periods the services are provided. The Company
ceased servicing vacation packages on January 13, 1997, as a result of
insufficient assets to the escrow. The ability of the Company to provide its
resort as a facility for servicing the vacation packages in the future is
dependent on the Company and Stupak being able to make adequate arrangements
that would be subject to Bankruptcy Court approval.
(14) GRAND AGREEMENT
In June 1994, Grand and the Company entered into an agreement (the
"Management and Development Agreement") which provided that Grand would, among
other things, supervise the design, development, construction and commencement
of the Company's operations (the "Opening"). Pursuant to the Management and
Development Agreement, prior to the opening, Grand provided the necessary
personnel to oversee and manage the development of the entire project. From the
opening on April 29, 1996, upon the Company's request, Grand continued to
provide consulting services until such services were terminated as of the
Petition Date.
(15) INCOME TAXES
The income tax benefit attributable to losses from operations for the years
ended December 28, 1997, December 29, 1996 and December 31, 1995 differed from
the amounts computed by applying the federal income tax rate of 35% as a result
of the following (in thousands):
1997 1996 1995
---- ---- ----
Current.......................................... $ -- $ -- $ --
Deferred benefit................................. (6,104) (122,095) (1,632)
Increase in deferred tax asset valuation
allowance...................................... 6,104 122,095 1,632
------- --------- -------
$ -- $ -- $ --
======= ========= =======
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22
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effect of significant temporary differences representing deferred
tax assets and liabilities for the Company is as follows at December 28, 1997
and December 29, 1996 (in thousands):
1997 1996
---- ----
Deferred tax assets (liabilities):
Current:
Allowance for doubtful accounts..................... $ 103 $ 66
Progressive jackpots................................ 108 258
Accrued vacation, workers' compensation............. (511) 1,753
Outstanding chip and token liability................ 80 189
Other............................................... (897) --
--------- ---------
(1,117) 2,266
--------- ---------
Long-term:
Depreciation........................................ (11,017) (1,060)
Pre-opening costs................................... 5,579 7,252
Allowance for doubtful accounts..................... 1,101 1,042
Excess of tax over book basis of assets acquired in
connection with Vegas World Asset Purchase....... 6,850 6,850
Excess of tax over book basis of assets due to write
down of assets................................... 98,338 103,581
Net operating loss carryforward..................... 35,932 9,631
--------- ---------
136,783 127,296
--------- ---------
Total deferred taxes................................ 135,666 129,562
Valuation allowance................................. (135,666) (129,562)
--------- ---------
$ -- $ --
========= =========
The Company recorded a valuation allowance at December 28, 1997, December
29, 1996 and December 31, 1995, relating to recorded tax benefits because of the
significant uncertainty as to whether such benefits will ever be realized.
The provision (benefit) for income taxes differs from the amount computed
at the federal statutory rate as a result of the following at December 31:
1997 1996 1995
---- ---- ----
Federal statutory rate.................................. (35)% (35)% (35)%
Permanent differences...................................
Increase in deferred tax asset valuation allowance...... 35% 35% 35%
--- --- ---
--% --% --%
=== === ===
As of December 28, 1997, the Company has a net operating loss carryforward
of approximately $102.7 million. The availability of the net operating loss
carryforward will be subject to the tax consequences of the final plan of
reorganization approved by the Bankruptcy Court.
(16) RELATED PARTY TRANSACTIONS
Pursuant to the Completion Guarantee under the Indenture to the First
Mortgage Notes the Company borrowed $50.0 million from Grand Casinos Inc. as of
December 29, 1996. The loan is subordinate to the First Mortgage Notes and
capital lease obligations and accrued interest at the rate of 14 1/4% up to the
Petition Date.
44
23
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
This liability is classified under the caption liabilities subject to compromise
in the consolidated balance sheet at December 28, 1997.
