Item 1. Business
General
Metro-Goldwyn-Mayer Inc., ("MGM"), is a premier global entertainment content company. We develop, produce and distribute theatrical motion pictures and television programs, and we intend to create and own interests in branded cable and satellite programming channels. See "Note 12 to Consolidated Financial Statements." Our principal subsidiaries are Metro-Goldwyn-Mayer Studios Inc., United Artists Corporation, United Artists Films Inc. and Orion Pictures Corporation. We are one of only seven major film and television studios worldwide. Our library contains over 4,000 theatrically released feature film titles and over 10,100 television episodes and is the largest collection of post-1948 feature films in the world. Films in our library have won over 200 Academy Awards, including Best Picture Awards for Annie Hall, The Apartment, The Best Years of Our Lives, Dances With Wolves, Hamlet, In the Heat of the Night, Marty, Midnight Cowboy, Platoon, Rain Man, Rocky, The Silence of the Lambs, Tom Jones and West Side Story. Our library also includes 21 titles in the James Bond film franchise, five titles in the Rocky film franchise and nine titles in the Pink Panther film franchise.
MGM was incorporated in Delaware on July 10, 1996. Our executive offices are located at 2500 Broadway Street, Santa Monica, California 90404. Our telephone number is (310) 449-3000.
Background of the Company
Tracinda Corporation, senior management of MGM Studios at the time and Seven Network Limited, a company formed under the laws of Australia, formed MGM to acquire from Consortium de Realisation, a wholly-owned subsidiary of Credit Lyonnais S.A., all of the outstanding capital stock of MGM Studios and its subsidiaries, including United Artists, in October 1996 for an aggregate consideration of $1.3 billion. Tracinda is wholly owned by Mr. Kerkorian.
In July 1997, we acquired all of the outstanding capital stock of Orion and its subsidiaries, including the entity formerly known as The Samuel Goldwyn Company and now known as Orion Film Classics Company, from Metromedia International Group, Inc. In connection with the Orion acquisition, we obtained the film and television libraries of the Orion companies consisting of approximately 1,900 film titles and 3,000 television episodes.
In November 1997, we completed an initial public offering, whereby we issued and sold 9,000,000 new shares of common stock, $.01 par value per share, at a price per share of $20, less an underwriting discount, for net proceeds (after expenses of the initial public offering) of $165 million. Concurrently with the consummation of the initial public offering, Tracinda purchased directly from us, at a purchase price of $18.85 per share (equal to the per share price to the public in the initial public offering, less the underwriting discount), 3,978,780 shares of the common stock for an aggregate purchase price of $75 million.
In September 1998, Tracinda and a Delaware corporation that is principally owned by Tracinda, which we refer to collectively as the "Tracinda Group," purchased 16,208,463 shares of the common stock from Seven Network, representing all of our capital stock held by Seven Network, for a price per share of $24 and an aggregate purchase price of $389 million.
In November 1998, we completed a rights offering, whereby we issued and sold 84,848,485 new shares of the common stock at a subscription price of $8.25 per share for net proceeds (after expenses of the rights offering) of $696.5 million. After giving effect to the completion of the 1998 rights offering and the exercise of the subscription rights distributed in connection therewith, the Tracinda Group continued to beneficially own approximately 89.5 percent of our outstanding common stock.
In January 1999, we acquired from PolyGram N.V. and its subsidiaries certain film libraries and film-related rights for consideration of $235 million. The PolyGram libraries contain over 1,300 feature films and are comprised of (a) the Epic library, which consists of approximately 1,000 film titles acquired between 1992 and 1997 by Credit Lyonnais Bank Nederland and Consortium de Realisation from various filmed entertainment companies, (b) the library of films released by PolyGram before March 31, 1996 and (c) the Island/Atlantic and Vision/Palace libraries, which had been previously acquired by PolyGram.
In April 1999, Alex Yemenidjian was appointed as Chairman and Chief Executive Officer and Chris McGurk was named Vice Chairman and Chief Operating Officer of MGM.
In November 1999, we completed a rights offering, whereby we issued and sold 49,714,554 new shares of the common stock at a subscription price of $14.50 per share for net proceeds (after expenses of the rights offering) of approximately $715 million. After giving effect to the completion of the 1999 rights offering and the exercise of the subscription rights distributed in connection therewith, the Tracinda Group continued to beneficially own approximately 89.0 percent of our outstanding common stock.
In May 2000, our shelf registration statement covering the sale of up to $750 million of securities was declared effective by the Securities and Exchange Commission. During 2000, we sold 5,363,800 shares of common stock for total consideration of $134.1 million pursuant to the registration statement. In February 2001, we agreed to invest $825 million in four cable channels owned and operated by Rainbow Media Holdings, Inc. We intend to obtain the cash for this transaction through sales of our equity securities. As of February 12, 2001, we had sold approximately 10.7 million additional shares of common stock to unaffilitated investors in a private placement pursuant to the registration statement and 15.7 million shares of preferred stock (which will become convertible into common stock, on a one-for-one basis, upon stockholder approval) to Tracinda, for total consideration of $545.5 million. See "-- Recent Developments."
Recent Developments
Cable Investment. On February 1, 2001, MGM agreed to invest $825 million in cash for a 20 percent interest in two general partnerships which own and operate the American Movie Channel, Bravo, the Independent Film Channel and WE: Women's Entertainment (formerly Romance Classics). These partnerships are now wholly-owned by Rainbow Media which is 74 percent owned by Cablevision Systems Corporation and 26 percent owned by NBC. The proceeds of our $825 million investment will be used as follows: (1) $365 million will be used to repay bank debt of the partnerships; (2) $295.5 million will be used to repay intercompany loans from Cablevision and its affiliates; and (3) $164.5 million will be added to the working capital of the partnerships. Our investment is to be made no later than April 2, 2001.
While we will not be involved in the day-to-day operations of the cable channels, our approval will be required before either partnership may: (1) declare bankruptcy or begin or consent to any reorganization or assignment for the benefit of creditors; (2) enter into any new transaction with a related party; (3) make any non-proportionate distributions; (4) amend the partnership governing documents; or (5) change its tax structure.
