# ***UNITED STATESSECURITIES AND EXCHANGE COMMISSION***

## **Washington, D.C. 20549**

 

**FORM10-Q**

 

**(Mark one)**
| **ý**                                                                                                                   | ** ** | **Quarterly Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                         |       |                                                                                          |
| **For the  quarterly period ended September 30, 2004**                                                                       |
|                                                                                                                         |       |                                                                                          |
| **OR**                                                                                                                       |
| ** **                                                                                                                   | ** ** | ** **                                                                                    |
| **o**                                                                                                                        | ** ** | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|                                                                                                                         |       |                                                                                          |
| **For the transition  period from         to        ** |

** **

## **Commission file number 1-14573**

 

# ***CAESARS ENTERTAINMENT, INC.***

(Exact name of registrantas specified in its charter)

 
| **Delaware**                                                                         | ** ** | **88-0400631**                        |
|--------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                     |       | (I.R.S. Employer  Identification No.) |
|                                                                                 |       |                                  |
| **3930  Howard Hughes Parkway  Las Vegas, Nevada**                                   | ** ** | **89109**                             |
| (Address of principal  executive offices)                                            |       | (Zip code)                            |
|                                                                                 |       |                                  |
| **(702)  699-5000**                                                                  |
| (Registrant’s telephone  number, including area code)                           |
|                                                                                 |
| **N/A**                                                                              |
| (Former name, former  address, and former fiscal year, if changed since last report) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelvemonths (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  ý      No  o.

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).  Yes  ý     No  o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

| **Title of Each Class**                  | ** ** | **Outstanding at November 1, 2004** |
|------------------------------------------|------------|-------------------------------------|
| Common Stock, par value  $0.01 per share | ** ** | **313,036,525**                     |

 

 

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**CAESARS ENTERTAINMENT, INC.**

**INDEX**

 
| **PART  I.**   | **FINANCIAL  INFORMATION**                                                                         | ** ** |
|----------------|----------------------------------------------------------------------------------------------------|------------|
|           |                                                                                               |       |
| Item  1.       | Unaudited  Condensed Consolidated Financial Statements                                             | 3          |
|           |                                                                                               |       |
|           | Condensed  Consolidated Balance Sheets  September 30, 2004 and December 31, 2003                   | 3          |
|           |                                                                                               |       |
|           | Condensed  Consolidated Income Statements  Three and nine months ended September 30, 2004 and 2003 | 4          |
|           |                                                                                               |       |
|           | Condensed  Consolidated Statements of Cash Flows  Nine months ended September 30, 2004 and 2003    | 5          |
|           |                                                                                               |       |
|           | Notes  to Condensed Consolidated Financial Statements                                              | 6          |
|           |                                                                                               |       |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations        | 21         |
|           |                                                                                               |       |
| Item 3.        | Quantitative and Qualitative Disclosures About  Market Risk                                        | 40         |
|           |                                                                                               |       |
| Item 4.        | Controls and  Procedures                                                                           | 40         |
|           |                                                                                               |       |
| **PART II.**   | **OTHER INFORMATION**                                                                              | **41**     |
|           |                                                                                               |       |
| Item 1.        | Legal Proceedings                                                                                  | 41         |
|           |                                                                                               |       |
| Item 6.        | Exhibits                                                                                           | 41         |
|           |                                                                                               |       |
| **SIGNATURES** | 42                                                                                                 |

 

2

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**PART I****. FINANCIAL INFORMATION**

**ITEM 1****. UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**CAESARS ENTERTAINMENT, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(dollars in millions, except par value)**

**(unaudited)**

 
| ** **                                                                                                                                                                 | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                                                                                                                                       |       |                    |       |                   |       |
| Assets                                                                                                                                                                     |       |                    |       |                   |       |
| Cash and  equivalents                                                                                                                                                      |       | $                       | 318        |                   | $          | 298 |   |
| Accounts  receivable, net                                                                                                                                                  |       | 148                     |       | 161                    |       |
| Inventory,  prepaids, and other                                                                                                                                            |       | 154                     |       | 124                    |       |
| Income taxes  receivable                                                                                                                                                   |       | —                  |       | 16                     |       |
| Deferred income  taxes, net                                                                                                                                                |       | 108                     |       | 103                    |       |
| Total current  assets                                                                                                                                                      |       | 728                     |       | 702                    |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Assets held for  sale                                                                                                                                                      |       | 493                     |       | 686                    |       |
| Investments                                                                                                                                                                |       | 77                      |       | 181                    |       |
| Property and  equipment, net                                                                                                                                               |       | 7,152                   |       | 6,961                  |       |
| Goodwill                                                                                                                                                                   |       | 700                     |       | 700                    |       |
| Other assets                                                                                                                                                               |       | 339                     |       | 284                    |       |
| Total assets                                                                                                                                                               |       | $                       | 9,489      |                   | $          | 9,514 |   |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Liabilities and  Stockholders' Equity                                                                                                                                      |       |                    |       |                   |       |
| Accounts payable  and accrued expenses                                                                                                                                     |       | $                       | 618        |                   | $          | 622 |   |
| Current  maturities of long-term debt                                                                                                                                      |       | 8                       |       | 1                      |       |
| Income taxes  payable                                                                                                                                                      |       | 55                      |       | —                 |       |
| Liabilities  related to assets held for sale                                                                                                                               |       | 61                      |       | 74                     |       |
| Total current  liabilities                                                                                                                                                 |       | 742                     |       | 697                    |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Long-term debt,  net of current maturities                                                                                                                                 |       | 4,171                   |       | 4,618                  |       |
| Deferred income  taxes, net                                                                                                                                                |       | 954                     |       | 957                    |       |
| Other  liabilities                                                                                                                                                         |       | 206                     |       | 184                    |       |
| Total  liabilities                                                                                                                                                         |       | 6,073                   |       | 6,456                  |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Commitments and  contingent liabilities                                                                                                                                    |       |                    |       |                   |       |
|                                                                                                                                                                       |       |                    |       |                   |       |
| Stockholders'  Equity:                                                                                                                                                     |       |                    |       |                   |       |
| Common stock,  $0.01 par value, 400.0 million shares authorized, 334.0 million and 326.9  million shares issued at September 30, 2004 and December 31, 2003,  respectively |       | 3                       |       | 3                      |       |
| Additional paid-in  capital                                                                                                                                                |       | 3,906                   |       | 3,828                  |       |
| Accumulated  deficit                                                                                                                                                       |       | (246                    | )          | (523                   | )          |
| Accumulated  other comprehensive income                                                                                                                                    |       | 15                      |       | 12                     |       |
| Common stock in  treasury at cost, 23.1 million shares at September 30, 2004 and December 31,  2003                                                                        |       | (262                    | )          | (262                   | )          |
| Total  stockholders' equity                                                                                                                                                |       | 3,416                   |       | 3,058                  |       |
| Total  liabilities and stockholders' equity                                                                                                                                |       | $                       | 9,489      |                   | $          | 9,514 |   |

 

See notes to condensedconsolidated financial statements

 

3

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**CAESARS ENTERTAINMENT, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED INCOME STATEMENTS**

**(in millions, except per share amounts)**

**(unaudited)**

 
| ** **                                                                                                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues                                                                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Casino                                                                                                                                   |       | $                                     | 765        |                                 | $          | 758 |   | $ | 2,254 |   | $ | 2,201 |   |
| Rooms                                                                                                                                    |       | 144                                   |       | 129                                  |       | 425 |   | 382 |   |
| Food and  beverage                                                                                                                       |       | 124                                   |       | 116                                  |       | 374 |   | 330 |   |
| Other revenue                                                                                                                            |       | 86                                    |       | 70                                   |       | 252 |   | 202 |   |
|                                                                                                                                     |       | 1,119                                 |       | 1,073                                |       | 3,305 |   | 3,115 |   |
| Expenses                                                                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Casino                                                                                                                                   |       | 374                                   |       | 390                                  |       | 1,131 |   | 1,141 |   |
| Rooms                                                                                                                                    |       | 45                                    |       | 45                                   |       | 134 |   | 126 |   |
| Food and  beverage                                                                                                                       |       | 112                                   |       | 106                                  |       | 327 |   | 297 |   |
| Other expense                                                                                                                            |       | 287                                   |       | 267                                  |       | 834 |   | 781 |   |
| Depreciation and  amortization                                                                                                           |       | 106                                   |       | 103                                  |       | 314 |   | 316 |   |
| Pre-opening  expense                                                                                                                     |       | 4                                     |       | —                               |       | 7 |   | 1 |   |
| Impairment loss  and other                                                                                                               |       | 9                                     |       | —                               |       | 11 |   | — |   |
| Merger costs                                                                                                                             |       | 6                                     |       | —                               |       | 6 |   | — |   |
| Corporate  expense                                                                                                                       |       | 12                                    |       | 8                                    |       | 34 |   | 25 |   |
|                                                                                                                                     |       | 955                                   |       | 919                                  |       | 2,798 |   | 2,687 |   |
| Equity in  earnings of unconsolidated affiliates                                                                                         |       | 3                                     |       | 3                                    |       | 14 |   | 14 |   |
| Operating income                                                                                                                         |       | 167                                   |       | 157                                  |       | 521 |   | 442 |   |
|                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Interest  expense, net of interest capitalized                                                                                           |       | (69                                   | )          | (78                                  | )          | (212 | ) | (234 | ) |
| Interest  expense, net from unconsolidated affiliates                                                                                    |       | (2                                    | )          | (2                                   | )          | (5 | ) | (5 | ) |
| Interest and  other income                                                                                                               |       | 2                                     |       | 2                                    |       | 5 |   | 4 |   |
| Investment gain                                                                                                                          |       | —                                |       | —                               |       | 3 |   | — |   |
|                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Income from  continuing operations before income taxes and minority interest                                                             |       | 98                                    |       | 79                                   |       | 312 |   | 207 |   |
| Provision for  income taxes                                                                                                              |       | 47                                    |       | 33                                   |       | 142 |   | 87 |   |
| Minority  interest, net                                                                                                                  |       | 2                                     |       | 1                                    |       | 6 |   | 2 |   |
| Income from  continuing operations                                                                                                       |       | 49                                    |       | 45                                   |       | 164 |   | 118 |   |
|                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Discontinued  operations                                                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Income from  discontinued operations (including $87 million gain on sale of the Las Vegas  Hilton in the nine months 2004), net of taxes |       | 9                                     |       | 3                                    |       | 113 |   | 12 |   |
| Net income                                                                                                                               |       | $                                     | 58         |                                 | $          | 48 |   | $ | 277 |   | $ | 130 |   |
|                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Basic earnings  per share                                                                                                                |       |                                  |       |                                 |       |   |   |   |   |
| Income from  continuing operations                                                                                                       |       | $                                     | 0.16       |                                 | $          | 0.15 |   | $ | 0.53 |   | $ | 0.39 |   |
| Discontinued  operations, net of taxes                                                                                                   |       | 0.03                                  |       | 0.01                                 |       | 0.37 |   | 0.04 |   |
| Net income                                                                                                                               |       | $                                     | 0.19       |                                 | $          | 0.16 |   | $ | 0.90 |   | $ | 0.43 |   |
|                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Diluted earnings  per share                                                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Income from  continuing operations                                                                                                       |       | $                                     | 0.15       |                                 | $          | 0.15 |   | $ | 0.52 |   | $ | 0.39 |   |
| Discontinued  operations, net of taxes                                                                                                   |       | 0.03                                  |       | 0.01                                 |       | 0.36 |   | 0.04 |   |
| Net income                                                                                                                               |       | $                                     | 0.18       |                                 | $          | 0.16 |   | $ | 0.88 |   | $ | 0.43 |   |
|                                                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average  shares outstanding                                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Basic shares                                                                                                                             |       | 310                                   |       | 302                                  |       | 308 |   | 301 |   |
| Diluted shares                                                                                                                           |       | 316                                   |       | 304                                  |       | 314 |   | 303 |   |

 

See notes to condensedconsolidated financial statements

 

4

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**CAESARS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(in millions)**

**(unaudited)**

 
| ** **                                                                                                   | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Operating  activities                                                                                        |       |                                 |       |   |   |
| Net income                                                                                                   |       | $                                    | 277        |   | $ | 130 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities of  continuing operations: |       |                                 |       |   |   |
| Depreciation and  amortization                                                                               |       | 314                                  |       | 316 |   |
| Pre-opening  expense                                                                                         |       | 7                                    |       | 1 |   |
| Income from  discontinued operations                                                                         |       | (113                                 | )          | (12 | ) |
| Impairment loss                                                                                              |       | 9                                    |       | — |   |
| Change in  working capital components:                                                                       |       |                                 |       |   |   |
| Accounts  receivable, net                                                                                    |       | 15                                   |       | 17 |   |
| Inventory,  prepaids, and other                                                                              |       | (28                                  | )          | (8 | ) |
| Accounts payable  and accrued expenses                                                                       |       | (17                                  | )          | (94 | ) |
| Income taxes  payable                                                                                        |       | 71                                   |       | (3 | ) |
| Deferred income  taxes                                                                                       |       | (8                                   | )          | 15 |   |
| Other                                                                                                        |       | 34                                   |       | 26 |   |
| Net cash  provided by operating activities of continuing operations                                          |       | 561                                  |       | 388 |   |
|                                                                                                         |       |                                 |       |   |   |
| Investing  activities                                                                                        |       |                                 |       |   |   |
| Capital  expenditures                                                                                        |       | (374                                 | )          | (222 | ) |
| Proceeds from  the sale of discontinued operations                                                           |       | 286                                  |       | — |   |
| Cash related to  conversion from equity method to consolidation method of accounting for a  subsidiary       |       | 9                                    |       | — |   |
| Pre-opening  expense                                                                                         |       | (7                                   | )          | (1 | ) |
| Other                                                                                                        |       | (11                                  | )          | (19 | ) |
| Net cash used in  investing activities of continuing operations                                              |       | (97                                  | )          | (242 | ) |
|                                                                                                         |       |                                 |       |   |   |
| Financing  activities                                                                                        |       |                                 |       |   |   |
| Change in Credit  Facility                                                                                   |       | (542                                 | )          | (265 | ) |
| Payments on  notes                                                                                           |       | (325                                 | )          | (300 | ) |
| Proceeds from  issuance of notes                                                                             |       | 375                                  |       | 300 |   |
| Proceeds from  exercise of stock options                                                                     |       | 63                                   |       | 15 |   |
| Debt issuance  costs                                                                                         |       | (25                                  | )          | (4 | ) |
| Other                                                                                                        |       | 3                                    |       | 2 |   |
| Net cash used in  financing activities of  continuing operations                                        |       | (451                                 | )          | (252 | ) |
| Cash related to  discontinued operations                                                                     |       | 7                                    |       | 33 |   |
| Increase  (decrease) in cash and equivalents                                                                 |       | 20                                   |       | (73 | ) |
| Cash and  equivalents at beginning of period                                                                 |       | 298                                  |       | 324 |   |
| Cash and  equivalents at end of period                                                                       |       | $                                    | 318        |   | $ | 251 |   |
|                                                                                                         |       |                                 |       |   |   |
| Supplemental  Disclosures of Cash Flow Information:                                                          |       |                                 |       |   |   |
| Non-cash  investing and financing activities:                                                                |       |                                 |       |   |   |
| Converision of  investment in subsidiary to preferred stock in subsidiary                                    |       | $                                    | 116        |   | $ | — |   |
| Cash paid for:                                                                                               |       |                                 |       |   |   |
| Interest, net of  amounts capitalized                                                                        |       | $                                    | 243        |   | $ | 266 |   |
| Income taxes,  net of refunds                                                                                |       | $                                    | 67         |   | $ | 46 |   |

 

See notes to condensedconsolidated financial statements

 

5

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**CAESARS ENTERTAINMENT, INC. ANDSUBSIDIARIES**

## **NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

## **(UNAUDITED)**

## ** **

### **Note 1. The Company**

### ** **

Caesars Entertainment,Inc. (“Caesars” or the “Company”), a Delaware corporation, was formed inJune 1998.  On January 6, 2004, theCompany changed its name from Park Place Entertainment Corporation to CaesarsEntertainment, Inc.  The Company isprimarily engaged, through subsidiaries, in the ownership, operation, anddevelopment of gaming facilities. The operations of the Company are currentlyconducted under the Caesars, Bally’s, Paris, Flamingo, Grand, Hilton and Conradbrands. The Company, through subsidiaries, operates and consolidates sixteenwholly owned casino hotels located in the United States; of which seven arelocated in Nevada; three are located in Atlantic City, New Jersey; five arelocated in Mississippi; and one is in New Orleans, Louisiana. Additionally, theCompany manages and consolidates an 82 percent owned riverboat casino inHarrison County, Indiana; manages the casino operations of Caesars Palace atSea on three cruise ships; and manages and consolidates two majority ownedcasinos in Nova Scotia, Canada. The company manages and consolidates an 86percent owned international casino in Punta del Este, Uruguay.  The Company partially owns and manages onecasino internationally, located in Johannesburg, South Africa, which isaccounted for under the equity method. In Windsor, Canada, the Company has a 50percent interest in a company that provides management services to the CasinoWindsor. The Company also provides management services to two casinos inQueensland, Australia and the slot operations at the Dover Downs racetrack inDelaware. The Company views each casino property as an operating segment andall such operating segments have been aggregated into one reporting segment.Each casino property derives its revenues primarily from casino operations,room rental and food and beverage sales.