Further, pursuant to the Memorandum of Agreement, Grand also entered into a
Standby Equity Commitment with the Company pursuant to which Grand may
contribute to the Company up to $20 million in new equity through the purchase
of Capital Stock (other than Disqualified Stock), on non-cumulative bases, in
each of the first three years following the time that the Stratosphere Tower
Project is operating. Such funds would be contributed to the Company, up to
$20.0 million of additional equity during each of the first three years
Stratosphere is Operating as long as the Company's Consolidated Cash Flow does
not reach $50.0 million, subject to certain terms and conditions to cover, on a
dollar for dollar basis, any shortfall in the Company's Consolidated Cash Flow.
The maximum commitment for the three years would be $60 million. Funds for the
Standby Equity Commitment would be made available, to the extent necessary,
through a rights offering of Common Stock, at a discount of approximately 50%
from the then-current market price, to all stockholders of the Company;
provided, however, that Grand would be obligated to purchase any such shares of
Common Stock, in addition to its pro rata share as a stockholder of the Company,
not so purchased by the other public stockholders. The Company would retain the
right to obtain the equity funds which would otherwise be provided by the
Standby Equity Commitment through other means deemed appropriate.
On February 19, 1998, the Bankruptcy Court determined that the Standby
Equity Commitment was an executory contract that the Company could not assume
due to its inability to perform and therefore, it was determined that the
Company could not compel Grand to perform under its obligation pursuant to the
agreement.
In connection with the Management and Development Agreement previously
discussed in Note 14, the Company paid Grand consulting fees and reimbursed
expenses totaling $2,318,873 and $414,000 during the fiscal years ended 1996 and
1995, respectively. No such fees were paid during fiscal year 1997.
In connection with the construction of the Company's facility and its
normal operations, approximately $187,041, $3,296,924 and $359,000 of fixed
assets were purchased from Grand Media & Electronics, which is a wholly owned
subsidiary of Grand Casinos, Inc. during the years ended December 28, 1997,
December 29, 1996 and December 31, 1995, respectively.
During 1996 the Company billed Stupak $4,777,687, of which $1,000,000 was
paid for amounts related to the Company providing its facility to service
Stupak's vacation packages. Accordingly, the Company has reserved the unfunded
amount of $2,977,687 in 1996. Stupak has disputed the billing and the escrow
account set up to satisfy these obligations remains unfunded. The amount of the
net receivable is classified as a related party receivable under other assets in
the consolidated balance sheets.
(17) COMMITMENTS
On July 30, 1997, the Bankruptcy Court approved management retention
agreements ("Retention Agreements") for eleven of the Company's executives. The
executives are divided into two groups for purposes of computing retention
compensation pursuant to the Retention Agreement. The "Group One" executives
consists of nine individuals who will receive additional monthly retention
compensation of 5% of their annual salary effective May 1, 1997. The first three
months of retention compensation is placed in escrow for the executive and is
payable on the earlier of (i) an involuntary termination or, (ii) ninety days
after a sale of the Company or confirmation of a plan of reorganization by the
Bankruptcy Court. After the initial three month period, the amount of continuing
retention compensation is accrued monthly and paid quarterly until the earlier
of the termination of the executive, the sale of the Company or confirmation of
a plan of reorganization by the Bankruptcy Court. In addition, the executive is
entitled to receive three months base salary upon an involuntary termination or
if the executive's title or job responsibilities are substantially diminished
upon conclusion of a change in ownership.
On January 23, 1998, the Bankruptcy Court approved Retention Agreements for
"group two" executives. The group two executives (two individuals) will have an
amount equal to 100% of their annual compensation as of May 1, 1997, placed in
escrow as additional compensation payable on the earlier of (i) an involuntary
45
24
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
termination or, (ii) ninety days after a sale of the Company or (iii) upon
confirmation of a plan of reorganization by the Bankruptcy Court. Consistent
with group one, the executives are not entitled to the compensation upon a
voluntary termination.