We will have the right to participate on a pro rata basis in any sale to a third party by Rainbow Media of its partnership interests, and Rainbow Media can require us to participate in any such sale. If a third party invests in either partnership, our interest and that of Rainbow Media will be diluted on a pro rata basis. Neither we nor Rainbow Media will be required to make additional capital contributions to the partnerships. However, if Rainbow Media makes an additional capital contribution and we do not, our interest in the partnerships will be diluted accordingly. If the partnerships fail to attain certain financial projections provided to us by Rainbow Media for the years 2002 through 2005, inclusive, we will be entitled, 30 days after receipt of partnership financial statements for 2005, to require Rainbow Media to acquire our partnership interests for fair market value at the time, as determined pursuant to the agreement.
Sale of Preferred Stock to Tracinda. On February 7, 2001, we sold approximately 15.7 million shares of our Series B preferred stock to Tracinda for $325 million. We intend to use the net proceeds of this sale to help
finance our cable channel investment. The preferred stock does not bear dividends but has a liquidation preference of $0.01 per share. The preferred stock will become convertible, at the option of the holder, into common stock on a share-for-share basis upon stockholder approval of the issuance of the common stock to Tracinda. Tracinda will have a demand registration right for the common stock it receives upon conversion of the preferred stock. We expect to obtain stockholder approval of the issuance of the common stock to Tracinda at our next annual meeting of stockholders scheduled to be held on May 2, 2001. The Tracinda Group currently beneficially owns approximately 82.2 percent of our outstanding common stock (83.4 percent assuming conversion of the preferred stock).
The Motion Picture and Television Industry
Motion Pictures--General. The motion picture industry consists of two principal activities: production and distribution. Production involves the development, financing and production of feature-length motion pictures. Distribution involves the promotion and exploitation of motion pictures throughout the world in a variety of media, including theatrical exhibition, home video, television and other ancillary markets. The U.S. motion picture industry can be divided into major studios and independent companies, with the major studios dominating the industry in the number of theatrical releases. In addition to us (including MGM Studios, MGM Pictures, UA Films and Orion), the major studios as defined by the Motion Picture Association of America are The Walt Disney Company (including Buena Vista, Touchstone and Miramax Films), Paramount Pictures Corporation, Sony Pictures Entertainment, Inc. (including Columbia Pictures), Twentieth Century Fox Film Corp., Universal Studios, Inc., and Warner Bros. (including Turner, New Line Cinema and Castle Rock Entertainment). The major studios are typically large diversified corporations that have strong relationships with creative talent, exhibitors and others involved in the entertainment industry and have global film production and distribution capabilities.
Historically, the major studios have produced and distributed the majority of high grossing theatrical motion pictures released annually in the United States. Over the past decade, the number of feature-length motion pictures released by the major studios has increased from 158 in 1990 (39.9 percent of the total) to 258 in 2000 (42.3 percent of the total). In addition, most of the studios have created or accumulated substantial and valuable motion picture libraries that generate significant revenues. These revenues can provide the major studios with a stable source of earnings that partially offsets the variations in the financial performance of their current motion picture releases and other aspects of their motion picture operations.
The independent companies generally have more limited production and distribution capabilities than do the major studios. While certain independent companies may produce as many films as a major studio in any year, independent motion pictures typically have lower negative costs and are not as widely released as motion pictures produced and distributed by the major studios. Additionally, the independent companies may have limited or no internal distribution capability and may rely on the major studios for distribution and financing.
Motion Picture Production. The production of a motion picture begins with the screenplay adaptation of a popular novel or other literary work acquired by the producer of the motion picture or the development of an original screenplay based upon a story line or scenario conceived or acquired by the producer. In the development phase, the producer may seek production financing and tentative commitments from a director, the principal cast members and other creative personnel. A proposed production schedule and budget are prepared. At the end of this phase, the decision is made whether or not to "greenlight," or approve for production, the motion picture.
After greenlighting, pre-production of the motion picture begins. In this phase, the producer engages creative personnel to the extent not previously committed, finalizes the filming schedule and production budget, obtains insurance or self insures and secures completion guaranties, if necessary. Moreover, the producer establishes filming locations, secures any necessary studio facilities and stages and prepares for the start of actual filming.
Principal photography, or the actual filming of the screenplay, generally extends from seven to 16 weeks, depending upon such factors as budget, location, weather and complications inherent in the screenplay. Following completion of principal photography, the motion picture enters what is typically referred to as post-production. In this phase, the motion picture is edited, opticals, dialogue, music and any special effects are added, and voice, effects and music soundtracks and pictures are synchronized. This results in the production of the negative from which release prints of the motion picture are made. Major studios and independent film companies hire editors, composers and special effects technicians on the basis of their suitability for a particular picture.
The production and marketing of theatrical motion pictures requires substantial capital. The costs of producing and marketing motion pictures have increased substantially in recent years. These costs may continue to increase in the future at rates greater than normal inflation, thereby increasing the costs to us of our motion pictures. Production costs and marketing costs are generally rising at a faster rate than increases in either domestic admissions to movie theaters or admission ticket prices, leaving us and all producers of motion pictures more dependent on other media, such as home video and television, and foreign markets.
Motion Picture Distribution. The distribution of a motion picture involves the licensing of the picture for distribution or exploitation in various markets, both domestically and internationally, pursuant to a release pattern. These markets include theatrical exhibition, non-theatrical exhibition (which includes airlines, hotels and armed forces facilities), home video (including rental and sell-through), presentation on television (including pay-per-view, pay, network, syndication or basic cable) and marketing of the other rights in the picture and underlying literary property, which may include publishing, merchandising and soundtracks. The domestic and international markets generally follow the same release pattern, with the starting date of the release in the international market varying from being concurrent with the domestic theatrical release to being as long as nine months afterwards. A motion picture typically is distributed by a major studio or one or more distributors that acquire rights from a studio or other producer in one or more markets or media or a combination of the foregoing.