 

On July 14, 2004, the Company, Harrah’s Entertainment, Inc. (“Harrah’s”) and Harrah’s Operating Company, Inc., a wholly-owned subsidiary of Harrah’s, (“Harrah’s Operating”) entered into an Agreement and Plan of Merger (the “Merger Agreement”), providing for the merger of the Company with and into Harrah’s Operating, which will be the surviving corporation.  The Merger Agreement provides that each Company stockholder may elect to receive for each outstanding share of Company common stock either $17.75 in cash or 0.3247 shares of Harrah’s common stock.  However, Harrah’s has limited the total (i) number of Harrah’s shares it will issue to the product of the Company’s outstanding number of shares multiplied by 0.6642 and further multiplied by the 0.3247 fraction referred to above (the “Stock Cap”) and (ii) cash it will issue to the product of the Company’s outstanding number of shares multiplied by 0.3358 and further multiplied by the $17.75 amount referred to above (the “Cash Cap”).  To the extent that the Company’s stockholders elect to receive (i) Harrah’s stock in excess of the Stock Cap or (ii) cash in excess of the Cash Cap, then the merger consideration paid to the Company’s stockholders shall be pro rated between Harrah’s common stock and cash pursuant to the terms of the Merger Agreement.  As of September 30, 2004, the outstanding number of shares of the Company’s common stock was approximately 310.9 million and using such number of shares, the aggregate merger consideration would equal (i) approximately 67.06 million shares of Harrah’s common stock and (ii) approximately $1.853 billion in cash.

 

The transaction with Harrah’s is subject to a number of conditions, including, among other things the approval and adoption of the Merger Agreement by the stockholders of the Company and Harrah’s and upon receipt of all necessary antitrust, gaming and other approvals, and the satisfaction or waiver of all other conditions precedent.

 

### **Note 2. Basis of Presentation**

 

The condensed consolidated financial statementsinclude the accounts of the Company, its subsidiaries, and investments inunconsolidated affiliates, which are 50 percent or less owned, that are

 

6

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accounted for under the equity method. The Company exercises significant influence over those investmentsaccounted for under the equity method due to ownership percentages, boardrepresentation, and management agreements. All material intercompany accountsand transactions are eliminated.

 

The condensed consolidated financial statementsincluded herein are unaudited and have been prepared by the Company pursuant tothe rules and regulations of the United States Securities and ExchangeCommission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to such rules and regulations, although the Company believesthat the disclosures are adequate to make the information presented notmisleading.  In the opinion ofmanagement, all adjustments (which include normal recurring adjustments)necessary for a fair presentation of results for the interim periods have beenmade. The results for the three and nine month periods ended September 30, 2004are not necessarily indicative of results to be expected for the full fiscalyear. These condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2003.

 

*Reclassifications*

 

The condensed consolidated financial statements forprior periods reflect certain reclassifications to conform to classificationsadopted in the current period. These reclassifications have no effect onpreviously reported net income.

 

*Recently Issued Accounting Pronouncement*

 

In September 2004, the Emerging Issues Task Force(“EITF”) of the Financial Accounting Standards Board (“FASB”) reached aconsensus on issue No. 04-08, “The Effect of Contingently ConvertibleInstruments on Diluted Earnings per Share” (“EITF 04-08”), which is effectivefor reporting periods ending after December 15, 2004. EITF 04-08 requirescompanies to include shares issuable under convertible instruments in diluted earningsper share computations (if dilutive) regardless of whether the market pricetrigger (or other contingent feature) has been met. In addition, prior periodearnings per share amounts presented for comparative purposes must be restated.In April 2004, the Company issued contingent convertible notes with terms asdescribed in Note 7. In accordance with EITF 04-08, there will be no impact onthe future diluted earnings per share calculated related to these notes unlessthe Company’s common stock price exceeds the conversion price. In thatsituation, the Company would reflect the additional common shares in thecalculation of diluted earnings per share using the treasury share method.

 

**Note 3. Stock-Based Compensation**

 

TheCompany has stock incentive plans and applies Accounting Principles BoardOpinion No. 25 and related interpretations in accounting for stock-basedcompensation plans using the intrinsic value method.  Had compensation cost for the Company’s stockincentive plans been determined based on the fair value at the grant dates forawards under those plans consistent with the method of Statement of FinancialAccounting Standard (“SFAS”) No. 123 “Accounting for Stock-BasedCompensation,” the Company’s net income and net income per share would havebeen reduced to the pro forma amounts as follows (in millions, except per shareamounts, unaudited):

 
| ** **                                                                                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Net income, as  reported                                                                                               |       | $                                     | 58         |                                 | $          | 48 |   | $ | 277 |   | $ | 130 |   |
| Add: Total  stock-based employee compensation expense included in reported net income,  net of related taxes           |       | 2                                     |       | 1                                    |       | 3 |   | 2 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  method, net of related taxes |       | (4                                    | )          | (4                                   | )          | (10 | ) | (11 | ) |
| Pro forma net  income                                                                                                  |       | $                                     | 56         |                                 | $          | 45 |   | $ | 270 |   | $ | 121 |   |
|                                                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Earnings per  share:                                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Basic, as  reported                                                                                                    |       | $                                     | 0.19       |                                 | $          | 0.16 |   | $ | 0.90 |   | $ | 0.43 |   |
| Basic, pro forma                                                                                                       |       | $                                     | 0.18       |                                 | $          | 0.15 |   | $ | 0.88 |   | $ | 0.40 |   |
|                                                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Diluted, as  reported                                                                                                  |       | $                                     | 0.18       |                                 | $          | 0.16 |   | $ | 0.88 |   | $ | 0.43 |   |
| Diluted, pro  forma                                                                                                    |       | $                                     | 0.18       |                                 | $          | 0.15 |   | $ | 0.86 |   | $ | 0.40 |   |

 

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### **Note 4. Discontinued Operations**

 

*Las Vegas Hilton*

 

On December 24, 2003, theCompany entered into a definitive agreement to sell the Las Vegas Hilton to anunrelated third party. This transaction was completed in June 2004 resulting inan after tax gain of $87 million. The gain is included in income fromdiscontinued operations for the nine months ended September 30, 2004. TheCompany received cash of approximately $286 million for the property, building,equipment and working capital that comprise the Las Vegas Hilton.

 

*Atlantic City Hilton and Bally’sTunica*

 

On September 27, 2004, theCompany entered into an agreement to sell the assets and certain relatedliabilities of the Atlantic City Hilton and Bally’s Tunica to an unrelatedthird party. The Company estimates that the after-tax proceeds will be approximately$480 million related to these two properties. The estimated selling price ofthe assets less the costs to sell these two properties exceeds their carryingvalue; therefore no loss has been recognized as of September 30, 2004. Any gainrelated to this sale will be recognized when the transaction is completed.

 

The results of the three propertiesdiscussed above are classified as discontinued operations and the condensed consolidatedfinancial statements for all prior periods have been adjusted to reflect thispresentation. Interest expense has been allocated to the income fromdiscontinued operations based on the ratio of the discontinued operations’ netassets to the consolidated net assets. In accordance with generally acceptedaccounting principles, the assets held for sale are no longer depreciated. Theassets and liabilities of the Las Vegas Hilton are classified as assets heldfor sale and liabilities related to assets held for sale in the accompanyingcondensed consolidated balance sheet as of December 31, 2003. The assets andliabilities of the Atlantic City Hilton and Bally’s Tunica are classified asassets held for sale and liabilities related to assets held for sale in theaccompanying condensed consolidated balance sheets as of September 30,2004 and December 31, 2003.

 

Summary operating resultsfor the discontinued operations are as follows (in millions, unaudited):

 
| ** **                                      | ** ** | **Three months ended****September 30,** | ** ** | **Nine months ended****September 30,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                | ** ** | **2003**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues                                    |       | $                                       | 96         |                                   | $          | 147 |   | $ | 385 |   | $ | 435 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Operating income                                |       | $                                       | 18         |                                   | $          | 11 |   | $ | 58 |   | $ | 40 |   |
| Interest expense                                |       | (4                                      | )          | (5                                     | )          | (17 | ) | (19 | ) |
| Income tax  provision                           |       | (5                                      | )          | (3                                     | )          | (15 | ) | (9 | ) |
| Gain on sale,  net of taxes of $47 million |       | —                                  |       | —                                 |       | 87 |   | — |   |
| Income from  discontinued operations            |       | $                                       | 9          |                                   | $          | 3 |   | $ | 113 |   | $ | 12 |   |

 

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Assets held for sale and liabilitiesrelated to assets held for sale are as follows (in millions, unaudited):

 
| ** **                                         | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Cash and  equivalents                              |       | $                       | 15         |                   | $          | 25 |   |
| Accounts  receivable, net                          |       | —                  |       | 22                     |       |
| Inventory,  prepaids, and other                    |       | 1                       |       | 7                      |       |
| Deferred income  taxes, net                        |       | —                  |       | 1                      |       |
| Property and  equipment, net                       |       | 369                     |       | 521                    |       |
| Goodwill                                           |       | 96                      |       | 96                     |       |
| Other assets                                       |       | 12                      |       | 14                     |       |
| Total assets  held for sale                        |       | $                       | 493        |                   | $          | 686 |   |
|                                               |       |                    |       |                   |       |
| Accounts payable  and accrued expenses             |       | $                       | 1          |                   | $          | 47 |   |
| Income tax  payable                                |       | 9                       |       | 8                      |       |
| Deferred income  taxes, net                        |       | 51                      |       | 19                     |       |
| Total  liabilities related to assets held for sale |       | $                       | 61         |                   | $          | 74 |   |

 

### **Note 5. Earnings Per Share**

 

The weighted-average number of common and commonequivalent shares outstanding used in the computation of basic and dilutedearnings per share is as follows (in millions, unaudited):

 
| ** **                                                           | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Weighted average  number of common shares outstanding – basic   |       | 310                                   |       | 302                                  |       | 308 |   | 301 |   |
| Potential  dilution from equity grants                               |       | 6                                     |       | 2                                    |       | 6 |   | 2 |   |
| Weighted average  number of common shares outstanding – diluted |       | 316                                   |       | 304                                  |       | 314 |   | 303 |   |

 

For the three and nine monthsended September 30, 2004, there were 38,000 shares and 449,000 shares excludedfrom the calculation of diluted EPS, respectively. The exercise price of thoseoptions exceeded the average market price. For the three and nine months ended September30, 2003, 15 million and 17 million shares were excluded from thecalculation of diluted EPS. In April 2004, the Company issued $375 million contingentconvertible Senior Notes due 2024. The notes are convertible into cash andshares of our common stock upon the occurrence of certain events described inNote 7. Shares potentially issuable upon conversion are not included in thecalculation of diluted EPS because the conditions for conversion have not beenmet.

 

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### **Note 6. Comprehensive Income**

 

Comprehensive income is the total of net income andall other non-stockholder changes in equity. Comprehensive income is as follows (in millions, unaudited):

 
| ** **                       | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                       |       | $                                     | 58         |                                 | $          | 48 |   | $ | 277 |   | $ | 130 |   |
| Currency  translation adjustment |       | 6                                     |       | —                               |       | 3 |   | 17 |   |
| Comprehensive  income            |       | $                                     | 64         |                                 | $          | 48 |   | $ | 280 |   | $ | 147 |   |

 

### **Note 7. Long-Term Debt**

 

Long-term debt is as follows (in millions, unaudited):

 
| ** **                                                                                                                                                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Senior and  senior subordinated notes, net of unamortized discount of $3 million as of  September 30, 2004 and $4 million as of December 31, 2003 |       | $                       | 3,522      |                   | $          | 3,471 |   |
| Credit  facilities                                                                                                                                               |       | 600                     |       | 1,142                  |       |
| Other                                                                                                                                                            |       | 50                      |       | 4                      |       |
|                                                                                                                                                             |       | 4,172                   |       | 4,617                  |       |
| Less current  maturities                                                                                                                                         |       | (8                      | )          | (1                     | )          |
| Market value of  interest rate swaps                                                                                                                             |       | 7                       |       | 2                      |       |
| Net long-term  debt                                                                                                                                              |       | $                       | 4,171      |                   | $          | 4,618 |   |

 

*Bank Credit Facilities*

 

In April 2004, the Companyentered into a new $2.0 billion senior credit facility, which expires in April2009, and is comprised of a $700 million term loan and a $1.3 billion revolver(collectively, the “Credit Facility”) and terminated its previous credit facilities.During the third quarter of 2004, the Company used excess cash to reduce theoutstanding balance on the term loan to $600 million, thereby reducing theoverall availability under the Company’s Credit Facility from $2.0 billion to$1.9 billion. As of September 30, 2004, $600 million was outstanding under theterm loan and no amounts were outstanding under the revolver. The Company isrequired to make repayments of the term loan under the Credit Facility in thefollowing amounts on the last day of the following fiscal quarters:  $3.5 million on the last day of the fiscalquarter ending June 30, 2006 and each fiscal quarter thereafter through andincluding March 31, 2007; $5.25 million on the last day of the fiscal quarterending June 30, 2007 and each fiscal quarter thereafter through and includingMarch 31, 2008; and $26.25 million on the last day of the fiscal quarter endingJune 30, 2008 and each fiscal quarter thereafter through and including March31, 2009. Once repaid, the availability of the term loan component ispermanently reduced. Amounts paid down under the revolver may be reborrowed.

 

The Credit Facility containsfinancial covenants including a maximum leverage ratio (consolidated debtdivided by consolidated ebitda, as defined in the Credit Facility) of 5.00:1.00and a minimum interest coverage ratio (consolidated ebitda, as defined in the CreditFacility, divided by consolidated interest expense) of 2.75:1.00.  The maximum leverage ratio is 5.00:1.00 forthe quarterly testing periods ended September 30, 2004 through and includingSeptember 30, 2005, 4.75:1.00 for the quarterly testing periods ending December31, 2005 and March 31, 2006, and 4.50:1.00 for the quarterly testing periodsending June 30, 2006 and thereafter.  Theinterest coverage ratio remains 2.75:1.00 for all

 

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quarterly testing periods.  TheCompany is required to compute its actual leverage and interest coverage ratioson a rolling twelve-month basis as of the end of each calendar quarter.  If the Company is not in compliance with therequired covenant ratios, an event of default would occur, which if not cured,could cause the entire outstanding borrowings under the Credit Facility tobecome immediately due and payable as well as trigger the cross defaultprovisions of other debt issues.  As of September30, 2004, the Company was in compliance with all applicable covenants.

 

Borrowings under the CreditFacility bear interest at a floating rate and may be obtained, at the Company’soption, as LIBOR advances for varying periods, or as base rate advances, eachadjusted for an applicable margin (as further described in the Credit Facility).  The Company has historically borrowed using LIBORadvances and expects to continue doing so for the foreseeable future.  The Company pays a margin over LIBOR which isa function of both the Company’s leverage ratio and the Company’s creditrating.  This margin is adjustedquarterly.  Based on the Company’sleverage ratio and credit rating as of September 30, 2004, the margin overLIBOR was 150 basis points.

 

Ina program designed for short-term borrowings at lower interest rates, theCompany has entered into an uncommitted line of credit with a lender whereby itcan borrow up to $100 million for periods of ninety days or less.  This agreement expires March 2005.  The Company is required to maintain availabilityunder the Credit Facility in an amount equal to the amount outstanding underthe short term borrowing program.  Noamounts were outstanding under this program at September 30, 2004 orDecember 31, 2003.

 

Theclosing of the pending transaction with Harrah’s may require certain amendmentsor waivers to the Credit Facility. There can be no assurance that suchamendments or waivers will be obtained.