The Company began reflecting the costs associated with the Retention
Agreements in its consolidated financial statements beginning July 30, 1997, at
which time the Company believes the benefits of such agreements began to be
realized. The expenses recorded in connection with the Retention Agreements is
classified to "Reorganization items."
(18) CONTINGENCIES
On January 27, 1997, the Company and its wholly-owned subsidiary
Stratosphere Gaming Corporation filed voluntary petitions for Chapter 11
Reorganization pursuant to the United States Bankruptcy Code. As of that date,
the United States Bankruptcy Court for the District of Nevada assumed
jurisdiction over the assets of the Company and SGC. The Company and SGC are
acting as debtors-in-possession on behalf of their respective bankruptcy
estates, and are authorized as such to operate their business subject to
bankruptcy court supervision.
On August 5, 1996, a complaint was filed in the United States District
Court for the District of Nevada (Michael Caesar, et al. v. Stratosphere
Corporation, et al.) against the Company, Lyle A. Berman (a former officer and
director of the Company and officer and director of Grand), Robert E. Stupak (a
former officer and director of the Company), Thomas A. Lettero (an officer and
current director of the Company), Thomas G. Bell (a director of the Company),
Andrew S. Blumen (an officer and director of the Company), and Grand. The
complaint purports to seek relief on behalf of a class of plaintiffs who
purchased the Company's Common Stock during the period from December 19, 1995,
through July 22, 1996, inclusive. The complaint alleges that the defendants made
misrepresentations and engaged in other wrongdoings.
In addition to the Caesar case, eight additional cases making the same
claims against the same defendants (and in one instance also against Stanley
Taube, a former director of the Company and also a former officer and director
of Grand) have been filed by the following plaintiffs: Regina Peltz on August
13, 1996; Ronald Stengel on August 13, 1996; Robert Johnson on September 19,
1996; David Vallee on September 25, 1996; Anthony L. Poli on October 7, 1996;
Darrell Russell and Gail Russell on October 7, 1996; Mitchell Gordon on October
7, 1996; and James J. Enright, Jr., on October 28, 1996. These complaints
purport to seek relief on behalf of a class of plaintiffs who purchased the
Company's Common Stock during the period from December 19, 1995, through July
22, 1996, inclusive. The complaints allege that the defendants made
misrepresentations and engaged in other wrongdoings. On January 15, 1997, the
court ordered these eight additional lawsuits to be consolidated with the Caesar
lawsuit under the caption "In re Stratosphere Corporation Securities
Litigation."
On February 14, 1997, plaintiffs filed a Consolidated and Amended Class
Action Complaint naming as defendants Grand, Bob Stupak, Lyle A. Berman, Stanley
M. Taube, David R. Wirshing, Thomas A. Lettero, Andrew S. Blumen, Thomas G.
Bell, Bob Stupak Enterprises, BT Securities Corporation and Montgomery
Securities, Inc. The Consolidated and Amended Class Action Complaint alleges
causes of action under the federal securities laws and Nevada law for purported
misrepresentations during the period between December 19, 1995, and July 26,
1996. The litigation is brought on behalf of a putative class of purchasers of
Stratosphere Corporation securities during that time period. The Consolidated
and Amended Class Action Complaint does not name the Company as a defendant,
presumably due to the automatic stay imposed by the Company's bankruptcy filing
and because any claims of plaintiffs against the Company will be resolved in the
bankruptcy proceedings. On February 25, 1997, Grand and certain individual
defendants filed a motion to dismiss the complaint. The court on May 21, 1997,
dismissed the complaint finding that plaintiffs complaint failed to specifically
allege facts supporting claims made by plaintiffs in connection with certain
documents issued as certain public statements made by the Company. On July 25,
1997, the court amended its May 21 order providing plaintiffs with the
opportunity to submit an amended complaint. The plaintiffs have since filed an
46
25
STRATOSPHERE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amended complaint and the defendants named in the amended complaint have again
filed a motion to dismiss complaint. Discovery and other proceedings have been
stayed pending the court's ruling on that motion.