Both major studios and independent film companies often acquire pictures for distribution through a customary industry arrangement known as a "negative pickup," under which the studio or independent film company agrees before commencement of or during production to acquire from a production company all rights to a film upon completion of production, and also acquire completed films, as well as all associated obligations.
Television Production. The production of television series programming involves the development of a format based on a creative concept or literary property into a television script, the hiring of talent, the filming or taping of the program and the technical and post-production work necessary to produce a finished program. Television producers may originate projects internally or acquire them from others. If a concept is deemed suitable for development, the studio or other producer or network typically commissions and pays for a script. Once a script is ordered, one or more license agreements are negotiated with the potential broadcasters of such program. A pilot episode usually is ordered or commissioned prior to the determination of whether a series will be produced.
Television production can generally be divided into two distinct markets: network production (i.e., television shows for ABC, CBS, NBC, Fox, UPN and The WB) and non-network production (i.e., made-for-cable and first-run syndication). The economics of the two types of television production are different. In network production, a network generally orders approximately six to 13 initial episodes of each new series for a license fee equal to a percentage of the program's cost. The balance of the production cost can only be recouped through international sales and syndication if a series is successful and generally remains unrecouped for at least four years. In the non-network production or first-run syndication business, a producer seeking to launch a new series commits to produce a minimum number of episodes if the producer can "clear" the series by selling to individual television stations in sufficient markets throughout the country (generally comprising at least 70 percent of U.S. television households). Once produced, the episodes are immediately available for licensing to international broadcasters as well. This approach generally involves a lower production cost risk and earlier
return on investment than the network production business; however, non- network programming generally reduces the potential total return on investment as compared to successful network production. See "--Production--Television Production."
Television Distribution. The U.S. television market is served by network affiliated stations, independent stations and cable systems, although the number of independent stations has decreased as many formerly independent stations have become affiliated with new networks in recent years. During "prime time" hours, network affiliates primarily broadcast programming produced for the network. In non-prime time, network affiliates telecast network programming, off-network programming, first-run programming (programming produced for distribution on a syndicated basis) and programming produced by the local stations themselves. Independent television stations and cable networks, during both prime and non-prime time, produce their own programs and telecast off-network programs or first-run programs acquired from independent producers or syndicators. Syndicators generally are companies that sell to independent television stations and network affiliates programming produced or acquired by the syndicator for distribution.
Business Strategy
Our goal is to become a fully-integrated global entertainment content company, thereby maximizing the value of our assets, including our film and television library and our film and television production and distribution units. To achieve this goal, we seek to:
Build and Leverage Our Library. We plan to build and leverage our film and television library by:
. Producing new motion pictures and television episodes;
. Aggressively marketing and repackaging our library's titles;
. Developing new distribution channels;
. Capitalizing on developments in technology;
. Further penetrating emerging international markets; and
. Incentivizing our employees to drive growth in sales of our library's titles.
Create Branded Cable and Satellite Programming Channels. We believe we can create significant value by utilizing our library and current production to establish MGM branded cable and satellite channels. We have been actively exploring strategic alternatives to gain carriage for our proposed channels.
Increase Film and Television Production While Improving Our Risk Profile. We intend to increase production in a financially disciplined manner by:
. Tightly monitoring development and production expenditures;
. Involving members of senior management from all areas of our company in the greenlighting process for films;
. Aggressively seeking production agreements and/or co-financing partners for our pictures and television product;
. Entering into production agreements and joint ventures with key producers of motion pictures and television product;
. Increasing our focus on the production of commercially successful motion pictures; and
. Using our film library as a proven source for sequels and remakes and the expansion of certain well-tested, familiar film franchises.
We have, for example:
. Entered into an agreement with Miramax Films pursuant to which we will jointly produce, finance and distribute up to eight motion pictures, relying on our film library as a prominent source of material;
. Entered into a co-production/co-financing agreement with Universal;
. Entered into a "first look" co-financing agreement with Hyde Park Entertainment (David Hoberman and Ashok Amritraj);
. Entered into a "first look" producing/directing agreement with Lion Rock Prods. (John Woo and Terence Chang);
. Entered into a "first look" agreement with Seth Jaret;
. Repositioned UA as a specialty film unit now known as UA Films, which is involved in production, sales and acquisitions of specialized motion pictures; and
. Entered into a split-rights agreement for specialized motion pictures with American Zoetrope (Francis Ford Coppola).
We intend to produce or co-produce and distribute ten to 15 motion pictures annually through MGM Pictures across a variety of genres. Through UA Films, we also intend to distribute annually an additional seven to ten specialty motion pictures that will have substantially lower average costs and will be produced mainly by third parties.
We plan to develop, produce and distribute television programs focusing on low financial risk formats, such as pre-clearing a television series for distribution prior to committing to development expenditures, as well as joint ventures, co-productions and other partnering arrangements for certain of our series.
Increase Distribution Revenues. We have taken steps to obtain greater flexibility in distributing our own product to enable us to realize additional revenue opportunities while reducing the costs associated with distribution. In 1999 we terminated our agreement with Warner Home Video so that, on February 1, 2000, we regained full control over the home video exploitation of our films. On October 31, 2000, we completed our withdrawal from United International Pictures or UIP with respect to the international theatrical distribution of our films. We executed the transition of our international home video and theatrical/non-theatrical distribution from Warner Home Video and UIP to Fox to gain more control over our international distribution in those media, and to maximize our revenue opportunities.
We plan to increase distribution revenues by:
. Self-distributing in the U.S. and Canada our library, as well as all motion pictures produced by MGM Pictures and UA Films;
. Distributing films that we co-produce with a third party in those territories where we have distribution rights and capabilities;
. Distributing motion pictures produced by others; and
. Taking advantage of new distribution platforms.
Capitalize on a Well Recognized Brand Name. We believe that the MGM name and lion logo are among the most recognized in the world. We intend to capitalize on the value inherent in our name and logo through the distribution of branded programming and the development of consumer products.
Streamline Operations. We have taken steps to make our operating process more efficient by
. Consolidating overhead across the MGM Pictures and UA production units; and
. Consolidating and centralizing operating and corporate functions.