 

*InterestRate Swaps*

 

Pursuant to the Company’srisk management policy, management may engage in actions to manage the Company’sinterest rate risk position.  During thelast half of 2003, the Company entered into four interest rate swapsrepresenting $300 million notional amount with members of its bank group tomanage interest expense.  The interest rate swaps have converted a portionof the Company’s fixed-rate debt to floating rate (“fair value hedges”). Under the agreements, the Company receives a fixed interest rate of 7 percentand pays a variable interest rate based on a margin above six month LIBOR on$300 million notional amount.  Theinterest rate swaps mature in 2013.  The net effect of the interest rateswaps resulted in a reduction in interest expense of $2 million and $7 million forthe three and nine months ended September 30, 2004.  The net effect of the interest rate swapsresulted in a reduction in interest expense of $0.2 million for the threeand nine months ended September 30, 2003.

 

These interest rate swapsmeet the shortcut criteria under SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” which permits the assumption of noineffectiveness in the hedging relationship between the swap and the underlyinghedged asset or liability.  As such, there is no income statement impactfrom changes in the fair value of the hedging instruments.  Instead, thefair value of the instrument is recorded as an asset or liability on theCompany’s balance sheet with an offsetting adjustment to the carrying value ofthe related debt.  In accordance with SFAS No. 133, the Company recordedother long-term assets of $7 million and $2 million as of September30, 2004 and December 31, 2003, respectively, representing the fair value ofthe interest rate swaps and a corresponding increase in long-term debt, asthese interest rate swaps are considered highly effective under the criteriaestablished by SFAS No. 133.

 

*Other*

 

Asof September 30, 2004, other debt in the table above includes $47 million relatedto Baluma Holdings, S.A. (see Note 9) which the Company began consolidating inSeptember 2004 due to an ownership restructuring.

 

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Thecondensed consolidated balance sheet as of December 31, 2003 excludes fromcurrent maturities $325 million of 7.0 percent Senior Notes due July 2004.This amount was classified as long-term as of December 31, 2003 because theCompany had both the intent and the ability to refinance these notes usingavailability under the long-term portion of the Credit Facility. These noteswere retired in July 2004 using proceeds from the Company’s April 2004convertible note offering and proceeds from the sale of the Las Vegas Hilton.

 

*ContingentConvertible Senior Notes*

 

InApril 2004, the Company issued $375 million Floating Rate ContingentConvertible Senior Notes due 2024 through a private placement offering toinstitutional investors.  The notes bearinterest at an annual rate equal to the three month LIBOR, adjustedquarterly.  The notes are convertibleinto cash and shares of common stock in the following circumstances:

 

•      duringany fiscal quarter commencing after the date of original issuance of the notes,if the closing sale price of the Company’s common stock for 20 out of 30consecutive trading days during the previous quarter is more than 120% of theconversion price of the notes on the last trading day of the previous quarter;

 

•      theCompany has called the notes for redemption and the redemption has not yetoccurred;

 

•      duringthe five trading day period immediately after any five consecutive trading dayperiod in which the trading price of the notes per $1,000 principal amount foreach day of such period was less than 95% of the product of the closing saleprice of the Company’s common stock on such day multiplied by the number ofshares issuable upon conversion; provided that, if on such date, the commonstock price is between the Conversion Price and 120% of the Conversion Price,as defined, then the holders will receive the principal amount of the notessurrendered plus accrued but unpaid interest; or

 

•      uponthe occurrence of specified corporate transactions as defined in the indenturecovering thesenotes.

 

Holders may convert any outstanding notes intocash and shares of the Company’s common stock at an initial conversion priceper share of $22.29. This represents a conversion rate of approximately 44.8632shares of common stock per $1,000 principal amount of notes (the “ConversionRate”). Subject to certain exceptions described in the indenture covering thesenotes, at the time the notes are tendered for conversion, the value (the “ConversionValue”) of the cash and shares of the Company’s common stock, if any, to bereceived by a holder converting $1,000 principal amount of the notes will bedetermined by multiplying the Conversion Rate by the “Ten Day Average ClosingStock Price,” which equals the average of the closing per share prices of theCompany’s common stock on the New York Stock Exchange on the ten consecutivetrading days beginning on the second trading day following the day the notesare submitted for conversion.  TheConversion Value will be delivered to holders as follows: (1) an amount in cash(the “Principal Return”) equal to the lesser of (a) the aggregate ConversionValue of the notes to be converted and (b) the aggregate principal amount of thenotes to be converted, and (2) if the aggregate Conversion Value of the notesto be converted is greater than the Principal Return, an amount in shares (the “NetShares”) equal to such aggregate Conversion Value less the Principal Return(the “Net Share Amount”).  The Companywill pay the Principal Return and deliver the Net Shares, if any, as promptlyas practicable after determination of the Net Share Amount.  The number of Net Shares to be paid will bedetermined by dividing the Net Share Amount by the Ten Day Average ClosingStock Price.

 

The Company filed a registration statement toregister these notes on behalf of the holder of the notes under the SecuritiesAct of 1933, as amended, and such registration statement was declared

 

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effective by the United States Securities and Exchange Commission on November8, 2004. The registration statement includes a description of the treatment ofthe notes as a result ofthe pending merger with Harrah’s Operating. The Notes are redeemable by theCompany at any time on or after April 20, 2009 at 100 percent of the principalamount of the notes plus accrued and unpaid interest.  Holders may require the Company to purchaseall or a portion of these notes on April 15, 2009, 2014, and 2019 at 100percent of the principal amount of the notes plus accrued and unpaid interest.  The notes are unsecured obligations, rankequal with the Company’s other senior indebtedness and are senior to all theCompany’s subordinated indebtedness.

 

**Note 8.  Commitments and Contingent Liabilities**

 

*Litigation*

 

TheCompany and its subsidiaries are involved in various legal proceedings relatingto its businesses. The Company believes that all the actions brought against itor its subsidiaries are without merit and will continue to vigorously defendagainst them. While any proceeding or litigation has an element of uncertainty,the Company believes that the final outcome of these matters is not likely tohave a material adverse effect upon its results of operations or financialposition.

 

*Shareholder Litigation*

 

On July 15, 2004, a purported class action (*Derasmo v. Caesars Entertainment, Inc. et al*)was filed in the District Court for Clark County, Nevada on behalf of theowners of Caesars Entertainment, Inc. shares of common stock against Caesarsand its directors. The lawsuit alleges breach of fiduciary duties and that theproposed transaction involving the acquisition of Caesars by Harrah’sEntertainment, Inc. (“Harrah’s”) provides benefits to Harrah’s and to themembers of the board of directors not available to the Caesars stockholders.The lawsuit seeks an injunction and a declaration that the proposed transactionis unlawful. On October 20, 2004, the plaintiff dismissed the complaint withoutprejudice; however, the Company expects that the plaintiff will file a newcomplaint based on the proposed transaction with Harrah’s.

 

*Slot Machine Litigation*

 

InApril 1994, William H. Poulos brought a purported class action in theUnited States District Court for the Middle District of Florida, OrlandoDivision captioned *William H. Poulos, et al.v. Caesars World, Inc., et al.* against 41 manufacturers,distributors and casino operators of video poker and electronic slot machines,including the Company. In May 1994, another plaintiff filed a class actioncomplaint in the United States District Court for the Middle District ofFlorida captioned *William Ahern, et al. v.Caesars World, Inc. et al.* alleging substantially the sameallegations against 48 defendants, including the Company. InSeptember 1995, a third action was filed against 45 defendants, includingthe Company, in the United States District Court for the District of Nevadacaptioned *Larry Schreier, et al. v. CaesarsWorld, Inc., et al.* The court consolidated the three actions in theUnited States District Court for the District of Nevada under the case caption *William H. Poulos, et al. v. Caesars World, Inc.et al.* The consolidated complaints allege that the defendants areinvolved in a scheme to induce people to play electronic video poker and slotmachines based on the false beliefs regarding how such machines operate and theextent to which a player is likely to win on any given play. The actionsincluded claims under the federal Racketeering Influence and CorruptOrganizations Act, fraud, unjust enrichment and negligent misrepresentation andseek unspecific compensatory damages. In July 2002, the United StatesDistrict Court denied the plaintiff’s motion to certify the case as a classaction. On August 10, 2004, the Ninth Circuit Court of Appeals affirmed theDistrict Court’s denial of the plaintiff’s motion to certify the case as aclass action.

 

*Mohawk Litigation*

 

InApril 2000, the Company entered into an agreement with the Saint RegisMohawk Tribe (the

 

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“Tribe”) pursuant to which it obtained the exclusive rights to developa Class II or Class III casino project in the State of New York withthe Tribe. There are various parties alleging that the grant of rights to theCompany infringed upon their rights. Such parties have commenced the variouslawsuits discussed below.

 

OnApril 26, 2000, certain individual members of the Saint Regis Mohawk Tribepurported to commence a class action proceeding in a “Tribal Court” inHogansburg, New York against the Company and certain of its executives. Theproceeding sought to nullify the Company’s agreement with the Saint RegisMohawk Tribe to develop and manage gaming facilities in the State of New York.On March 20, 2001, the “Tribal Court” purported to render a defaultjudgment against the Company and one of its executives in the amount of$1.787 billion, which judgment the Company refuses to recognize as valid.On June 2, 2000, the Company and certain of its executives filed an actioncaptioned *Park Place EntertainmentCorporation, et al. v. Arquette, et al.*, in the United StatesDistrict Court for the Northern District of New York seeking to enjoin thedissident Tribal members from proceeding in the “Tribal Court” with an actionthat the Company believes has been unlawfully convened and is without merit. InSeptember 2000, the District Court dismissed the action on the groundsthat the Court lacked jurisdiction. In October 2000, the Company appealedthe judgment to the United States Court of Appeals for the Second Circuit. InJanuary 2002, the Second Circuit remanded the matter to the District Courtfor further development of the record. In April 2002, the District Courtrequested the United States Department of the Interior, Bureau of IndianAffairs (“BIA”) to provide its current position with regard to the legitimacyof the Tribe’s form of government and “Tribal Court”. Following receipt ofletters issued by the BIA, dated June 5, 2002, June 26, 2002 and July 12,2002, this Court entered an Order on July 29, 2002, affirming that the BIArecognizes only the Three Chief system of government for the Saint Regis MohawkTribe (the “Tribal Council”), that the Tribal Council has, by Resolution havingthe force of law of the Tribe, invalidated the Tribal court system and that theMohawk people have, by popular vote, determined that the purported “TribalCourt” is without authority to adjudicate matters of Tribal law. On February11, 2004, the Magistrate Judge issued a decision requiring the Department ofthe Interior to review its decision to recognize the Three Chief system ofgovernment. On February 16, 2004, the Tribal Council received a letter from theDepartment of the Interior continuing to recognize the Tribal Council as theofficial representatives of the Saint Regis Mohawk Tribe.

 

OnJune 6, 2000, President R.C.-St. Regis Management Company and itsprincipal, Ivan Kaufman, filed an action captioned *President R.C.-St. Regis Management Co., et al. v. Park Place EntertainmentCorporation, et al.* in the Supreme Court of the State of New York,County of Nassau, against the Company and certain of its executives seekingcompensatory and punitive damages in the amount of approximately$550 million. The action alleges claims based on breach of a proposedletter agreement between plaintiffs, the Company, and the Saint Regis MohawkTribe concerning the tribe’s existing casino in Hogansburg, New York,fraudulent inducement, tortious interference with contract, and defamation.Alternatively, plaintiffs seek specific performance and/or injunctive relief inconnection with the proposed letter agreement. In April 2004, the partiesreached a settlement, with neither side admitting liability, wherein thelitigation was dismissed with prejudice and the Company agreed to make certainpayments as follows: (i) $4 million to a charitable institution of plaintiff’schoice, of which $2 million was paid immediately and $2 million will bepaid in two years; and (ii) after the occurrence of certain events, amongothers the receipt of regulatory approvals of the Company’s managementagreement with the Tribe, four annual payments of $750,000 to the samecharitable institution and four annual payments of $250,000 to the plaintiff.

 

OnNovember 13, 2000, Catskill Development, LLC, Mohawk Management, LLC andMonticello Raceway Development Company, LLC (collectively, “CatskillDevelopment”) filed an action captioned *CatskillDevelopment L.L.C., et al. v. Park Place Entertainment Corporation, et al.*,against the Company in the United States District Court for the SouthernDistrict of New York. The action arises out of Catskill Development’s effortsto develop land in Sullivan County as a Native American gaming facility inconjunction with the Saint Regis Mohawk Tribe. Catskill Development claims thatthe Company wrongfully interfered with several agreements between itself andthe Tribe pertaining to the proposed gaming facility. The plaintiffs allegetortious interference with contract and prospective business relationships,unfair

 

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competition and state anti-trust violations and seek over$3 billion in damages. On May 14, 2001, the Court granted the Company’smotion to dismiss three of the four claims made by Catskill Development. OnMay 30, 2001, Catskill Development moved for reconsideration of thatruling, and the District Court reinstated one of the dismissed claims, withCatskill Development’s claims for tortious interference with contract and prospectivebusiness relationship remaining after such decision. On or about May 15,2002, the Company filed a motion for summary judgment dismissing the complaint.On or about June 18, 2002, the Company filed a motion for reconsiderationof the Court’s decision reinstating plaintiffs’ tortious interference withcontract claim on the basis of intervening case law from a Federal AppealsCourt. On August 22, 2002, the Court granted the Company’s motion forsummary judgment dismissing plaintiffs’ remaining two claims for tortiousinterference with contractual relations and tortious interference withprospective business relations. On August 26, 2002, the Court grantedjudgment to the Company dismissing plaintiffs’ complaint in its entirety.Plaintiffs have appealed the District Court’s decision to the United StatesCourt of Appeals for the Second Circuit. Subsequent to the filing of theappeal, the Plaintiffs moved on March 14, 2003 to reopen the judgment on thegrounds that certain information had not been provided to Plaintiffs indiscovery. In a decision rendered on October 7, 2003, the District Courtgranted Plaintiffs limited discovery for a 30-day period to explore whetherthey had been deprived of relevant information. That discovery period has nowended, and the matter is before the Court for a final determination. In itsdecision of October 7, 2003, the District Court emphasized that, whatever theresult of the discovery, it would reaffirm its summary judgment decision sincethe issues raised in Plaintiffs’ motion related to only one of two alternativegrounds for the granting of summary judgment. Once the District Court decidesthe motion to reopen the judgment, the entire matter will be heard by theSecond Circuit. The Company believes this matter to be without merit and willcontinue to vigorously contest the case.

 

OnMarch 29, 2001, the Company and its then general counsel, Clive Cummissued thirty individual Tribe members in the Supreme Court of the State of NewYork in the case of *Park Place EntertainmentCorp., et al. vs. Marlene Arquette, et al.,* alleging maliciousdefamation and *prima facie* tort in connectionwith the individuals’ purported “Tribal Court” proceedings and mediapublication of their purported “default judgment” against the Company, all ofwhich the Company believes has been injurious to the good name and reputationof the plaintiffs and seeks compensatory damages in an amount to be proved attrial (plus interest, costs and disbursements including reasonable attorneyfees), as well as unspecified punitive damages. Defendants asserted acounterclaim alleging the action was commenced in violation of New York’s CivilRights Law. Defendant Michael Rhodes-Devey moved to change venue to FranklinCounty, New York and to dismiss the complaint. By order dated November 14,2001, the Court granted the change of venue motion and denied without prejudicethe motion to dismiss. Plaintiffs moved to dismiss the counterclaim for failureto state a cause of action. In February 2002, defendants cross-moved to dismissthe complaint. By Decision and Order dated September 9, 2002, the Courtdenied defendants’ motion to dismiss the complaint and plaintiffs’ cross-motionto dismiss the counterclaim.

 

OnJune 27, 2001, the individual members of the Saint Regis Mohawk Tribe thatare plaintiffs in the Tribal Court action referenced above commenced an actionin United States District Court for the Northern District of New York againstthe Company and one of its executives, seeking recognition and enforcement ofthe purported March 20, 2001 $1.787 billion “Tribal Court” defaultjudgment against defendants, which judgment the Company refuses to recognize asvalid. The Company has taken the position that the purported “Tribal Court” inwhich the proceeding has been invoked is an invalid forum and is not recognizedby the lawful government of the Saint Regis Mohawk Tribe or by the UnitedStates Department of the Interior, Bureau of Indian Affairs (“BIA”). After theparties made cross-motions for summary judgment, the parties agreed to settlethe action with discontinuance. A settlement agreement has been circulated forsignature by all the plaintiffs. Although a fully signed settlement agreementhas not been exchanged, the Court has discontinued the action withoutprejudice.