On March 14, 1997, the plaintiffs in the consolidated federal litigation
discussed above (the "Securities Litigation Claimants") filed a complaint
against the Company in an adversary proceeding in the context of the Company's
bankruptcy proceedings in the United States Bankruptcy Court for the District of
Nevada. The Securities Litigation Claimants allege that the Company made
misrepresentations and engaged in other wrongdoings during the period between
December 19, 1995, and July 22, 1996, in violation of the federal securities
laws and Nevada law. These claims are scheduled to be determined in an
estimation proceeding in the bankruptcy court. A hearing in the estimation
proceeding was scheduled to begin on May 5, 1997, but was canceled.
On August 16, 1996, a complaint was filed in District Court , Clark County,
Nevada (Victor Opitz et al. v. Stratosphere Corporation et al.) against the
Company, Grand, Robert B. Stupak (a former officer and director of the Company),
Lyle A. Berman and Stanley Taube. The complaint purports to seek relief on
behalf of a class of plaintiffs who purchased stock during the period from
December 19, 1995, to July 22, 1996. The complaint alleges the defendants made
misrepresentations and engaged in other wrongdoing. The court has granted the
Company's motion to stay this litigation pending the outcome of the federal
shareholder litigation.
On April 3, 1994, a complaint was filed in the United States District Court
for the District of Nevada (Harvey J. Cohen, et al. v. Stratosphere Corporation,
et al.) against the Company, Mr. Stupak, Lyle Berman, Grand and others. By Order
filed April 10, 1995, the district court dismissed the federal securities law
claims with prejudice and dismissed the common law claims without prejudice. On
May 3, 1995, the plaintiffs filed a notice of appeal of the district court's
order with the United States Court of Appeals for the Ninth Circuit. The
complaint purported to seek relief in connection with the Company's initial
public offering (the "IPO"), each consisting of one share of Common Stock and
one warrant, on behalf of two classes of plaintiffs for unspecified monetary
damages. The complaint alleged that the defendants made misrepresentations,
breached a contract and engaged in other wrongdoing in connection with the IPO,
so that the defendants and their affiliates, associates and friends could, while
avoiding all economic risk, purchase the IPO Units in the IPO rather than one
plaintiff class, and that this alleged conduct caused a second dealer to lose
out on other profits it allegedly deserved. The Court of Appeals affirmed the
district court's order.
On or about August 29, 1995, a complaint was filed in the District Court,
Clark County, Nevada (Harvey J. Cohen, et al. vs. Stratosphere Corporation, et
al.) against the Company, Mr. Stupak, Lyle Berman, Grand and others. The
complaint purports to represent a class of plaintiffs and seeks relief for
misrepresentation, breach of contract and tortious interference with contract
regarding the IPO. The parties have stipulated to dismiss this suit.
On or about June 15, 1995, the case of City of Las Vegas Downtown
Redevelopment Agency vs. Crockett et al. and on or about November 8, 1995, the
court in the case of City of Las Vegas Downtown Redevelopment Agency vs. Mouldon
et al. dismissed these complaints based upon the City's lack of legal
justification to condemn these properties. Both cases appealed to the Nevada
Supreme Court where a decision is pending. On January 23, 1998, the Supreme
Court issued an Order of Limited Remand ordering an evidentiary hearing on
whether the Company intends to reject or accept the Owner Participation
Agreement and should the Company reject, whether the City intends to purchase
the subject properties.
The Company, based in part on the advice of its counsel, believes that it
has meritorious defenses and does not believe the above described legal actions
will have a material adverse effect on the consolidated financial statements. In
addition, in the ordinary course of business, the Company is party to various
legal actions. In management's opinion, the ultimate outcome of such legal
actions will not have a material effect on the results of operations or the
financial position of the Company.
47