We intend to continue to pursue our goal of becoming an integrated global entertainment content company. In pursuit of this goal, we may consider various strategic alternatives, such as business combinations with companies with strengths complementary to ours, other acquisitions and joint ventures, as opportunities arise. The nature, size and structure of any such transaction could require us to seek additional financing. Acquisitions and other strategic alternatives, however, involve numerous risks, including diversion of management's attention away from our operating activities. We cannot assure you that we will not encounter unanticipated problems or liabilities with respect to any acquisitions that have been or may be completed by MGM or with the integration of an acquired company's operations with those of MGM, and we cannot assure you that the anticipated benefits of any acquisitions and alternatives that have been, or will be, completed by us will be achieved. We recently entered into an agreement to invest in four cable channels. See "-- Recent Developments."
Film and Television Library
We currently own or hold certain distribution rights to over 4,000 theatrically released motion pictures. Our library also contains the largest collection of feature films produced since 1948. In 1948, certain major studios negotiated consent decrees requiring that the studios separate their exhibition businesses from their production and distribution businesses and mandating the divestiture of certain theater holdings. This is generally believed to have triggered greater competition among the studios and an increased emphasis on the potential for commercial success in the development and production stages, resulting in a greater focus on the content and quality of the motion pictures produced and distributed by the studios. We believe that films produced and developed after 1948 generally are more valuable than films that were previously produced and developed.
In addition to being the largest modern motion picture library in the world, our library is also one of the most critically acclaimed libraries in the motion picture industry, representing one of the largest collections of Academy Award-winning films. The motion pictures in our library have won over 200 Academy Awards. Fourteen motion pictures in our library have won the Academy Award for Best Picture: Annie Hall, The Apartment, The Best Years of Our Lives, Dances With Wolves, Hamlet, In the Heat of the Night, Marty, Midnight Cowboy, Platoon, Rain Man, Rocky, The Silence of the Lambs, Tom Jones and West Side Story.
Our library also includes over 10,100 episodes from television series previously broadcast on prime-time network television, cable or in first-run syndication, including episodes of The Addams Family, American Gladiators, Bat Masterson, Cagney & Lacey, Fame, Green Acres, Highway Patrol, In the Heat of the Night, Mr. Ed, The Patty Duke Show, Pink Panther, Sea Hunt and thirtysomething. The television programs in our library have won, among others, 114 Emmy awards and 17 Golden Globe awards.
Our library includes titles from a wide range of genres, including dramas, comedies, action-adventure movies, westerns and suspense thrillers. We believe that our library's diversity, quality and extensive size provides us with substantial competitive advantages. We seek to continue to build upon these advantages by producing and acquiring new motion pictures across a variety of genres and budget ranges to update and enhance our library. See "-- Production--Motion Picture Production."
We will continue to implement the strategy of developing new projects from existing library assets. Our library represents a readily-available, "market tested" source of development ideas. For example, in 1999 we had success with the remake of The Thomas Crown Affair and in 1995 we had success with The Birdcage, a remake of La Cage aux Folles. Rollerball is an upcoming example of this strategy. Furthermore, we have successfully expanded the valuable film franchises within our library, most notably the James Bond franchise, with the commercial success of GoldenEye in 1995, Tomorrow Never Dies in 1997 and The World Is Not Enough in 1999. Additionally, we have successfully developed television series based on library motion pictures such as: Poltergeist: The Legacy based on Poltergeist; Stargate SG-1 based on Stargate; and All Dogs Go to Heaven, based on the movie of the same name. We also have produced a remake of Twelve Angry Men and Inherit The Wind as made-for-television movies for Showtime Networks Inc.
We, together with Danjaq LLC, are the sole owners of all of the James Bond motion pictures. Nineteen James Bond motion pictures in our library are produced and distributed pursuant to a series of agreements with Danjaq. The motion pictures are produced by Danjaq, and we have the right to approve all key elements of the pictures, such as the selection of the director and the leading actors. The copyright in each of the motion pictures is owned jointly by MGM and Danjaq. Generally, we have the right to distribute each of the pictures in all media worldwide in perpetuity or for a term of 15 years. Where our distribution rights are not perpetual, the rights revert to joint control by MGM and Danjaq after expiration of the distribution term. Danjaq controls certain merchandising rights with respect to the pictures, and we are entitled to receive a portion of the revenues from Danjaq's merchandising licenses. Additionally, we control all the marketing rights and the music from The Living Daylights (1987) and all subsequent pictures. All other rights relating to the pictures are controlled jointly by MGM and Danjaq. The agreements contain certain restrictions on the sale or licensing by MGM of any of our rights in the pictures.
With two recent acquisitions, our library now contains every James Bond motion picture ever made, and we are the only studio to hold such rights. In 1998, we acquired the rights to Never Say Never Again, produced by Warner Bros. and Taliafilms and, in 1999, we acquired the distribution rights to Casino Royale, produced by Columbia and Famous Artists Productions (a subsidiary of MGM). See "Item 3. Legal Proceedings."
We seek aggressively to market and distribute titles in our film library in existing pay and free television, home video and other markets worldwide. We believe that the size of our library allows us to minimize the over- exploitation of any title and therefore better preserve the ongoing value of our library by actively managing the rotation of titles through such markets. As of December 31, 2000, approximately 70 percent of the theatrical motion picture titles and approximately 67 percent of the television title episodes in our library have been exploited.
We also seek aggressively to market and distribute our titles through developing technology. See "--Distribution--Home Video Distribution." We believe that the development and growth of direct broadcast satellite and other new distribution systems may generate significant incremental profits for the industry as the number of channels requiring content grows.