 

OnOctober 15, 2001, Scutti Enterprises, LLC (“Scutti”) filed an actionagainst the Company in the Supreme Court of the State of New York, County ofMonroe. The action arises out of Scutti’s efforts to redevelop and manage theMohawk Bingo Palace owned by the Saint Regis Mohawk Tribe on the Tribe’s

 

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reserve in Akwesasne, New York. Scutti claims that the Companywrongfully interfered with its relationship with the Tribe pertaining to theproposed redevelopment and management of the Mohawk Bingo Palace. Scuttialleges tortious interference with contract and prospective businessrelationships, unfair competition and state anti-trust violations and seeksover $82 million in damages. The action was removed to United StatesDistrict Court for the Western District. The Company moved to dismiss theaction and, in March 2002, the Court dismissed the action with prejudice.Plaintiff has appealed the dismissal and also moved for relief from judgmentwith respect to the Court’s dismissal of plaintiff’s claims for tortiousinterference with contractual relations. On November 26, 2002, the Courtdenied plaintiff’s motion for relief from judgment. On February 28, 2003, theSecond Circuit Court of Appeals affirmed in part and reversed in part theDistrict Court’s dismissal of the action, affirming the dismissal of Scutti’sclaim for tortious interference with contractual relations, and vacating thedismissal of Scutti’s claim for tortious interference with prospective businessrelations and remanding the case to the District Court regarding only thatclaim.  The Company believes this matterto be without merit and will continue to vigorously contest this matter.

 

OnJanuary 29, 2002, two substantially identical actions were filed in theSupreme Court of the State of New York, County of Albany, challenging the 2001legislation that, among other things, authorized the Governor of the State ofNew York to execute tribal-state gaming compacts, approved the use of slotmachines as “games of chance,” approved the use of video lottery terminals atracetracks and authorized the participation of New York State in a multi-statelottery. The matters are captioned *Dalton,et al. v. Pataki, et al.* and *Karrv. Pataki, et al.*  Plaintiffssought a declaratory judgment declaring the legislation unconstitutional andenjoining the implementation thereof. On July 7, 2004, the Appellate Divisionof the New York State Supreme Court held that the legislation authorizing sixnew Native American casinos in New York State, including three in theCatskills, is consistent with the New York Constitution as well as applicablestate and federal law. An appeal by the plaintiffs to the Court of Appeals, NewYork State’s highest court, is expected.

 

On December 8, 2003, a groupof financial institutions filed a complaint in the United States District Courtfor the Eastern District of New York captioned *McIntoshCounty Bank, et al. v. Park Place Entertainment Corp., et al.*  Plaintiffs, who obtained assignments of two loansfrom President R.C.-St. Regis Management Company (“President”) in the amount of$12,116,000, allege that two officers of the Company purportedly conspired withtwo officers of President to induce government officials of the Saint RegisMohawk Tribe to terminate a management agreement between the Tribe andPresident, which, in turn, allegedly resulted in the Tribe’s failure to honor aseparate pledge agreement by which it agreed to escrow funds for purposes ofpaying the subject loans.  On March 31,2004, the plaintiffs filed an amended complaint alleging purported causes ofaction for interference with contract, interference with prospective businessrelations, constructive trust and accounting against the Company, and allegingunspecified damages in the amount of $20 million.  All defendants have moved for dismissal ofthe amended complaint.  The Companybelieves the matter is without merit and will vigorously contest the case.

 

*U.S. Attorney Subpoenas*

 

Atvarious times during 2003, the U.S. Attorney’s Office in Orlando, Floridaserved grand jury subpoenas on the Company and Caesars Palace.  The subpoenas were served in connection withan investigation by the U.S. Attorney’s Office which the Company believes isfocusing on possible money laundering in connection with certain cashtransactions engaged in by a former customer of Caesars Palace.  The investigation continues and the currentand former employees of the Company and Caesars Palace have been interviewed bythe U.S. Attorney’s Office.  The Companyand Caesars Palace continue to cooperate. Neither the Company nor Caesars Palace has been advised that eitherentity is a target of the grand jury investigation.

 

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*Reno Hilton Litigation*

 

In *Verderber vs.Reno Hilton, et al.*, a class action lawsuit in Nevada State Court,the plaintiffs sought damages based on the outbreak of a Norwalk, orNorwalk-like, virus at the Reno Hilton in May and June of 1996.  In 2002, the jury awarded individualjudgments against the Company, its subsidiary FHR Corporation, and Reno HiltonResort Corporation for (i) compensatory damages to five of the eightrepresentative class plaintiffs ranging from $2,011 to $9,822 each and (ii)punitive damages for the entire class of plaintiffs in the amount of $25.2million.  The Company believes the awardof punitive damages, and the amount thereof, is not supportable in either lawor in fact and has filed a special writ in the Nevada Supreme Court seekingrelief prior to determination of the unnamed class members’ claims.

 

*DevelopmentProjects*

 

*Saint Regis Mohawk Project*

 

The Company entered into anagreement in April 2000 with the Saint Regis Mohawk Tribe in Hogansburg, NewYork in which it paid $3 million for the exclusive rights to develop a Class IIor Class III casino project with the Tribe in the State of New York.  In November 2001, the parties entered into adevelopment agreement and a management agreement for the Company to develop andmanage the Tribe’s planned $500 million casino and resort complex, that is tobe located at Kutsher’s Country Club in Thompson, New York, which managementagreement was subject to the approval of the National Indian Gaming Commission(the “NIGC”).  In response to commentsfrom the NIGC, the Company and the Tribe entered into an amended managementagreement (the “Amended Management Agreement”) and a development agreement (the“Amended Development Agreement”) on November 10, 2003.  The Amended Management Agreement provides,among other things, that the Company will manage the casino for seven years fora management fee equal to 30 percent of Net Total Revenue, as defined, and thatthe exclusive right for casino development in the State of New York has beenmodified to provide for mutual non-compete protections within a 125 mile zonefrom the Sullivan County location.  TheAmended Development Agreement provides, among other things, that the Companywill acquire lands for the casino and transfer the lands to the United Statesto be held in trust for the Tribe, provide development assistance andconstruction management for the casino and receive a $15 million developmentfee and provide pre-construction advances of funds up to an aggregate of $20million.  It also provides that, subjectto a number of conditions including, among other things, approval by theCompany of a construction budget, having received all necessary federal, stateand local governmental, tribal and regulatory approvals, and the AmendedManagement Agreement becoming effective, the Company will assist the Tribe inarranging the financing necessary for the costs of construction and the initialcosts of operation and provide credit support, as necessary, for suchfunding.  The Company also has the right,but not the obligation, to advance such funds. While the Company has not finalized or approved any size of constructionbudget, during the first half of 2004, the Company and the Tribe began toexplore third-party financing alternatives. The Company and the Tribe have also commenced discussions regarding theform and magnitude of any credit support that may be necessary.  The Company’s ability to provide variousforms of credit support will be subject to the Credit Facility described inNote 7 above.  The effectiveness of the AmendedManagement Agreement remains subject to a number of regulatory approvals,including without limitation, final approval by the NIGC.

 

The Company has entered intoa definitive agreement, as amended, to acquire approximately 66 acres ofthe Kutsher’s Resort Hotel and Country Club in Sullivan County, New York, forapproximately $10 million, with an option to purchase the remaining 1,400acres for $40 million.  Upon approval ofthe Bureau of Indian Affairs (the “BIA”), the 66 acre parcel will betransferred to be held in trust for the Saint Regis Mohawk Tribe.

 

All of the agreements andplans relating to the development and management of this project are contingentupon various regulatory and governmental approvals, including execution of acompact

 

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between the Saint Regis Mohawk Tribe and the State of New York, andreceipt of approvals from the BIA, NIGC and local planning and zoningboards.  There is no guarantee that therequisite regulatory approvals will be received.

 

The Company is party tonumerous lawsuits regarding its involvement in the Saint Regis Mohawk project,which lawsuits seek various monetary and other damages against theCompany.  Additionally, there are twolawsuits challenging the constitutionality of the legislation that, among otherthings, authorized the Governor of the State of New York to execute tribalstate gaming compacts and approved the use of slot machines as “games ofchance.”  While the Company believes thatit will prevail on these various matters, there can be no assurance that itwill and, if it does not prevail, there can be no assurance that the damagesassessed against the Company would be immaterial to the Company.

 

On May 12, 2003, the SaintRegis Mohawk Tribe and the Governor of the State of New York signed amemorandum of understanding which outlined the terms under which the Tribe isauthorized to proceed with the casino development.  The Saint Regis Mohawk Tribe announced subsequently,that it would withdraw from the memorandum of understanding and continue tonegotiate with the State of New York to reach an agreement on the subjectscontained in the memorandum of understanding. These negotiations are on-going.

 

Asof September 30, 2004, the Company had $42 million invested in the developmentof this project, which is classified as other long-term assets on the Company’scondensed consolidated balance sheet.  Ofthat amount,****$17 million is to bereimbursed to the Company by the Tribe over a five year period commencing withthe opening of the gaming facility. In the event the project is not completed, thetotal amount invested would be written off.

 

*Pauma-Yuima Band ofLuiseño**Mission Indians*

 

In October 2004, thePauma-Yuima Band of Luiseño Mission Indians withdrew from negotiations with theCompany to develop and manage a Caesars-branded casino on tribal lands in PaumaValley in Southern California, just south of Temecula, California

 

*Big Sandy Band of WesternMono Indians*

 

In September 2004, theCompany signed formal agreements with the Big Sandy Band of Western MonoIndians that will govern the development, construction, and management of theplanned casino resort on tribal lands near Fresno, California. Preliminaryplans for the project call for development of a casino resort on more than 48acres of Tribal land near Fresno in the San Joaquin Valley in CentralCalifornia. The casino resort would become the second to directly serve theFresno metropolitan area which has a population of approximately 1.2 million.The casino resort would initially include 250 to 300 hotel rooms, approximately75,000 square feet of gaming space, at least 2,000 slot machines, approximately20 gaming tables, restaurants, retail shops, and meeting space andentertainment facilities. The Big Sandy Tribe currently operates the Mono WindCasino in Auberry, California, about 15 miles northeast of the site of theproposed casino project.

 

The management agreement forthe casino resort is for an initial term of seven years, renewable upon theconsent of both parties, and still requires the approval of the NIGC and otherregulatory bodies. In addition, the Big Sandy Tribe would have to amend itsexisting compact with the State of California, or negotiate a new compact forthe new casino project. The project is also dependent on other regulatoryapprovals and contingencies.  As of September30, 2004, the Company has capitalized $1.2 million spent towards acquiringreal estate related to this project and $1.7 million advanced to the BigSandy Tribe for development costs approved by the Company and the Big Sandy Tribe.  Pursuant to a promissory note between theCompany and the Big Sandy Tribe, the $1.7 million advance is to be repaidcommencing in April 2006.

 

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*Caesars Wembley*

 

In October 2004, the Companyannounced plans to develop and operate a casino resort in London, adjacent tothe redeveloped Wembley National Stadium and the legendary Wembley Arena. Subjectto entering into definitive agreements, it is contemplated that the Companywould own 50 percent of the planned joint venture with the Company’sprospective partner in the casino project, Quintain Estates and DevelopmentPLC. It is also contemplated that the Caesars Wembley would be built on 13acres in the 58-acre redevelopment area and will include a casino, a 400-roomluxury hotel, a full-service spa and swimming pool, shops, convention andmeeting facilities and a variety of restaurants, bars and lounges.

 

**Note 9. ****Restructuring of Baluma Holdings, S.A.**

 

Overthe past several years, the Company has loaned to Baluma Holdings, S.A. (“Holdings”)$80 million (the “Baluma Loans”). Holdings is the ultimate parent ofBaluma, S.A. (“Baluma”) the entity that owns the Conrad Punta del Este (the “Resort”),in Punta del Este, Uruguay. The Baluma Loans matured on July 31, 2002 and wereincluded in investments on the December 31, 2003 balance sheet. The principal,together with certain accrued and unpaid interest, was not repaid. The BalumaLoans were secured by a first priority lien on all the assets comprising theResort and the stock of Baluma. In October 2003, the Board of Directors ofBaluma agreed to restructure the indebtedness owed to us by exchanging theBaluma Loans together with accrued and unpaid interest for 7 percentconvertible preferred stock of Holdings. In September 2004, the Companycompleted the restructuring, increasing (i) its ownership to approximately 86percent and (ii) its seats on Baluma’s Board of Directors to seven of theeleven seats. As a result of the restructuring, the Company converted itsinvestment balance to equity and began consolidating the results of operationsand financial condition of Baluma beginning in September 2004.

 

**Note 10.  Impairment Loss and Other**

 

*ImpairmentLoss*

 

During the third quarter of2004, the Company recognized a $9 million impairment charge related to itsCaesars Tahoe property.  In accordancewith Statement of Financial Accounting Standards (SFAS) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” the Company determinedthere were indications of impairment when, during the third quarter of 2004,offers to purchase our Caesars Tahoe property were submitted to the Company andreviewed by management. Based on these offers, management determined that thebook value of the property exceeded the fair market value by approximately$9 million.

 

*ContractTermination Fee*

 

Duringthe second quarter, the Company recognized $2 million in charges related toexecutive contract terminations.

 

**Note 11.  Merger Costs**

 

During the third quarter of2004, the Company expensed $6 million related to the pending merger ofCaesars Entertainment with Harrah’s Operating. In connection with the pendingtransaction, the Company expects to continue to incur significant fees andexpenses, including without limitation, fees and expenses payable to legal andother advisors. Caesars and Harrah’s have also agreed to “stay bonuses” ofapproximately $19 million in total which will be paid to select employees whoare critical to the continued operations of Caesars through the completion ofthe merger. The stay bonuses will become payable at either the completion ofthe merger or on the date the merger has been terminated, provided in eithercase that the selected employee has remained in the employment of the Companyto the applicable date. The stay bonuses were communicated to select employeesin October 2004 and will be accrued over the expected service period.

 

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Effectof the Pending Merger on the 1998 Stock Incentive Plan

 

The occurrence of a “Changein Control” of the Company has two effects on the stock options grantedpursuant to the Company’s 1998 Stock Incentive Plan (the “Plan”).

 

Under the Plan, a “Change inControl” will occur if the Company’s stockholders approve the Company’s pendingmerger with Harrah’s. Upon such event, (a) all currently outstanding optionswhich are unvested shall become fully exercisable and vested; and (b) optionholders can utilize the Plan’s “Change in Control Cash-Out” (the “Cash-OutOption”). The Plan’s Cash-Out Option provides that during a period of 60 days fromthe date of a Change in Control, a Plan participant shall have the right to notifythe Company that he or she wishes to surrender all or part of any Plan stockoption to the Company and receive cash, within 30 days of such notice, in anamount equal to: (a) the number of applicable options multiplied by (b) the “Spread.”The “Spread” is equal to: (a) the greater of (i) the highest price of theCompany’s common stock during the 60-day period prior to and including the dateof the Change in Control or (ii) the highest price per share of Company commonstock paid in the proposed merger; less (b) the exercise price of such option.

 

OnNovember 1, 2004, the Company’s common stock closed at $17.95 per share. Usingsuch share price and assuming that the Cash-Out Option was elected for alloutstanding options under the Plan as of November 1, 2004 (for an aggregate ofapproximately 17.5 million shares), the Company would be obligated to payapproximately $150 million, which would be expensed in the Company’s statementof operations in the period in which the Plan participant exercised theCash-Out Option. The actual amount (if any) that the Company will be obligatedto pay in settlement of the Cash-Out Option will depend upon the Company’sstock price during the 60-day period prior to the Company’s Special Meeting ofShareholders (which is currently expected to take place in February 2005), andon the number of shares subject to outstanding options with respect to whichPlan participants elect the Cash-Out Option. Upon settlement of the Cash-OutOption, the underlying options (and related shares) will be deemed retired andwill not be entitled to any consideration upon consummation of the pendingmerger with Harrah’s.

** **

**Note 12.  Investment Gain**

 

Duringthe second quarter of 2004, the Company completed the sale of its partnershipinterest in an office building, in which the Company’s corporate office islocated.  The Company received proceedsof $8 million and recognized a gain of $3 million.

 

**Note 13. Subsequent Event**

 

On October 22, 2004, the Company entered into an agreement to sell its equity interest in Belle of Orleans, LLC, which does business as Bally’s Casino New Orleans to an unrelated third party for $24 million. The transaction is scheduled to close by the end of the second quarter of 2005 and is subject to customary regulatory approvals and closing conditions outlined in the purchase agreement. The estimated selling price of the assets less the costs to sell this property exceeds its carrying value; therefore no loss has been recognized as of September 30, 2004. Any gain related to this sale will be recognized when the transaction is completed.

 

20

 

**ITEM 2****.****         ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS**

 

### **OVERVIEW**

 

We are one of the largestcasino/hotel operators in the United States. We have a significant presence inNevada, New Jersey and Mississippi, the three largest state gaming markets inthe United States.  Our propertiesoperate under the Caesars, Bally’s, Paris, Flamingo, Grand, Hilton and Conradbrand names. In order to better leverage what we believe is the best knownbrand name in gaming and to better position our Company throughout our existingmarkets and future development opportunities, we changed our name from ParkPlace Entertainment Corporation to Caesars Entertainment, Inc. in January 2004.

 

*Operational Discussion*

 

Our primary sources ofrevenue consist of casino operations, room rentals, and food and beveragesales.  We generate approximately 70percent of our net revenues from casino operations.  Casino revenue is derived primarily frompatrons wagering on slot machines, table games and other gamingactivities.  Table games generallyinclude Blackjack or Twenty One, Craps, Baccarat and Roulette.  Other gaming activities include Keno, Pokerand Race and Sports wagering.  Casinorevenue is defined as the win from gaming activities, computed as thedifference between gaming wins and losses, not the total amounts wagered.  “Table game volume,” “table game drop” (termswhich are used interchangeably), “slot volume” and “slot handle” are casinoindustry specific terms that are used to identify the amount wagered by patronsfor a casino table game or slot machine, respectively. “Table game hold” and “slothold” represent the percentage of the total amount wagered by patrons that thecasino has won. Hold is derived by dividing the amount won by the casino by theamount wagered by patrons. Casino revenue is recognized at the end of eachgaming day.

 

Room revenues are derivedfrom rooms and suites rented to guests.  “Averagedaily rate” is an industry specific term used to define the average amount ofrevenue per rented room per day.  “Occupancypercentage” defines the total percentage of rooms occupied, and is computed bydividing the number of rooms occupied by the total number of roomsavailable.  Room revenue is recognized atthe time the room is provided to the guest.

 

Food and beverage revenuesare derived from food and beverage sales in the food outlets of ourcasino/hotels, including restaurants, room service and banquets. Food andbeverage revenue is recognized at the time the food and/or beverage is providedto the guest. Due to the addition of new food outlets over the past year weexpect food and beverage revenue to increase over time.

 

Other revenue is derivedprimarily from entertainment, retail and management fee services.  Like our room revenues and food and beveragerevenues, these revenues are recognized at the time the service is provided.

 

Casinorevenues vary from time to time due to general economic conditions, popularityof entertainment offerings, table game hold, slot hold, and occupancypercentages in our hotels. Casino revenues also vary depending upon the amountof gaming activity as well as variations in the odds for different games ofchance. We are also using technology to increase revenues and/or decreaseexpenses. Some examples of our new technology are cashless wagering on slotmachines and business-intelligence software to manage food and beverageoperations and increase yield on hotel rooms. Casino revenues, room revenues,food and beverage revenues, and other revenues also vary due to generaleconomic conditions and competition.  Asnoted in our results for the quarter and nine months ended September 30, 2004,we experienced improvements in our revenues. We believe these improvements are due to an improving general economy ascustomers demonstrated an increased demand for our products.

 

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*Financial Strategy*

 

Inthe past, collectively, our properties have generated substantial positive cashflow, and we expect that our properties will collectively continue to generatepositive cash flow for the foreseeable future. Our first priority for the useof that cash flow is to reinvest in our properties through the maintenance andenhancement of existing facilities, to add new amenities to those facilities,and to invest in new developments in new markets. Our second priority is toreduce our debt leverage by using the cash flow in excess of what is reinvestedin our properties and new developments to pay down debt.  Our third priority for the use of cash flowis the return of capital to stockholders, through share repurchases ordividends.  Only to the extent that wehave sufficient excess cash flow after reinvestment in our properties and reductionof debt will we be able to make meaningful returns of capital to stockholders.

 

*PendingMerger with Harrah’s Entertainment, Inc.*

 

On July 14, 2004, the Company, Harrah’s Entertainment, Inc. (“Harrah’s”) and Harrah’s Operating Company, Inc., (“Harrah’s Operating”) a wholly-owned subsidiary of Harrah’s, entered into an Agreement and Plan of Merger (the “Merger Agreement”), providing for the merger of the Company with and into Harrah’s Operating, which would be the surviving corporation. The Merger Agreement provides that each Company stockholder may elect to receive for each outstanding share of Company common stock either $17.75 in cash or 0.3247 shares of Harrah’s common stock. However, Harrah’s has limited the total (i) number of Harrah’s shares it will issue to the product of the Company’s outstanding number of shares multiplied by 0.6642 and further multiplied by the 0.3247 fraction referred to above (the “Stock Cap”) and (ii) cash it will issue to the product of the Company’s outstanding number of shares multiplied by 0.3358 and further multiplied by $17.75 amount referred to above (the “Cash Cap”). To the extent that the Company’s stockholders elect to receive (i) Harrah’s stock in excess of the Stock Cap or (ii) cash in excess of the Cash Cap, then the merger consideration paid to the Company’s stockholders shall be pro rated between Harrah’s common stock and cash pursuant to the terms of the Merger Agreement. As of****September 30, 2004, the outstanding number of shares of the Company’s common stock was approximately 310.9 million and using such number of shares, the aggregate merger consideration would equal (i) approximately 67.06 million shares of Harrah’s common stock and (ii) approximately $1.853 billion in cash.

 

The transaction with Harrah’s is subject to a number of conditions, including, among other things the approval and adoption of the Merger Agreement by the stockholders of the Company and Harrah’s and upon receipt of all necessary antitrust, gaming and other approvals, and the satisfaction or waiver of all other conditions precedent.

 

**Resultsof Operations**

 

On December 24, 2003, weentered into a definitive agreement to sell the Las Vegas Hilton.  This transaction was completed in June 2004. OnSeptember 27, 2004, we entered into a definitive agreement to sell the assetsand certain liabilities of the Atlantic City Hilton and Bally’s Tunica.  The results of these three properties, aswell as the gain on the sale of the Las Vegas Hilton, are classified asdiscontinued operations in all periods presented. Amounts in the “Results ofOperations” discussions below exclude the results of the Las Vegas Hilton, the AtlanticCity Hilton and Bally’s Tunica. On October 22, 2004, we entered into adefinitive agreement to sell to an unrelated third party the equity interestsin Belle of Orleans, LLC, which does business as Bally’s Casino New Orleans,for $24 million. We regularly evaluate all of our assets within ourportfolio and have and will continue to consider dispositions of assets, whichin our opinion, do not represent the best use of our capital. In addition, inconnection with the pending merger with Harrah’s Operating, we may decide todispose or may be required by regulatory authorities to dispose of certainassets or properties.

 

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Our results of operationsinclude the following properties, owned by subsidiaries, whose operations arefully consolidated except as noted:

 
| **Western Region**     |     | **Eastern Region**         |     | **Mid-South Region**                |     | **International Region**     |
|------------------------|----------|----------------------------|----------|-------------------------------------|----------|------------------------------|
| Caesars Palace         | * * | Bally’s Atlantic City | * * | Grand Casino Biloxi                 | * * | Casino Nova Scotia - Halifax |
| Paris Las Vegas        | * * | Caesars Atlantic City      | * * | Grand Casino Gulfport               | * * | Casino Nova Scotia - Sydney  |
| Bally’s Las Vegas | * * | Atlantic City Hilton (1)   | * * | Grand Casino Tunica                 | * * | Conrad Punta del Este (4)    |
| Flamingo Las Vegas     | * * | Dover Downs (2)            | * * | Sheraton Casino Hotel               | * * | Casino Windsor (5)           |
| Caesars Tahoe          | * * |                       | * * | Bally’s Casino Tunica (1)      | * * | Caesars Gauteng (6)          |
| Reno Hilton            | * * |                       | * * | Caesars Indiana                     | * * | Conrad Jupiters (2)          |
| Flamingo Laughlin      | * * |                       | * * | Bally’s Casino New Orleans (3) | * * | Conrad Treasury (2)          |
|                   | * * |                       | * * |                                | * * | Caesars Palace at Sea        |

 

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(1)      The results of these properties areclassified as discontinued operations in the accompanying results of operationsfor all periods presented.

 

(2)      These are properties from which our solesources of income are management fees and royalties.

 

(3)      In October 2004, we entered into a definitiveagreement to sell this property.  Theresults of this property are included in income from continuing operations asthe property was not held for sale as of September 30, 2004.

 

(4)      In September 2004, we reorganized theownership structure of this property. The reorganization increased our ownership interest in the property from46 percent to 86 percent.  As a result,we have consolidated the results of the property beginning in September 2004.

 

(5)      This is a property in which we own 50 percentof a company that manages the hotel/casino complex and our investment in thatmanagement company is accounted for under the equity method.

 

(6)      This is a property which we manage and inwhich we have a 50 percent or less ownership interest.  It is accounted for using the equity method.

 

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The following discussionpresents an analysis of our results of operations for the three and nine monthsended September 30, 2004 and 2003.

 

*Comparisonof three and nine months ended September 30, 2004 with September 30, 2003*

 

A summary of ourconsolidated net revenue and earnings for the three and nine months endedSeptember 30, 2004 and 2003 is as follows (in millions, except per shareamounts):

 
| ** **                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                             | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenue                                            |       | $                                     | 1,119      |                                 | $          | 1,073 |   | $ | 3,305 |   | $ | 3,115 |   |
| Operating income                                       |       | 167                                   |       | 157                                  |       | 521 |   | 442 |   |
| Income from  continuing operations                     |       | 49                                    |       | 45                                   |       | 164 |   | 118 |   |
| Discontinued  operations                               |       | 9                                     |       | 3                                    |       | 113 |   | 12 |   |
| Net income                                             |       | 58                                    |       | 48                                   |       | 277 |   | 130 |   |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Basic earnings  per share from continuing operations   |       | $                                     | 0.16       |                                 | $          | 0.15 |   | $ | 0.53 |   | $ | 0.39 |   |
| Diluted earnings  per share from continuing operations |       | $                                     | 0.15       |                                 | $          | 0.15 |   | $ | 0.52 |   | $ | 0.39 |   |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Basic earnings  per share                              |       | $                                     | 0.19       |                                 | $          | 0.16 |   | $ | 0.90 |   | $ | 0.43 |   |
| Diluted earnings  per share                            |       | $                                     | 0.18       |                                 | $          | 0.16 |   | $ | 0.88 |   | $ | 0.43 |   |

 

Werecorded income from continuing operations of $49 million and diluted earningsper share from continuing operations of $0.15 for the three months endedSeptember 30, 2004 which compares to $45 million and $0.15, respectively,for the three months ended September 30, 2003. For the nine months endedSeptember 30, 2004, we recorded income from continuing operations of $164million and diluted earnings per share from continuing operations of $0.52which compares to $118 million and $0.39, respectively, for the nine monthsended September 30, 2003.  Netincome for the three months ended September 30, 2004 and 2003, includesincome from discontinued operations of $9 million and $3 million, respectively.Net income for the nine months ended September 30, 2004 includes incomefrom discontinued operations of $113 million which also includes the$87 million after-tax gain on the sale of the Las Vegas Hilton. Net incomefor the nine months ended September 30, 2003 includes income from discontinuedoperations of $12 million.

 

*Casino*

 

Consolidated casino revenuesincreased one percent or $7 million to $765 million for the three months endedSeptember 30, 2004, compared to $758 million for the three months endedSeptember 30, 2003. This increase consisted of a $7 million increasein the International Region, a $3 million increase in the Mid-South Region anda $1 million increase in the Western Region, offset by a $4 milliondecrease in the Eastern Region. As a result of our ownership increase in ConradPunta del Este in Uruguay, in September 2004 we began consolidating theirresults of operations which contributed a $6 million increase in casinorevenues for the International Region. The increased results in the Mid-SouthRegion were primarily attributable to an increase of $5 million in casinorevenues due to slot volume and hold at Caesars Indiana. Caesars Indiana’sincreased volume can be attributed to new cashless slots and promotionalactivity while the increased hold is attributable to a movement towards thelower denominated slot games. In the Western Region, the Flamingo Las Vegasexperienced increased slot and table hold resulting in a $4 million increasein casino revenues.  Combined revenues atour other Western Region properties decreased $3 million primarily due todecreased hold and volume at our Caesars Tahoe property during the thirdquarter.

 

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In the Eastern Region, ourcasino revenue decline was attributable to increased competition, primarily asa result of the opening of the Borgata Hotel Casino in July 2003, a casinohotel operated by a competitor, and increased gaming capacity at other existingproperties. As a result, gaming volumes were down, which caused a decrease in casinorevenue.

 

Our consolidated casinooperating margin improved to 51.1 percent for the three months endedSeptember 30, 2004 compared to 48.5 percent for the three monthsended September 30, 2003 as a result of decreases in promotional spending and baddebt expense.

 

Consolidated casino revenuesincreased two percent or $53 million to $2.254 billion for the nine monthsended September 30, 2004, compared to $2.201 billion for the nine months endedSeptember 30, 2003. This increase primarily consisted of a$54 million increase in the Western Region, a $22 million increase inthe Mid-South Region and an $8 million increase in the InternationalRegion, offset by a $31 million decline in the Eastern Region. Theincreased results in the Western Region were primarily attributable to our LasVegas Strip properties. At Caesars Palace, casino revenue increasedapproximately $26 million due to improved casino volume. The increasedcasino volumes at Caesars Palace were principally driven by additional guesttraffic due to new casino space which opened in late 2003, new restaurants, thecontinued entertainment success of “A New Day....” starring Celine Dion and a newshow, “The Red Piano” featuring Elton John, which began this year. At Paris LasVegas and Bally’s Las Vegas, a combined $24 million increase in casino revenueresulted primarily from an increase in slot hold at both properties and anincrease in table hold at Paris Las Vegas due to reducing the more volatile highend credit play. At the Flamingo Las Vegas casino revenue increased$13 million primarily due to an increase in the slot hold for the ninemonths ended September 30, 2004 as compared to the prior year’s period.

 

In the Mid-South Region,Caesars Indiana reported a $15 million increase in casino revenueattributable to increased slot volume and hold. The increased volume can beattributed to cashless slots and promotional activity while the increased holdis attributable to a movement towards the lower denominated slot games. GrandBiloxi’s $11 million increase in casino revenue for the nine months endedSeptember 30, 2004 is due to increased hold and volume for both table games andslots. A new marketing campaign as well as new cashless slots have contributedto the increased gaming volumes at Grand Biloxi.  At Grand Gulfport, improved table holdcontributed to a $3 million increase in casino revenue for the nine monthsended September 30, 2004.  Casinorevenues decreased $9 million at Grand Tunica due to table hold and slot volumedecreases. In the International Region, the consolidation of Conrad Punta delEste’s operating results, beginning in September 2004, contributed $6 millionin casino revenues.

 

Our Eastern Regionproperties all reported casino revenue decreases attributable to a decline ingaming volumes reflecting the increased competition from additional gamingcapacity in that market as noted above.

 

Our consolidated casinooperating margin improved to 49.8 percent for the nine months endedSeptember 30, 2004 compared to 48.2 percent for the nine months endedSeptember 30, 2003 as a result of the increase in revenues in the WesternRegion as noted above as well as decreases in promotional spending and bad debtexpense.

 

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*Rooms*

 
|             |   | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** |       |
|------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|             |   | **Average Daily  Rate**               | ** ** | **Occupancy  Percentage**            | ** ** | **Average Daily  Rate** | ** ** | **Occupancy  Percentage** |   |
|             |   | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** |   |
| Western Region   |   | $                                     | 98         |                                 | $          | 91 |   | 94 | % | 94 | % | $ | 103 |   | $ | 95 |   | 93 | % | 92 | % |
| Eastern Region   |   | $                                     | 101        |                                 | $          | 96 |   | 98 | % | 99 | % | $ | 91 |   | $ | 87 |   | 97 | % | 98 | % |
| Mid-South Region |   | $                                     | 71         |                                 | $          | 65 |   | 90 | % | 92 | % | $ | 68 |   | $ | 62 |   | 88 | % | 90 | % |

 

Consolidated room revenuesincreased 12 percent or $15 million to $144 million for the three monthsended September 30, 2004 compared to $129 million recorded for the three monthsended September 30, 2003. This increase is almost entirely attributable tothe Western Region where room revenues increased approximately $12 million dueto higher average daily rates as noted in the table above. The most significantimprovements in room revenues were recorded by our Las Vegas Strip propertieswhere convention business and visits by the leisure/pleasure traveler werestrong. Increased room rates in the Mid-South and Eastern Regions contributedto a combined $2 million increase in room revenues for those regions inthe third quarter of 2004.

 

Our consolidated roomoperating margin for the three months ended September 30, 2004 was68.8 percent compared to 65.1 percent for the three months endedSeptember 30, 2003. The increased margin was due to increasing room rateswithout corresponding increases in room expenses.