We have differing types of rights to the various titles in our library. In some cases, we own the title outright, with the right to exploit the title in all media and territories for an unlimited time. In other cases, the title may be owned by a third party and we may have obtained the right to distribute the title in certain media and territories for a limited term. Even if we own a title, we may have granted rights to exploit the title in certain media and territories to others. As of December 31, 2000, we owned outright, or had been granted rights in perpetuity to, approximately 67 percent of the titles in our library. Our rights in the other library titles are limited in time and, pursuant to the terms of the existing arrangements, the rights granted to us, with respect to approximately four percent of the library expire over the next two years (i.e. through the end of 2002), with respect to another approximately 14 percent over the seven years thereafter (from 2003 to 2010), and with respect to another approximately 15 percent thereafter (from 2010 on). We have generally been able to renew such rights on acceptable terms; however, no assurances can be made that we will continue to be able to do so in the future. In accordance with industry practice, for purposes of calculating the size of the library, we include any title that we have the right to distribute in any territory in any media for any term.
Due to certain long-term pre-paid licenses entered into before 1993 by prior management, we do not expect to receive significant revenue with respect to substantial portions of our library from domestic free and certain major international television markets for the next several years. As of December 31, 2000, the titles included in these licenses represent a cross-section of the titles in the library, including substantially all of the pre-1990 MGM and UA titles, which have been licensed in one or more of the U.S., France and Spain, and approximately 40 percent (some are starting to expire) of the Orion and PolyGram titles, which have been licensed in one or more of France, Spain, Germany and the United Kingdom. See "--Distribution--Television Distribution." We expect to benefit as certain rights to the library that have been previously licensed to others revert to us over time. See "--Distribution."
Because we have historically derived approximately 40 percent of our revenues from non-U.S. sources, our business is subject to risks inherent in international trade, many of which are beyond our control. These risks include: changes in laws and policies affecting trade, investment and taxes, including laws and policies relating to the repatriation of funds and to withholding taxes; differing degrees of protection for intellectual property; the instability of foreign economies and governments; and fluctuating foreign exchange rates. See "--Regulation," "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 7A. Quantitative and Qualitative Disclosures about Market Risk."
Production
Motion Picture Production
We currently develop and produce theatrical motion picture projects through two separate production entities, MGM Pictures and UA Films. MGM Pictures concentrates on developing and producing mainstream, major studio budget level films. UA Films concentrates on developing, producing and acquiring specialized films with a net cost investment of less than $10 million. Both production units are supported by centralized marketing, sales, legal, physical production and distribution functions.
MGM Pictures plans to distribute approximately ten to 15 motion pictures annually across a variety of genres and budget ranges. MGM Pictures employs a development staff of creative executives who refine concepts and scripts so that projects are developed to the point that production decisions can be made. MGM Pictures also intends to enter into production alliances with a select group of producers, many of them genre-specific. These producers will develop and produce motion pictures exclusively or semi-exclusively for MGM Pictures and will use their relationships and creative abilities to provide another source of product for MGM Pictures. The ten to 15 pictures distributed by MGM Pictures are anticipated to be a combination of internally developed pictures, pictures developed and/or produced by the allied producers, pictures which are co-produced or co-financed with other major studios or independent partners and pictures acquired through negative pickups or other distribution arrangements.
MGM Pictures' strategy is to both increase creative diversity and mitigate financial risk in connection with motion picture production. We expect to enhance creative diversity by employing the production alliance strategy discussed above and by entering into selective production agreements with successful established producers such as Lion Rock Prods. (John Woo and Terence Chang), Seth Jaret and Hyde Park Entertainment (David Hoberman and Ashok Amritraj). As an example of this strategy, in July 1999, we entered into an agreement with Miramax Films pursuant to which MGM and Miramax will jointly produce, finance and distribute up to eight motion pictures, relying on our film library as a prominent source of material. Initial titles identified for potential production under this agreement include Cold Mountain, based on the best-selling novel, contributed by us, and the remake of the comedy classic Harvey, contributed by Miramax. Miramax will develop the films under this agreement, which MGM and Miramax will jointly finance. Half of these films will be released domestically by each partner, with the other providing international distribution.
We also intend to seek to spread the financial risk inherent in motion picture production, as well as increase the breadth of our release slate, by entering into co-production and/or co-financing arrangements such as our agreement with Miramax and our co-production agreement with Universal. In April 1999, we entered into an agreement with Universal that increased our commitment under our existing co-production arrangement by up to $100 million in production expenses, of which $50 million would be available only with respect to pictures from four significant outside production companies who have business relationships with Universal. The motion pictures to be co- produced under the arrangement will be selected over the next two years, but we may incur the related production expenditures over a longer period of time. We will distribute internationally, with Universal being responsible for domestic distribution. We share the production's costs and receipts from the picture equally except for certain ancillary rights. There has been some disagreement between us and Universal with regard to whether certain of the projects which Universal has submitted to us for consideration under the co- financing deal qualify for consideration under the terms of the deal; we expect to engage in further discussions with Universal
to seek resolution of these issues. In addition, we co-produced with Universal the feature film Hannibal (a sequel to The Silence of the Lambs). Under our co-production arrangement with Universal, we will distribute the picture in the domestic marketplace, with Universal being responsible for international distribution. We share the production costs for Hannibal evenly with Universal, and the receipts from the picture will also be divided evenly between us and Universal.
We have established UA Films as a filmmaker-oriented studio which will release approximately seven to ten motion pictures each year. These motion pictures will be produced or co-produced by UA Films or acquired through negative pickups or other distribution arrangements and will include some motion pictures in a variety of genres generally involving producers and directors, writers or other talent who typically work outside of the studio system as well as lower budget films from established filmmakers. Our investment in such pictures is expected to be significantly less than our investment for pictures produced through MGM Pictures. We believe that this strategy of releasing specialty motion pictures will add greater diversity to our release slate and enhance the library both through the addition of new film product and the building of relationships with up-and-coming producers and directors, writers and other talent. As an example of this strategy, in March 2000, we entered into an agreement with filmmaker Francis Ford Coppola's production company American Zoetrope, for the financing and distribution in the U.S. and Canada of up to ten lower-budget motion pictures to be produced by Zoetrope for UA Films over a three-year period. Under the agreement, we have a "first-look" on such projects developed by Zoetrope. See "Item 13. Certain Relationships and Related Transactions."