 

Consolidated room revenuesincreased 11 percent or $43 million to $425 million for the nine monthsended September 30, 2004 compared to $382 million recorded for the nine monthsended September 30, 2003. This increase is attributable to the WesternRegion, where room revenues increased approximately $36 million due to higheraverage daily rates and occupancy as noted in the table above. The mostsignificant improvements in room revenues were recorded by our Las Vegasproperties where convention business and visits by the leisure/pleasuretraveler continued to increase over prior periods. Increased room rates in theMid-South and Eastern Regions contributed to a combined $5 millionincrease in room revenues for those regions in the first nine months of 2004.

 

Our consolidated roomoperating margin for the nine months ended September 30, 2004 was68.5 percent compared to 67.0 percent for the nine months endedSeptember 30, 2003. The increased margin was due to increasing room rateswithout corresponding increases in room expenses.

 

*Food and Beverage*

 

Consolidated food andbeverage revenues increased $8 million to $124 million for the three monthsended September 30, 2004. This increase is attributable to improvements at ourWestern Region properties. The most significant increases over prior year wereat our Las Vegas properties where we recorded an increase of approximately $6million at the Flamingo Las Vegas with the opening of Jimmy Buffett’sMargaritaville in December 2003; and an increase in revenues of approximately$3 million at Caesars Palace due to new restaurants in the Roman Plaza as wellas increased visitation to existing restaurants. Paris Las Vegas and Bally’sLas Vegas contributed a $2 million decrease in their food and beveragerevenues due to decreased banquet revenues during the quarter.

 

Our consolidated food andbeverage operating margin increased to 9.7 percent for the three months endedSeptember 30, 2004 compared to 8.6 percent in the prior year as a result of therevenue increases in high margin outlets noted above such as Margaritaville.

 

Consolidated food andbeverage revenues increased $44 million to $374 million for the nine

 

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months ended September 30, 2004. This increase is almost entirelyattributable to the Western Region’s $42 million increase.  The most significant increases over prioryear were at our Las Vegas properties where we recorded an increase ofapproximately $22 million at the Flamingo Las Vegas with the addition of twonew food outlets that opened in the summer of 2003 and the opening of JimmyBuffett’s Margaritaville in December 2003; a combined increase in revenues ofapproximately $9 million at Paris Las Vegas and Bally’s Las Vegas due toincreased customer traffic, improved banquet revenue associated with increasedconvention business, a new restaurant and nightclub which opened in March of2003 and the expansion of the buffet in the first half of the year; and anincrease of approximately $8 million at Caesars Palace due to the new foodvenues which opened at that property in March 2003 and during the third quarterof 2004.

 

Our consolidated food andbeverage operating margin increased to 12.6 percent for the nine months endedSeptember 30, 2004 compared to 10.0 percent for the nine months endedSeptember 30, 2003 as a result of the revenue increases noted above.

 

*Other*

 

Consolidated other revenuesinclude retail sales, entertainment sales, telephone, management fee income andother miscellaneous income at our casino/hotels.

 

Consolidated other revenuesincreased to $86 million for the three months ended September 30, 2004,compared to $70 million for the three months ended September 30, 2003. Theincrease came primarily from Caesars Palace, Flamingo Las Vegas and Paris LasVegas. Entertainment offerings at The Colosseum, including the opening of a newshow “The Red Piano” featuring Elton John, contributed to Caesars Palace’sincrease of approximately $9 million in revenue. The Flamingo Las Vegasexperienced an approximate $4 million increase in retail revenue with theopening of Jimmy Buffett’s Margaritaville in December of 2003.  At Paris Las Vegas the August 2004 opening ofthe musical “We Will Rock You” contributed $2 million in additionalrevenues for the three months ended September 30, 2004.

 

Consolidated other expensesinclude costs associated with selling, general, administrative, propertyoperations, retail, entertainment, telephone and other miscellaneous costs atour casino hotels. Consolidated other expenses increased $20 million for thethree months ended September 30, 2004 compared to the three months endedSeptember 30, 2003. The increase includes approximately $12 millionrelated to entertainment costs at Caesars Palace, principally those related tothe new show featuring Elton John, $2 million related to Margaritavilleretail and administrative costs and approximately $3 million related to themusical “We Will Rock You” at Paris Las Vegas.

 

Consolidated other revenuesincreased to $252 million for the nine months ended September 30, 2004,compared to $202 million for the nine months ended September 30, 2003. Theincrease came primarily from Caesars Palace where entertainment offerings atThe Colosseum contributed to an increase of approximately $30 million inrevenue which includes revenues from Elton John’s new show as well as otherheadliner entertainment.  During thefirst nine months of 2004, Elton John held 32 performances and is expected toperform more than 40** **shows atCaesars Palace in 2004.  The Flamingo LasVegas experienced an approximate $12 million increase in retail revenue relatedto Margaritaville which opened in December of 2003.  Management fee income increased approximately$3 million due to the improved results of our international propertiesespecially the two properties in Australia.

 

Consolidated other expensesincreased $53 million for the nine months ended September 30, 2004 compared tothe nine months ended September 30, 2003. The increase includes approximately $31 million related to costs atCaesars Palace, principally entertainment costs related to the headlinerentertainment noted above, and $9 million at Flamingo Las Vegas which isrelated to Margaritaville retail and administrative costs.

 

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*Pre-Opening Expense*

 

Pre-opening expense in thequarter and nine months ended September 30, 2004 was $4 million and $7 million,respectively, and related to the production and premiere of the musical “WeWill Rock You” at Paris Las Vegas and the opening of the Roman Plaza at CaesarsPalace. For the nine months ended September 30, 2003, we incurred $1million of pre-opening expense associated with the premiere of “A New Day....”starring Celine Dion at Caesars Palace. We expect to incur pre-opening expensein the future related to the new hotel tower currently under construction atCaesars Palace that is scheduled to open in Summer of 2005.

 

*Impairment Loss and Other*

 

During the third quarter of2004, we recognized a $9 million impairment charge related to our CaesarsTahoe property. In accordance with Statement of Financial Accounting Standards(SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” we determined there were indications of impairment when, during thethird quarter of 2004, offers to purchase our Caesars Tahoe property weresubmitted to us and reviewed by management. Management determined that the bookvalue of the property exceeded the fair market value by approximately$9 million.

 

During the second quarter of2004, we recognized $2 million in charges related to executive contractterminations.

 

*Merger Costs*

 

During the third quarter of2004, we expensed $6 million related to the pending merger of the Companywith Harrah’s Operating. In connection with the pending transaction, we expectto incur significant fees and expenses, including without limitation, fees andexpenses payable to legal and other advisors. Caesars and Harrah’s have also agreedto “stay bonuses” of approximately $19 million in total which will be paid toselect employees who are critical to the continued operations of Caesars throughthe completion of the merger. The stay bonuses will become payable at eitherthe completion of the merger or on the date the merger has been terminated,provided in either case that the selected employee has remained in theemployment of the Company to the applicable date. The stay bonuses werecommunicated to select employees in October 2004 and will be accrued over theexpected service period.

 

Effectof the Pending Merger on the 1998 Stock Incentive Plan

 

The occurrence of a “Changein Control” of the Company has two effects on the stock options grantedpursuant to the Company’s 1998 Stock Incentive Plan (the “Plan”).

 

Under the Plan, a “Change inControl” will occur if the Company’s stockholders approve the Company’s pendingmerger with Harrah’s. Upon such event, (a) all currently outstanding optionswhich are unvested shall become fully exercisable and vested; and (b) optionholders can utilize the Plan’s “Change in Control Cash-Out” (the “Cash-OutOption”). The Plan’s Cash-Out Option provides that during a period of 60 daysfrom the date of a Change in Control, a Plan participant shall have the rightto notify the Company that he or she wishes to surrender all or part of anyPlan stock option to the Company and receive cash, within 30 days of such notice,in an amount equal to: (a) the number of applicable options multiplied by (b)the “Spread.” The “Spread” is equal to: (a) the greater of (i) the highestprice of the Company’s common stock during the 60-day period prior to andincluding the date of the Change in Control or (ii) the highest price per shareof Company common stock paid in the proposed merger; less (b) the exerciseprice of such option.

 

OnNovember 1, 2004, the Company’s common stock closed at $17.95 per share. Usingsuch share price and assuming that the Cash-Out Option was elected for alloutstanding options under the Plan as of November 1, 2004 (for an aggregate ofapproximately 17.5 million shares), the Company would be obligated to payapproximately $150 million, which would be expensed in the Company’s statementof operations in the period in which the Plan participant exercised the Cash-OutOption. The actual amount

 

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(if any) that the Company will be obligated to pay in settlement of theCash-Out Option will depend upon the Company’s stock price during the 60-dayperiod prior to the Company’s Special Meeting of Shareholders (which iscurrently expected to take place in February 2005), and on the number of sharessubject to outstanding options with respect to which Plan participants electthe Cash-Out Option. Upon settlement of the Cash-Out Option, the underlyingoptions (and related shares) will be deemed retired and will not be entitled toany consideration upon consummation of the pending merger with Harrah’s.

 

*Equity in Earnings ofUnconsolidated Affiliates*

 

Equity in earnings ofunconsolidated affiliates consists of earnings from the Company’s share ofownership in Conrad Punta del Este in Uruguay, Caesars Gauteng near Johannesburg,South Africa and Casino Windsor in Windsor, Canada. For the three months endedSeptember 30, 2004 and 2003 equity in earnings of unconsolidated affiliatesremained constant at $3 million. For the nine months ended September 30,2004 and 2003, equity in earnings of unconsolidated affiliates remained constantat $14 million.

 

*Restructuring of Baluma Holdings, S.A.*

 

Overthe past several years, we have loaned to Baluma Holdings, S.A. (“Holdings”)$80 million (the “Baluma Loans”). Holdings is the parent of Baluma, S.A. (“Baluma”),the entity that owns the Conrad Punta del Este (the “Resort”), in Punta delEste, Uruguay. The Baluma Loans matured on July 31, 2002 and were included ininvestments on the December 31, 2003 balance sheet. The principal, together withcertain accrued and unpaid interest, was not repaid. The Baluma Loans weresecured by a first priority lien on all the assets comprising the Resort andthe stock of Baluma. In October 2003, the Board of Directors of Baluma agreedto restructure the indebtedness owed to us by exchanging the Baluma Loanstogether with accrued and unpaid interest for 7 percent convertiblepreferred stock of Holdings. In September 2004, we completed the restructuring,increasing (i) our ownership to approximately 86 percent and (ii) our seats onBaluma’s Board of Directors to seven of the eleven seats. As a result of therestructuring, we converted our investment balance into equity and beganconsolidating the results of operations and financial condition of Balumabeginning in September 2004.

 

*Corporate Expense*

 

Corporate expense increased$4 million to $12 million for the three months endedSeptember 30, 2004 compared to the prior year. The increase consists of payrolland related benefit costs as well as costs related to our pursuit ofdevelopment opportunities and legal expenses. For the nine month period,corporate expense increased $9 million compared to prior year for the samereasons.

 

*Interest Expense*

 

Consolidated interestexpense decreased $9 million to $69 million for the three months endedSeptember 30, 2004, compared to the three months ended September 30,2003. For the nine months ended September 30, 2004, interest expensedecreased $22 million to $212 million compared to the prior year.  The decrease in interest expense was due to adecline in our average borrowing rate and a reduction in our average long-termdebt outstanding.  Our cost of borrowinghas declined as compared to last year due to interest rate swaps we executed inthe second half of 2003 and the benefits we have received from issuing $375 millionof contingent convertible floating rate debt in April 2004, to replace existinghigher cost debt. The swaps converted $300 million of our 7% fixed rate debt tovariable rate. During the first nine

 

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months of 2004, we reduced our total debt balance by $440 million.Including the debt subject to the interest rate swaps, at September 30,2004, $1.3 billion of our total debt outstanding is subject to a variable rateinterest. A hypothetical 100 basis point (1 percent) change in the interestrate index on which our floating rate debt is based would result in an annualexpense charge of approximately $13 million based on our debt balance atSeptember 30, 2004. Capitalized interest for the three months endedSeptember 30, 2004 and 2003 was approximately $3 million and$1 million, respectively. For the nine months ended September 30,2004 and 2003, capitalized interest was $5 million and $4 million,respectively. Going forward, capitalized interest will increase due to theconstruction costs of the hotel tower at Caesars Palace and the new garage atCaesars Atlantic City.

 

*Investment Gain*

 

During the second quarter of2004, we completed the sale of our partnership interest in an office building,in which our corporate office is located. We received proceeds of$8 million and recognized a gain of $3 million.

 

*Income Taxes*

 

### **Our effective income tax rate for the three months ended**September 30, 2004, was 48.0 percent compared to 41.8 percent inthe comparable period for prior year. The effective tax rate in the thirdquarter of 2004 was impacted by a $5 million expense arising from oursettlement of a dispute involving a 1998 tax allocation and indemnity agreemententered into by a Caesars subsidiary and Lakes Entertainment, Inc. For the ninemonths ended September 30, 2004, the effective tax rate was 45.5 percentcompared to 42.0 percent in the nine months ended September 30, 2003. Theincrease in our effective tax rate for the nine month period is due to theabove charge as well as additional state income tax expense of $7 million(after federal income tax benefit) recorded in the first quarter as a result ofthe Indiana Tax Court’s decision (in a case not involving the Company) thatgaming taxes paid to the State based on casino revenues are not deductible forIndiana income tax purposes. While we previously believed that the gaming taxeswere deductible, during the second quarter of 2004, we were assessed additionalincome taxes related to this decision for the fiscal years 2000 through 2002,as a result of the competitor’s tax case outcome. The $7 million relates tofiscal years 2000 through 2003, inclusive. These items resulted in an increasein our effective tax rate for the three months and nine months ended September30, 2004 of 5.1 percentage points and 3.8 percentage points,respectively. Our effective income tax rate is determined by the level andcomposition of pretax income subject to varying federal, foreign, state, andlocal taxes.

 

*Discontinued Operations*

 

### **Las Vegas Hilton**

 

### **On December 24, 2003, we entered into a definitiveagreement to sell the Las Vegas Hilton to an unrelated third party. Thistransaction was completed in June 2004 resulting in a gain of $87 million(net of taxes of $47 million). The gain is included in income fromdiscontinued operations for the nine months ended September 30, 2004. Wereceived cash of approximately $286 million for the property, building,equipment**and working capital that comprise the Las Vegas Hilton.

 

AtlanticCity Hilton and Bally’s Tunica

 

On September 27, 2004, weentered into an agreement to sell the assets and certain related liabilities ofthe Atlantic City Hilton and Bally’s Tunica to an unrelated third party. We estimatethat the after-tax proceeds will be $480 million related to these twoproperties. The estimated selling price of the assets less the costs to sellthese two properties exceeds their carrying value; therefore no loss has beenrecognized as of September 30, 2004. Any gain related to this sale will berecognized when the

 

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transaction is completed.

 

The results of the three properties discussedabove are classified as discontinued operations and the condensed consolidatedfinancial statements for all prior periods have been adjusted to reflect thispresentation. Interest expense has been allocated to the income fromdiscontinued operations based on the ratio of the discontinued operations’ netassets to the total consolidated net assets. In accordance with generallyaccepted accounting principles, the assets held for sale are no longerdepreciated. The assets and liabilities of the Las Vegas Hilton are classifiedas assets held for sale and liabilities related to assets held for sale in theaccompanying condensed consolidated balance sheet as of December 31, 2003. Theassets and liabilities of the Atlantic City Hilton and Bally’s Tunica areclassified as assets held for sale and liabilities related to assets held forsale in the accompanying condensed consolidated balance sheet as of September30, 2004 and December 31, 2003.

 

Bally’s Casino New Orleans

 

On October 22, 2004, we entered into anagreement to sell our equity interest in Belle of Orleans, LLC, which doesbusiness as Bally’s Casino New Orleans, to an unrelated third party for $24million, subject to changes in working capital. The transaction is scheduled toclose by the end of the second quarter of 2005 and is subject to customaryregulatory approvals and closing conditions outlined in the purchase agreement.The results of Bally’s Casino New Orleans are included in continuing operationsas this asset was not held for sale as of September 30, 2004. The estimatedselling price of the assets less the costs to sell this property exceeds itscarrying value; therefore no loss has been recognized as of September 30, 2004.Any gain related to this sale will be recognized when the transaction iscompleted.