Compared to other major studios, we have entered into, and intend to pursue, fewer traditional producer or talent "overhead" arrangements in which a studio pays a portion of the overhead of creative talent (i.e., producer, director or actor) for the right to receive a "first look" at that party's projects. We generally believe that our capital resources are better allocated to acquire literary properties or the services of talent for a specific project. In addition, our current business plan also calls for our annual release slates to be comprised of proportionately fewer large budget "event" motion pictures than the current release slates of the other major studios.
We do not own any studio facilities or stages but lease facilities and sound stages on an "as needed" basis in connection with the production of specific motion picture and television projects. We have not experienced any difficulties in leasing appropriate facilities and sound stages when needed.
Motion picture production and distribution is highly speculative and inherently risky. There can be no assurance of the economic success of any motion picture since the revenues derived from the production and distribution of a motion picture (which do not necessarily bear a direct correlation to the production or distribution costs incurred) depend primarily upon its acceptance by the public, which cannot be predicted. The commercial success of a motion picture also depends upon the acceptance of competing films released into the marketplace at or near the same time, the availability of alternative forms of entertainment and leisure time activities, general economic conditions and other tangible and intangible factors, all of which can change and cannot be predicted with certainty. Further, the theatrical success of a motion picture is generally a key factor in generating revenues from other distribution channels. There is a substantial risk that some or all of our motion pictures will not be commercially successful, resulting in costs not being recouped or anticipated profits not being realized. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
The following table details our tentative 2001 domestic theatrical release schedule:
Release Schedule
We may revise the release date of a motion picture as the production schedule changes or in such a manner as we believe is likely to maximize revenues. Additionally, there can be no assurance that any of the motion pictures scheduled for release will be completed, that completion will occur in accordance with the anticipated schedule or budget, or that the motion pictures will necessarily involve all of the creative talent listed above. See the discussion above in "--Motion Picture Production."
Television Production
We have in the past engaged in the development and production of episodic television series, mini-series and movies for distribution on domestic and international television networks, local independent and network-affiliated television stations, pay television networks, basic cable networks and home video. Since the re-establishment of our television series production operations in 1994, we have obtained commitments for approximately 1,035 hours of television programming, of which approximately five percent remained to be aired as of December 31, 2000. Historically, our television activities were focused on the traditional network production business and made-for-television movies, and many of the television programs in our library were produced as network series. However, since the networks have substantially lowered the license fees as a percentage of the budget for network television programming in recent years, resulting in significantly larger production investment risks for the producers of such programming, we altered our television strategy in 1994. See "--The Motion Picture and Television Industry."
Since 1994, we have focused primarily on the development and production of series for the first-run syndication business, which involves a lower production investment risk for us, and movies and mini-series for both network and off-network broadcasters. Our strategy is designed to (a) minimize up- front capital investment through the production of series for the first-run syndication business and through co-production arrangements, (b) minimize risks associated with large deficit financing by developing product such as two-hour movies or mini-series that generally offer stable, predictable cash flows, (c) use valuable library assets such as The Outer Limits, Poltergeist, Stargate and All Dogs Go to Heaven to develop recognizable products with enhanced marketability and (d) develop alternative types of programming, such as animated cartoon strips, talk shows, variety/magazine shows such as National Enquirer's Uncovered, game shows such as Sex Wars and reality-based programming such as LAPD--Life on the Beat.
As part of our strategy, in 1994 we entered into a programming arrangement with Showtime whereby we provided television series and movies for premiere on Showtime. Showtime agreed to license from us exclusive U.S. pay television rights to the following television series: (a) 132 hours (six seasons) of The Outer Limits (winner of the Cable Ace award for Best Dramatic Series in 1995 and 1996) all of which have been aired as of December 31, 2000; (b) 66 episodes (three seasons) of Poltergeist: The Legacy all of which have been aired as of December 31, 2000; and (c) 110 episodes (five seasons) of Stargate SG-1 of which 30 episodes remained to be aired as of December 31, 2000. We have no further commitments from Showtime with respect to these series. Following their initial exhibition cycle on Showtime, we exploit these programs further in other markets. In this respect, we entered into a license agreement with Sci-Fi Channel for the exclusive domestic basic cable exhibition rights of The Outer Limits, Poltergeist: The Legacy and Stargate SG-I. Additionally, we produced 22 new episodes of Poltergeist for USA/Sci Fi, of which no episodes remained to be aired as of December 31, 2000, and we are currently producing 22 new episodes of Outer Limits for USA/Sci Fi. All episodes will be aired in 2001.
The programming agreement with Showtime also includes a commitment by Showtime to license eight made-for-television movies from us, three of which remained to be produced as of December 31, 2000. One of these movies, Dirty Pictures, recently won the Golden Globe award for "Best Mini-Series or Motion Picture Made for Television," giving Showtime its first ever victory in that category. In addition, Showtime has committed to licensing three new one-hour, 20-episode series, all of which remain to be produced as of December 31, 2000.
In 1998, we obtained a commitment from Paxson Communications to license 88 episodes of Flipper, a one-hour series, which includes a production order for 44 episodes, all of which have been delivered. The series began airing in fall 1998 on Paxson's PAX NET network, comprised principally of owned and operated stations, which cover in excess of 65 percent of U.S. television households.
In addition to National Enquirer's Uncovered, which premiered in first-run syndication in September 1999, and Sex Wars, which premiered in first run syndication in September 2000, we are currently developing the following: Chat Room America, a nightly, interactive talk show for network or cable television; a new American Gladiators series to be financed and distributed domestically by Tribune; Bull Durham, a one-hour dramatic
adaptation of our 1988 feature film for network or first-run syndication; Sea Hunt, a one-hour action show based upon our 1960s adventure series; Mystic Pizza, a one-hour dramatic adaptation of our 1988 feature film for network or first-run syndication; The Thomas Crown Affairs, a one-hour adaptation of our popular feature film for network or first-run syndication; Jeremiah, a one- hour action series for Showtime; and Leap Years, a one-hour dramatic series for Showtime. We are also currently developing I Want Kandee and Whatever as potential teen series for network or cable.
From time to time, we may produce series for network television on a selective basis, which typically require deficit financing but generally offer the potential for greater financial return.
We intend to pursue joint ventures, co-productions and other partnering arrangements for some of our existing or future series in order to minimize the up-front capital investment and limit the financial risk to us with respect to the production of those series.
Since our ability to recover production costs and realize profits on our television programs depends on various factors, including but not limited to the programs' acceptance by the public, fluctuations in prevailing advertising rates, and the ability to distribute the programs subsequent to their first- run license, there can be no assurance that we can recover the production costs or realize profits on any television series. Thus, there is a substantial risk that some or all of our television projects will not be commercially successful, resulting in costs not being recouped or anticipated profits not being realized. See "--Distribution" and "--Competition." In addition, our focus on first-run syndicated television programming is generally licensed based on a pilot episode that we finance. If an insufficient number of stations license the programming, our pilot costs will not be recouped. There is also financial exposure to us after the programming is licensed to the extent that advertising revenues and/or license fees we receive are not sufficient to cover production costs. Moreover, we may have certain financial obligations to the producer of a first-run syndicated series if we cancel production prior to commencement of production for any broadcast season for which the series was licensed.
Distribution
Theatrical Distribution
General. The initial step in the release of a motion picture is the booking of engagements with theatrical exhibitors. The exhibitors retain a portion of admissions paid at the box office, which generally includes a fixed amount per week, as well as a percentage of the gross receipts that escalates over time. A studio's or other producer's (or third party distributor's) share is generally approximately 50 percent of gross box office receipts, although that percentage has generally decreased in recent years and varies depending upon factors such as market competition and the overall performance of the film.
We intend to release a slate of films appealing to a wide variety of audiences. By strategically timing the release of our motion pictures throughout the year, we seek to avoid some of the risks posed when a motion picture is inappropriately released during the most crowded and competitive box office seasons. We believe that this strategy is unlikely to have a negative impact on our ability to generate home video rentals.
All motion pictures that we release theatrically in the U.S. and Canada, whether produced by MGM Pictures, UA Films or third parties, are marketed and distributed by MGM Distribution Co.
In June 1999, we entered into an agreement with Fox pursuant to which Fox will provide distribution services for our films in the international theatrical market. This distribution services arrangement took effect on November 1, 2000. Although Fox will be servicing international theatrical distribution activities on our behalf, we have reserved broad powers to direct and control the handling and release of our films. We believe that this arrangement with Fox will reduce the amount of fixed overhead related to the distribution of our theatrical product in the international marketplace.
On October 31, 2000, we closed a transaction with UIP and the other UIP partners (Paramount Pictures International B.V. and Universal Studios International B.V.), pursuant to which we finalized our exit from UIP and arranged for an orderly transition from UIP of certain of our product that was in its international theatrical and non-theatrical distribution cycle.
Co-Production and Distribution Agreements. In addition to producing motion pictures independently, we enter into co-production agreements, such as those with Miramax and Universal, split rights deals and similar arrangements under which we retain certain distribution rights with respect to a picture and share the cost of production with a partner that obtains other rights. While such agreements limit our risk relating to a motion picture's performance as they reduce our production costs, such agreements also limit profitability. We also acquire rights to distribute films through negative pickup arrangements under which we acquire a completed motion picture, or certain rights therein, from a third party. Under co-production agreements, split rights deals or negative pickup arrangements, we may be committed to spend specified amounts for prints and advertising. Additionally, we occasionally enter into "rent-a- system" arrangements under which we provide distribution services to an independent film company for a percentage distribution fee. Under rent-a- system arrangements, the independent film company generally is responsible for all print and advertising costs. These types of arrangements may be entered into before, during or after production of a particular motion picture.
Theatrical Marketing. Our theatrical marketing department consists of five functional groups: research, media planning, advertising, promotion and publicity. The objective of the marketing department is to maximize each motion picture's commercial potential by designing and implementing a marketing campaign tailored to appeal to the picture's most receptive audience. The marketing process begins with research before a motion picture is completed. The research department determines, through audience screenings and focus groups, a motion picture's appeal to its most likely target audience. The marketing group begins to develop marketing materials well in advance of a motion picture's scheduled theatrical release. The marketing campaign generally begins six months before release with the circulation of teaser trailers, posters and exhibitor advertising materials. The campaign becomes more aggressive two to three months before release as full-length trailers are released in theaters and additional materials are sent to exhibitors. Finally, a national media campaign is launched four to five weeks before opening day. This media campaign generally involves advertising a picture's release on national television, including network prime time and syndication markets, national cable and radio and in magazines, newspapers and specific target markets. In addition, public appearances, such as television talk shows, are arranged for a picture's stars in order to promote the film. The entire process is managed by our in-house staff, although outside agencies are frequently retained to provide creative services.
Home Video Distribution
Our marketing and distribution strategy in the home video market domestically and internationally is to (a) market our motion picture and television titles in cohesive promotions, (b) create branded product lines, (c) adapt to a maturing home video rental market and a growing DVD market (d) release new motion pictures into the home entertainment market at the time of the year that we believe will generate the most sales without diminishing revenues from other markets. In addition to organizing our VHS and DVD product into branded collections, we have launched an integrated sales and marketing branding initiative designed to create awareness for MGM catalog product and to drive store traffic to dedicated displays in key customer outlets. Under the "MGM Means Great Movies" umbrella message, the general advertising, retailer-specific advertising, and all in-store signage for the MGM dedicated sections are combined to create awareness and demand for MGM catalog titles and to help consumers find them in stores. Additionally, in connection with new films which we release into the market, we often release related library films, or groups of library films, in order to increase sales of both the library films and new releases. An example is the worldwide re-release of the James Bond video catalog conducted in connection with the November 1999 theatrical release of The World Is Not Enough. We intend to continue this strategy of packaging groups of films or film franchises and releasing them in connection with the releases of our most highly visible new films.
MGM Home Entertainment Inc. manages the marketing and distribution of both current feature motion pictures and library product of MGM Studios and Orion and their subsidiaries in the home video and other home entertainment markets.