 

*OtherEvents*

 

OnOctober 1, 2004, members of Local 54 of the Hotel Employees and RestaurantEmployees International Union (the “Local 54”) began a strike against sevenAtlantic City casino resorts, including the three operated by CaesarsEntertainment. On November 3, 2004 the members of Local 54 voted to end thestrike and started retuning to work shortly thereafter.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

 

*Liquidity*

 

As of September 30, 2004, we had cash and cashequivalents of $318 million, which includes cash in our casinos to fundour daily operations. In addition, at September 30, 2004, approximately$1.3 billion was undrawn under our credit facility. Net cash provided byoperating activities for the nine months ended September 30, 2004 was $561 millioncompared to $388 million in the prior year’s period. The increase in cashprovided by operating activities is due to the increase in income fromcontinuing operations and to the change in net working capital, partiallyoffset by the change in deferred taxes. Cash provided by operating activitiesreflect amounts we earned during our normal course of operations. We use ourcash flows from operating activities to fund our investing and financing activities,including capital expenditures, new development opportunities, to reduce ouroutstanding debt balances as well as additional merger costs as noted under"Merger Costs" above. We expect to finance our operations and capitalexpenditures through cash flows from current operations, existing cashbalances, borrowings under our credit facility (see below) and capital markettransactions.

 

*Investing Activities*

 

For the nine months endedSeptember 30, 2004, net cash used in investing activities was $97 million,consisting principally of the proceeds from the sale of discontinued operationsof $286 million and $374 million of capital expenditures.  Our capital expenditures include maintenancecapital expenditures of $135 million which are those long-lived assetsrequired to maintain our properties

 

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in good operating condition. Such capital items include new gaming equipment, room and restaurantrefurbishments, computer hardware, furniture and office equipment, and othersimilar items. Additionally, our capital expenditures for the nine months endedSeptember 30, 2004 include growth projects of $239** **million.These projects include the new hotel tower, convention facility and Roman Plazaat Caesars Palace, and a parking garage adjacent to Caesars Atlantic City.

 

We currently expect to spendapproximately $642 million on capital investments in 2004, including$274 million for maintenance related projects and $368 million for growthcapital.  Our growth capital budgetincludes $202 million for the new room tower and meeting space at CaesarsPalace; $42 million for the garage adjacent to Caesars Atlantic City; $36million for the purchase of land behind Bally’s Las Vegas; $25 million forthe Roman Plaza project at Caesars Palace; and $12 million related todevelopment of Native American projects in New York State and California.  Other significant growth capital investmentsare an additional $17 million for selected projects at Caesars Palace;$9 million related to the musical “We Will Rock You” playing at Paris LasVegas; $8 million at Caesars Atlantic City, principally for new dining andentertainment venues, renovation of the façade and construction of the bridgeconnecting the second floor of the casino to the Pier at Caesars; and$2 million related to a new hotel revenue management system.

 

*Financing Activities*

 

During the nine monthsended September 30, 2004, we reduced our aggregate debt by $440 million,including the $5 million increase related to the market value of ourinterest rate swaps.

 

*BankCredit Facilities*

 

In April 2004, we enteredinto a $2.0 billion senior credit facility, which expires in April 2009,and is comprised of a $700 million term loan and a $1.3 billion revolver(collectively, the “Credit Facility”) and terminated our previous creditfacilities.  During the third quarter of2004, we used excess cash to reduce the outstanding balance on the term loan to$600 million, thereby reducing the overall availability under our CreditFacility from $2.0 billion to $1.9 billion. As of September 30, 2004,$600 million was outstanding under the term loan and no amounts wereoutstanding under the revolver.  We arerequired to make repayments of the term loan under the Credit Facility in thefollowing amounts on the last day of the following fiscal quarters:  $3.5 million on the last day of thefiscal quarter ending June 30, 2006 and each fiscal quarter thereafterthrough and including March 31, 2007; $5.25 million on the last day of thefiscal quarter ending June 30, 2007 and each fiscal quarter thereafterthrough and including March 31, 2008; and $26.25 million on the last dayof the fiscal quarter ending June 30, 2008 and each fiscal quarterthereafter through and including March 31, 2009. Once repaid, theavailability of the term loan component is permanently reduced.  Amounts paid down under the revolver may bereborrowed.

 

The Credit Facility containsfinancial covenants including a maximum leverage ratio (consolidated debtdivided by consolidated ebitda, as defined in the Credit Facility) of 5.00:1.00and a minimum interest coverage ratio (consolidated ebitda, as defined in theCredit Facility, divided by consolidated interest expense) of 2.75:1.00.  The maximum leverage ratio is 5.00:1.00 forthe quarterly testing periods ended September 30, 2004 through and includingSeptember 30, 2005, 4.75:1.00 for the quarterly testing periods ending December31, 2005 and March 31, 2006, and 4.50:1.00 for the quarterly testing periodsending June 30, 2006 and thereafter.  Theinterest coverage ratio remains 2.75:1.00 for all quarterly testing periods. Weare required to compute our actual leverage and interest coverage ratios on arolling twelve-month basis as of the end of each calendar quarter. If we arenot in compliance with the required covenant ratios, an event of default wouldoccur, which if not cured, could cause the entire outstanding borrowings underthe Credit Facility to become immediately due and payable as well as triggerthe cross default provisions of other debt issues. As of September 30, 2004, wewere in compliance with all applicable covenants.

 

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Borrowings under the CreditFacility bear interest at a floating rate and may be obtained, at our option,as LIBOR advances for varying periods, or as base rate advances, each adjustedfor an applicable margin (as further described in the Credit Facility). We havehistorically borrowed using LIBOR advances and expect to continue doing so forthe foreseeable future. We pay a margin over LIBOR which is a function of bothour leverage ratio and our credit rating. This margin is adjusted quarterly.Based on our leverage ratio and credit rating as of September 30, 2004,the margin over LIBOR was 150 basis points.

 

Ina program designed for short-term borrowings at lower interest rates, we haveentered into an uncommitted line of credit with a lender whereby we can borrowup to $100 million for periods of ninety days or less. This agreement expiresMarch 2005. We are required to maintain availability under our Credit Facilityin an amount equal to the amount outstanding under the short term borrowingprogram. No amounts were outstanding under this program at September 30, 2004or December 31, 2003.

 

Theclosing of the pending transaction with Harrah’s may require certain amendmentsor waivers to the Credit Facility. There can be no assurance that suchamendments or waivers will be obtained.

 

*Interest Rate Swaps*

 

Pursuant to our riskmanagement policy, management may engage in actions to manage our interest raterisk position. During the last half of 2003, we entered into four interest rateswaps representing $300 million notional amount with members of our bank groupto manage interest expense. The interest rate swaps have converted a portion ofour fixed-rate debt to floating rate (“fair value hedges”). Under theagreements, we receive a fixed interest rate of 7 percent and pay a variableinterest rate based on a margin above six month LIBOR on $300 millionnotional amount.  The interest rate swapsmature in 2013.  The net effect of the interest rate swaps resulted in areduction in interest expense of $2 million and $7 million for the threeand nine months ended September 30, 2004. For the three and nine months endedSeptember 30, 2003, the net effect of the interest rate swaps resulted in areduction in interest expense of $0.2 million.

 

These interest rate swapsmeet the shortcut criteria under SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” which permits the assumption of noineffectiveness in the hedging relationship between the swap and the underlyinghedged asset or liability.  As such, there is no income statement impactfrom changes in the fair value of the hedging instruments.  Instead, thefair value of the instrument is recorded as an asset or liability on theCompany’s balance sheet with an offsetting adjustment to the carrying value ofthe related debt.  In accordance with SFAS No. 133, we recorded otherlong-term assets of $7 million and $2 million as of September30, 2004 and December 31, 2003, respectively, representing the fair valueof the interest rate swaps and a corresponding increase in long-term debt, asthese interest rate swaps are considered highly effective under the criteriaestablished by SFAS No. 133.

 

*Other*

 

Asof September 30, 2004, our consolidated debt balance includes $47 million relatedto Baluma Holdings, S.A. (see "Restructuring of Baluma Holdings,S.A." above) which we began consolidating in September 2004 due to anownership restructuring.

 

Thecondensed consolidated balance sheet as of December 31, 2003 excludes from currentmaturities $325 million of 7.0 percent Senior Notes due July 2004. Thisamount was classified as long-term as of December 31, 2003 because we had boththe intent and the ability to refinance these notes using availability underthe long-term portion of the Credit Facility. These notes were retired in July2004.

 

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*Contingent Convertible Senior Notes*

 

InApril 2004, we issued $375 million Floating Rate Contingent Convertible SeniorNotes due 2024 through a private placement offering to institutional investors.The notes bear interest at an annual rate equal to the three month LIBOR,adjusted quarterly. The notes are convertible into cash and shares of commonstock in the following circumstances:

 

•      duringany fiscal quarter commencing after the date of original issuance of the notes,if the closing sale price of our common stock for 20 out of 30 consecutivetrading days during the previous quarter is more than 120% of the conversionprice of the notes on the last trading day of the previous quarter;

 

•      wehave called the notes for redemption and the redemption has not yet occurred;

 

•      duringthe five trading day period immediately after any five consecutive trading dayperiod in which the trading price of the notes per $1,000 principal amount foreach day of such period was less than 95% of the product of the closing saleprice of our common stock on such day multiplied by the number of sharesissuable upon conversion; provided that, if on such date, the common stockprice is between the Conversion Price and 120% of the Conversion Price, asdefined, then the holders will receive the principal amount of the notessurrendered plus accrued but unpaid interest; or

 

•      uponthe occurrence of specified corporate transactions as defined in the indenturecovering these notes.

 

Holdersmay convert any outstanding notes into cash and shares of our common stock atan initial conversion price per share of $22.29. This represents a conversionrate of approximately 44.8632 shares of common stock per $1,000 principalamount of notes (the “Conversion Rate”). Subject to certain exceptionsdescribed in the indenture covering these notes, at the time the notes aretendered for conversion, the value (the “Conversion Value”) of the cash andshares of our common stock, if any, to be received by a holder converting$1,000 principal amount of the notes will be determined by multiplying theConversion Rate by our “Ten Day Average Closing Stock Price,” which equals theaverage of the closing per share prices of our common stock on the New YorkStock Exchange on the ten consecutive trading days beginning on the secondtrading day following the day the notes are submitted for conversion.  The Conversion Value will be delivered toholders as follows: (1) an amount in cash (the “Principal Return”) equal to thelesser of (a) the aggregate Conversion Value of the notes to be converted and(b) the aggregate principal amount of the notes to be converted, and (2) if theaggregate Conversion Value of the notes to be converted is greater than thePrincipal Return, an amount in shares (the “Net Shares”) equal to suchaggregate Conversion Value less the Principal Return (the “Net Share Amount”).  We will pay the Principal Return and deliverthe Net Shares, if any, as promptly as practicable after determination of theNet Share Amount. The number of Net Shares to be paid will be determined bydividing the Net Share Amount by the Ten Day Average Closing Stock Price.

 

Wefiled a registration statement to register these notes on behalf of the holdersof the notes under the Securities Act of 1933, as amended, and such registration statement wasdeclared effective by the United States Securities and Exchange Commission on November8, 2004.The registration statement includes adescription of the treatment of the notes as a result of the pending mergerwith Harrah’s Operating. The notes are redeemableby us at any time on or after April 20, 2009 at 100 percent of the principal amount of thenotes plus accrued and unpaid interest.  Holders may require us to purchase all or aportion of the notes on April 15, 2009, 2014, and 2019 at 100 percent of the principal amount ofthe notes plus accrued and unpaid interest.  The notes are unsecured obligations, rankequal with our other senior indebtedness and are senior to all of oursubordinated indebtedness.

 

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**DEVELOPMENTPROJECTS**

 

*SaintRegis Mohawk Tribe*

 

We entered into an agreementin April 2000 with the Saint Regis Mohawk Tribe in Hogansburg, New York inwhich we paid $3 million for the exclusive rights to develop a Class II orClass III casino project with the Tribe in the State of New York.  In November 2001, the parties entered into adevelopment agreement and a management agreement for the Company to develop andmanage the Tribe’s planned $500 million casino and resort complex, that is tobe located at Kutsher’s Country Club in Thompson, New York, which managementagreement was subject to the approval of the National Indian Gaming Commission(the “NIGC”).  In response to commentsfrom the NIGC, the Company and the Tribe entered into an amended managementagreement (the “Amended Management Agreement”) and a development agreement (the“Amended Development Agreement”) on November 10, 2003.  The Amended Management Agreement provides,among other things, that the Company will manage the casino for seven years fora management fee equal to 30 percent of Net Total Revenue, as defined, and thatthe exclusive right for casino development in the State of New York has beenmodified to provide for mutual non-compete protections within a 125 mile zonefrom the Sullivan County location.  TheAmended Development Agreement provides, among other things, that the Companywill acquire lands for the casino and transfer the lands to the United Statesto be held in trust for the Tribe, provide development assistance andconstruction management for the casino and receive a $15 million developmentfee and provide pre-construction advances of funds up to an aggregate of $20million.  It also provides that, subjectto a number of conditions including, among other things, approval by theCompany of a construction budget, having received all necessary federal, stateand local governmental, tribal and regulatory approvals, and the AmendedManagement Agreement becoming effective, the Company will assist the Tribe inarranging the financing necessary for the costs of construction and the initialcosts of operation and provide credit support, as necessary, for suchfunding.  The Company also has the right,but not the obligation, to advance such funds. While the Company has not finalized or approved any size of constructionbudget, during the first half of 2004, the Company and the Tribe began toexplore third-party financing alternatives and met with a group of financialinstitutions on April 27, 2004.  TheCompany and the Tribe have also commenced discussions regarding the form andmagnitude of any credit support that may be necessary.  The Company’s ability to provide variousforms of credit support will be subject to the Credit Facility described under “Liquidityand Capital Resources.”  Theeffectiveness of the Amended Management Agreement remains subject to a numberof regulatory approvals, including without limitation, final approval by theNIGC.

 

The Company has entered intoa definitive agreement, as amended, to acquire approximately 66 acres ofthe Kutsher’s Resort Hotel and Country Club in Sullivan County, New York, forapproximately $10 million, with an option to purchase the remaining 1,400acres for $40 million.  Upon approval ofthe Bureau of Indian Affairs (the “BIA”), the 66 acre parcel will betransferred to be held in trust for the Saint Regis Mohawk Tribe.

 

All of the agreements andplans relating to the development and management of this project are contingentupon various regulatory and governmental approvals, including execution of acompact between the Saint Regis Mohawk Tribe and the State of New York, andreceipt of approvals from the BIA, NIGC and local planning and zoningboards.  There is no guarantee that therequisite regulatory approvals will be received.

 

The Company is party tonumerous lawsuits regarding its involvement in the Saint Regis Mohawk project,which lawsuits seek various monetary and other damages against theCompany.  Additionally, there are twolawsuits challenging the constitutionality of the legislation that, among otherthings, authorized the Governor of the State of New York to execute tribalstate gaming compacts and approved the use of slot machines as “games ofchance.”  While the Company believes thatit will prevail on these various matters, there can be no

 

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assurance that it will and, if it does not prevail, there can be noassurance that the damages assessed against the Company would be immaterial tothe Company.

 

On May 12, 2003, the SaintRegis Mohawk Tribe and the Governor of the State of New York signed amemorandum of understanding which outlined the terms under which the Tribe isauthorized to proceed with the casino development.  The Saint Regis Mohawk Tribe announcedsubsequently, that it would withdraw from the memorandum of understanding andcontinue to negotiate with the State of New York to reach an agreement on thesubjects contained in the memorandum of understanding. These negotiations areon-going.

 

As of September 30, 2004,the Company had $42 million invested in the development of this project,which is classified as other long-term assets on our condensed consolidatedbalance sheet.  Of that amount,$17 million is to be reimbursed to us by the Tribe over a five year periodcommencing with the opening of the gaming facility. In the event the project isnot completed, the total amount invested would be written off.

 

*Pauma-Yuima Band of Luiseño**Mission Indians*

 

InOctober 2004, the Pauma-Yuima Band of Luiseño Mission Indians withdrew fromnegotiations with Caesars Entertainment to develop and manage a Caesars-brandedcasino on tribal lands in Pauma Valley in Southern California, just south ofTemecula, California.

 

*Big Sandy Band of Western MonoIndians*

 

In September 2004, we signedformal agreements with the Big Sandy Band of Western Mono Indians that willgovern the development, construction and management of the planned casinoresort on tribal lands near Fresno, California. Preliminary plans for theproject call for development of a casino resort on 48 acres of Tribal land nearFresno in the San Joaquin Valley in Central California. The casino resort wouldbecome the second to directly serve the Fresno metropolitan area which has apopulation of approximately 1.2 million. The casino resort would initiallyinclude 250 to 300 hotel rooms, approximately 75,000 square feet of gamingspace, at least 2,000 slot machines, approximately 20 gaming tables,restaurants, retail shops, meeting space and entertainment facilities. The BigSandy Tribe currently operates the Mono Wind Casino in Auberry, California,about 15 miles northeast of the site of the proposed casino project.

 

The management agreement forthe casino resort is for an initial term of seven years, renewable upon theconsent of both parties, and still requires the approval of the NIGC and otherregulatory bodies. In addition, the Big Sandy Tribe would have to amend itsexisting compact with the State of California, or negotiate a new compact forthe new casino project. The project is also dependent on other regulatoryapprovals and contingencies. As of September 30, 2004, we have capitalized$1.2 million spent towards acquiring real estate related to this projectand $1.7 million advanced to the Big Sandy Tribe for development costsapproved by us and the Big Sandy Tribe. Pursuant to a promissory note with theBig Sandy Tribe, the $1.7 million advance is to be repaid commencing in April2006.

 

*Caesars Wembley*

 

In October 2004, weannounced plans to develop and operate a casino resort in London, adjacent tothe redeveloped Wembley National Stadium and the legendary Wembley Arena. Subjectto entering into definitive agreements, it is contemplated that we would own 50percent of the planned joint venture with our prospective partner in the casinoproject, Quintain Estates and Development PLC. It is also contemplated that theCaesars Wembley would be built on 13 acres in the 58-acre redevelopment areaand will include a casino, a 400-room luxury hotel, a full-service spa andswimming pool, shops, convention and meeting facilities and a variety ofrestaurants, bars and lounges.

 

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**OFFBALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS**

 

Adescription of the Company’s off-balance sheet arrangements and contractualobligations can be found in Item 7 of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2003.  Inconnection with the reorganization of Conrad Punta del Este’s ownership, we nolonger guarantee the repayment of a $5 million bank loan to Conrad Puntadel Este, and we cancelled a $5 million letter of credit that supported thatguarantee. In connection with the pending merger with Harrah’s, we have certainobligations under stay bonuses and stock options plans as described in Note 11to the Condensed Consolidated Financial Statements. There have been no othermaterial changes to these disclosures as of September 30, 2004.

 

**CRITICAL ACCOUNTING POLICIES**

 

A description of the Company’s critical accountingpolicies and estimates can be found in Item 7 of the Company’s AnnualReport on Form 10-K for the year ended December 31, 2003. There have been nomaterial changes to these policies or estimates as of September 30, 2004.

 

**RecentlyIssued Accounting Pronouncement**

 

                In September 2004, the Emerging Issues Task Force(“EITF”) of the Financial Accounting Standards Board (“FASB”) reached aconsensus on issue No. 04-08, “The Effect of Contingently ConvertibleInstruments on Diluted Earnings per Share” (“EITF 04-08”), which is effectivefor reporting periods ending after December 15, 2004. EITF 04-08 requirescompanies to include shares issuable under convertible instruments in dilutedearnings per share computations (if dilutive) regardless of whether the marketprice trigger (or other contingent feature) has been met. In addition, priorperiod earnings per share amounts presented for comparative purposes must berestated. In April 2004, we issued contingent convertible notes with terms asdescribed in Note 7 to the Condensed Consolidated Financial Statements. Inaccordance with EITF 04-08, there will be no impact on the future diluted earningsper share calculated related to these notes unless the our common stock priceexceeds the conversion price. In that situation, we would reflect theadditional common shares in the calculation of diluted earnings per share usingthe treasury share method.

 

**FORWARD-LOOKING STATEMENTS**

 

**Factors that MayAffect Future Results**

**(Cautionary Statements Under the Private Securities Litigation ReformAct of 1995)**

 

Certaininformation included in this Form 10-Q and other materials filed or to befiled by the Company with the Securities and Exchange Commission (as well asinformation included in oral statements or other written statements made or tobe made by the Company or its representatives) contains or may contain forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These statements can be identified by the fact that they do notrelate strictly to historical or current facts. We have based these forward-lookingstatements on our current expectations about future events. The forward-lookingstatements include statements that reflect management’s beliefs, plans,objectives, goals, expectations, anticipations, intentions with respect to thefinancial condition, results of operations, future performance and the businessof the Company including statements relating to our business strategy, ourcurrent and future development plans.

 

Further,statements that include the words “may,” “could,” “should,” “would,” “believe,”“expect,” “anticipate,” “estimate,” “intend,” “plan,” or other words orexpressions of similar meaning, may identify forward-looking statements. Thesestatements reflect our judgment on the date they are made and we undertake noduty to update such statements in the future. Such statements includeinformation relating to plans for future expansion and other businessdevelopment activities as well as capital spending, financing sources and theeffects of regulation (including gaming and tax regulation) and competition.From time to time, oral or written forward-looking statements are also includedin the Company’s periodic reports on Forms 10-K, 10-Q and 8-K, press releasesand other materials released to the public.

 

Althoughwe believe that the expectations in these forward-looking statements arereasonable, any or all of the forward-looking statements in this report and inany other public statements that are made may prove to be incorrect. This mayoccur as a result of inaccurate assumptions or as a consequence of known orunknown risks and uncertainties. Many factors discussed in this report, such asthe competitive environment and government regulation, will be important indetermining the Company’s future performance. Consequently, actual results maydiffer materially from those that might be anticipated from forward-lookingstatements. In light of these and other uncertainties, you should not regardthe inclusion of a forward-looking statement in this report or other publiccommunications that we might make as a representation by us that our plans andobjectives will be achieved, and you should not place undue reliance on suchforward-looking statements.

 

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Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.However, any further disclosures made on related subjects in the Company’ssubsequent reports filed with the Securities and Exchange Commission on Forms10-K, 10-Q and 8-K should be consulted. The following discussion of risks,uncertainties and possible inaccurate assumptions relevant to the Company’sbusiness includes factors that management believes could cause the Company’s actualresults to differ materially from expected and historical results. Thisdiscussion is provided as permitted by the Private Securities Litigation ReformAct of 1995.

 

•              The Company’s operations are affected bychanges in local and national general economic and market conditions in thelocations where those operations are conducted and where customers live.

 

•              Our ability to meet our debt serviceobligations and to refinance existing debt will depend on our futureperformance and other conditions or events, which will be subject to manyfactors that are beyond our control.

 

•              Our Nevada properties are adversely affectedby disruptions in air travel.

 

•              All of our Las Vegas properties are in closeproximity to each other. Our Atlantic City properties are also in closeproximity to each other. If a natural disaster or calamity occurs in eithermarket that affected these properties, our results may be impacted.

 

•              The Company operates in very competitiveenvironments, particularly Las Vegas, Atlantic City and Mississippi. To theextent that hotel and/or casinos are expanded by others in markets in which theCompany operates, competition will increase and the increased competition couldadversely impact our future operations. The growth in the number of guest roomsand casino capacity in Las Vegas, including a new resort casino currently underconstruction, and Atlantic City, in which a new hotel casino has recentlyopened, may negatively affect our operating results. Additionally, theestablishment of gaming operations on Native American lands in the states ofNew York, California, and Arkansas and any other states near our existingoperations could adversely affect the operations of the Company’s properties.The expansion of state-owned or mandated casinos in our existing markets andadjoining states could also adversely affect our properties.

 

•              The Company’s gaming operations are highlyregulated by governmental authorities and the gaming operations are subject toperiodic reviews and audits by the governmental authorities. We will alsobecome subject to regulation in any other jurisdiction where the Companyconducts gaming in the future.

 

•              The pending merger of the Company by Harrah’sOperating Company, Inc. (“Harrah’s Operating”), including risks associated withthe effects of the pendency thereof on the Company’s operations and customersand delays or the failure to complete the transaction.

 

•              We may be unable to complete our proposedmerger with Harrah’s Operating and Harrah’s Operating may be unable to timelyand cost-effectively integrate us into their operations.

 

•              Our properties face a variety of risks whichmay result in loss.  Specifically,several of our properties are located in coastal areas and are subject to windand flood damage from storms.  Inaddition, all of our properties could be considered at risk for terrorist orother hostile acts and our properties can be victims of criminal acts bypatrons and others. Conditions in the insurance marketplace have made it moredifficult to purchase insurance on economically reasonable terms.  As a result, we are now subject tosignificantly higher

 

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self-insuredretentions on virtually all of our insurance coverages, and we carry onlylimited insurance against terrorist acts. For all these reasons, we are at a greater risk of loss than we havebeen in the past.

 

•              Changes in applicable laws or regulationscould have a significant effect on our operations. Our ability to comply withgaming regulatory requirements, as well as possible changes in governmental andpublic acceptance of gaming could materially adversely affect our business.

 

•              The terrorist attacks of September 11, 2001,and the potential for future terrorist attacks or acts of war or hostility,have created economic and political uncertainties that could adversely impactour business levels and results of operations.  Leisure and businesstravel, especially travel by air to Las Vegas, is sensitive to globalgeopolitical events.

 

•              The Company’s properties are large consumersof electricity and other energy. Accordingly, the recent increases in energycosts may continue to have a negative impact on our operating results.Additionally, higher energy and gasoline prices which affect our customers mayadversely impact the number of customers who visit our properties and adverselyimpact our revenues.

 

•              Any future construction can be affected by anumber of factors, including time delays in obtaining necessary governmentalpermits and approvals, legal challenges and the ability to obtain at reasonablerates appropriate insurance coverage for such projects. Changes may be made ina project’s scope, budgets and/or schedules for competitive, aesthetic or otherreasons and these changes may also result from circumstances beyond ourcontrol. These circumstances include weather interference, shortages ofmaterials and labor, work stoppages, labor disputes, unforeseen engineering,environmental or geological problems and unanticipated cost increases. Any circumstancescould give rise to delays in the completion of any project we undertake and/orcost overruns.

 

•              The Company’s development projects aresubject to many factors, some of which are beyond the Company’s control.Development projects are dependent on factors such as reaching definitiveagreements with third parties, securing sites and land, obtaining requisitegovernmental approvals, the effect of the pending transaction with Harrah’s andcompeting for such development projects with other gaming and resort companies.Further, while the Company is pursuing and will continue to pursue developmentopportunities there can be no assurance that such opportunities will becomeoperational.

 

•              Certain of our properties are located incountries outside the United States where political and economic instabilityexposes us to additional risk.  Suchrisks range from currency fluctuation risk, which could increase the volatilityof our results from such operations, to outright expropriation.  In addition, the system of laws in thesejurisdictions may be different from the laws that exist in the UnitedStates.  As a result we may be subject tooutcomes in legal disputes that are different from what might be expected inthe United States.

 

•              The gaming industry represents a significantsource of tax revenues to the state, county and local jurisdictions in whichour properties operate. From time to time, various state and federallegislators and officials have proposed increasing tax rates and other chargesand levies assessed against gaming operations, or in the administration of thelaws affecting the gaming industry. If taxes are increased, such increase willnegatively impact our cash flows and could impact our ability to meet debtservice requirements and, depending on the level of taxation, would adverselyaffect our business.

 

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•              Claims have been brought against us invarious legal proceedings, and additional legal and/or regulatory claims mayarise from time to time. While we believe that the ultimate disposition ofcurrent matters will not have a material impact on our financial condition orresults of operations, it is possible that our cash flows and results ofoperations could be affected from time to time by the resolution of one or moreof these contingencies. See the further discussion under “Legal Proceedings”contained in this report and our other periodic filings with the Securities andExchange Commission.

 

•              There is intense competition to attract andretain management and key employees in the gaming industry, which risk may befurther increased as a result of the pending transaction with Harrah’s. Ourbusiness could be adversely affected in the event of the inability to recruitor retain key personnel.

 

Whilethe Company from time to time communicates with securities analysts, it isagainst our policy to disclose to them any material non-public information orother confidential business information. It should not be assumed that we agreewith any statement or report issued by any analysts, irrespective of thecontent of the statement or report.

 

#### **ITEM 3**.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

 

There have been no materialchanges in our market risk since the information disclosed in our Annual Reporton Form 10-K for the year ended December 31, 2003. In April 2004, we issued$375 million Floating Rate Contingent Convertible Senior Notes due 2024through a private placement offering to institutional investors. The notes bearinterest at an annual rate equal to the three month LIBOR, adjusted quarterly.Including the debt subject to interest rate swaps, at September 30, 2004, $1.3 billionof our total debt outstanding is subject to variable rate interest. Ahypothetical 100 basis point (1 percent) change in the interest rate indexon which our floating rate debt is based would result in an annual expensechange of approximately $13 million based on our debt balance at September 30,2004.

 

#### **ITEM 4.**          CONTROLSAND PROCEDURES

 

(a) Disclosure Controls andProcedures.  The Company’s management,with the participation of the Company’s Chief Executive Officer and Interim ChiefFinancial Officer (who, as previously announced, has replaced the former ChiefFinancial Officer who resigned on May 12, 2004), has evaluated theeffectiveness of the Company’s disclosure controls and procedures (as such termis defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Actof 1934, as amended (the “Exchange Act”)) as of the end of the period coveredby this report.  Based on suchevaluation, the Company’s Chief Executive Officer and Interim Chief FinancialOfficer have concluded that, as of the end of such period, the Company’sdisclosure controls and procedures are effective.

 

(b) Internal Control Over FinancialReporting.  There have not been anychanges in the Company’s internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) duringthe fiscal quarter to which this report relates that have materially affected,or are reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

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**PART II****.   OTHER INFORMATION**

 

**ITEM 1.****          LEGALPROCEEDINGS**

 

*Shareholder Litigation*

 

On July 15, 2004, a purported class action (*Derasmo v. Caesars Entertainment, Inc. et al*)was filed in the District Court for Clark County, Nevada on behalf of theowners of Caesars Entertainment, Inc. shares of common stock against Caesarsand its directors.  The lawsuit allegesbreach of fiduciary duties and that the proposed transaction involving theacquisition of Caesars by Harrah’s Entertainment, Inc. (“Harrah’s”) (see Note 1to the condensed consolidated financial statements) provides benefits to Harrah’sand to the members of the board of directors not available to the Caesarsstockholders. The lawsuit seeks an injunction and a declaration that theproposed transaction is unlawful.  OnOctober 20, 2004, the plaintiff dismissed the complaint without prejudice;however, the Company expects that the plaintiff will file a new complaint basedon the proposed transaction with Harrah’s.

 

*Slot Machine Litigation*

 

InApril 1994, William H. Poulos brought a purported class action in theUnited States District Court for the Middle District of Florida, OrlandoDivision captioned *William H. Poulos, et al.v. Caesars World, Inc., et al.* against 41 manufacturers,distributors and casino operators of video poker and electronic slot machines,including the Company. In May 1994, another plaintiff filed a class actioncomplaint in the United States District Court for the Middle District ofFlorida captioned *William Ahern, et al. v.Caesars World, Inc. et al.* alleging substantially the sameallegations against 48 defendants, including the Company. InSeptember 1995, a third action was filed against 45 defendants, includingthe Company, in the United States District Court for the District of Nevadacaptioned *Larry Schreier, et al. v. CaesarsWorld, Inc., et al.* The court consolidated the three actions in theUnited States District Court for the District of Nevada under the case caption *William H. Poulos, et al. v. Caesars World, Inc.et al.* The consolidated complaints allege that the defendants areinvolved in a scheme to induce people to play electronic video poker and slotmachines based on the false beliefs regarding how such machines operate and theextent to which a player is likely to win on any given play. The actionsincluded claims under the federal Racketeering Influence and CorruptOrganizations Act, fraud, unjust enrichment and negligent misrepresentation andseek unspecific compensatory damages. In July 2002, the United StatesDistrict Court denied the plaintiff’s motion to certify the case as a classaction. On August 10, 2004, the Ninth Circuit Court of Appeals affirmed theDistrict Court’s denial of the plaintiff’s motion to certify the case as aclass action.

 

**ITEM 6****.****          EXHIBITS**

 

**(a)****   Exhibits**

 
| 31.1   | Certification of the Chief Executive Officer of  Caesars Entertainment, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                        |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                           |
| 31.2   | Certification of the Interim Chief Financial Officer  of Caesars Entertainment, Inc. pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                |
|   |                                                                                                                                                                                           |
| 32.1   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the  Chief Executive Officer of Caesars Entertainment, Inc.         |
|   |                                                                                                                                                                                           |
| 32.2   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the  Interim Chief Financial Officer of Caesars Entertainment, Inc. |

 

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### **SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this Report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| ** **              | **CAESARS ENTERTAINMENT, INC.** |
|-------------------------|---------------------------------|
|                    | (Registrant)                    |
|                    |                            |
|                    |                            |
|                    | ** **                      | /s/ WESLEY D. ALLISON | ** ** |
|                    |                            | Name: | Wesley D. Allison |   |
|                    |                            | Title: | Senior Vice President, Controller and  Interim Chief Financial Officer  (Principal Accounting Officer) |
|                    |
| Dated: November 8, 2004 |
|                         |                                 |  |  |  |  |

 

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