In 1990, as part of the acquisition of MGM/UA by Pathe, MGM-Pathe (the predecessor in interest to MGM Studios), MGM/UA and UA Pictures entered into a long-term agreement with the predecessor to Warner Home Video, granting to Warner Home Video certain home video distribution rights with respect to new motion pictures and the motion picture library of MGM/UA and UA Pictures throughout the world for a distribution fee expressed as a percentage of worldwide home video revenues. The Warner Home Video agreement was originally scheduled to expire in May 2003, with the home video rights of each of the films still covered by the Warner Home Video agreement at that time reverting to us five years after the film's initial availability in the U.S. home video market. In 1999, we entered into an agreement with Warner Home Video and Turner to accelerate the expiration of the Warner Home Video agreement. Under this agreement, Warner Home Video completed its distribution of certain of our product in the home video marketplace on January 31, 2000. As part of this agreement, (a) we paid Warner Home Video $225.0 million and (b) we reconveyed as of January 1, 1999 to Warner Home Video our right to distribute in the home video markets worldwide until June 2001, approximately 2,950 titles from the Old MGM library, the Turner library and all pre-1949 Warner titles, which titles had been serviced under the Warner Home Video agreement.
Even with the Warner Home Video agreement in effect, our home video sales have increased since 1993. From 1993 to 2000, we increased our annual worldwide home video gross revenue from feature films by approximately 122 percent, from $243.0 million to $538.2 million. We believe that this increase is in part a result of more effective and efficient marketing, the distribution of more current product, the distribution of more titles due to the Orion and PolyGram acquisitions, the renegotiation of key vendor relationships, a reorganization of our distribution infrastructure and the emergence of DVD and e-commerce sales.
We have handled the distribution of our product in the domestic home video market since February 2000. We believe that the agreement to terminate the Warner Home Video agreement, our transition to self-distribution in the domestic market and our international agreement with Fox, as discussed below, enables us to manage home video distribution in a more cost-effective manner and further increase sales and profitability. Although we have experienced video distribution management, we cannot assure you that we will not encounter unanticipated problems related to the early termination of the Warner Home Video agreement or the establishment of our own distribution infrastructure, nor can we assure you that we will realize the anticipated benefits of self- distribution in the domestic home video marketplace or distribution through Fox in the international home video marketplace.
In June 1999, we entered into an agreement with Fox pursuant to which Fox will provide distribution services for our films in the international home video market. This distribution arrangement became effective on February 1, 2000. Although Fox is servicing international home video distribution activities on our behalf, we have reserved broad powers to direct and control the handling of our home video product.
We have entered into revenue sharing agreements for our new releases and certain library titles pursuant to which we lease titles to rental establishments and receive a percentage of the consumer rental revenues generated from such titles. We anticipate that we will continue to enter into more of such agreements in the future. Although we can give you no assurance, in part because of the recent introduction of these arrangements in the industry, we believe that such arrangements may increase our revenues from the home video rental market by allowing us to participate in increased revenues from successful titles even though these revenues will be received over a longer period.
We intend to capitalize on new distribution technologies and emerging distribution formats such as DVD, a high-quality mass-produced delivery system for video and audio data. We believe that we have positioned ourselves to benefit from the rapid market growth of the DVD format. The DVD hardware installed base in the United States grew from over one million households at the beginning of 1999 to a base of ten million households by the end of 2000. This rapid growth, combined with the strong desire among new DVD owners to
create new film collections, will continue to be a source of incremental profitability for us in the near future. Our DVD sales have increased from $79.4 million in 1999 to $224.0 million in 2000. We intend to continue rapid expansion of our DVD library product into 2001. The development and/or emergence of such distribution technologies, platforms and formats, however, may create new risks to the Company's ability to protect its intellectual property.
Television Distribution
General. We generally license our current theatrical motion pictures for pay television through output agreements pursuant to which films not yet produced are pre-licensed for a specified fee paid on delivery. We believe that output agreements with international distributors with recognized expertise are beneficial as they assure that a significant advance will be received for a given territory and that a prominent distributor with recognized distribution and marketing capabilities will distribute the picture in such territory.
We intend to enter into relatively short-term licenses of our library motion pictures for pay and free television with title selections designed for the relevant marketplace. We have created a proprietary database for use by our sales force which contains detailed information on each of our films, including dates of availability, media controlled by us, sales history, genre, format, length, stars, soundtrack, etc. The sales force can utilize this information in order to fulfill customer demand for strategically designed offerings of motion pictures based on one or more various criteria. We believe that this system provides our sales force with an advantage in a competitive marketplace that requires large amounts of diverse content.
Domestic Pay Television. We have a theatrical motion picture output agreement with Showtime requiring our future theatrical motion pictures to air on Showtime's pay television network. We have extended the output term of the agreement with Showtime. The new output term covers pictures theatrically released in the U.S. commencing January 1, 2000 and continuing until the earlier of December 31, 2008 or the delivery of 270 pictures under the agreement. The license fees for each picture are generally determined according to a formula based on U.S. theatrical rentals of such picture.
Domestic Free Television. We distribute our feature motion pictures to U.S. and Canadian networks, local television stations in the U.S. and Canada and basic cable networks. We also generate revenue by granting syndication licenses on a barter basis. Barter syndication allows the television stations to license our product in exchange for a portion of the local commercial airtime. We, in turn, sell commercial airtime to advertisers on a national basis, while the television stations retain a portion of the commercial airtime for local advertisers. We have used outside barter companies to sell television spots to advertisers in the past, but we commenced our own barter sales business in 1996.
In connection with the acquisition of MGM/UA by Pathe in November 1990, MGM- Pathe licensed the domestic free television rights to a substantial portion of its library (the UA library and the post-1986 MGM/UA titles in theatrical release at the time, constituting approximately 850 titles) and selected television programs to Turner for a period of ten years beginning from the availability of each such product in that market. The license excludes motion pictures released theatrically after 1987. With respect to most of the motion pictures and television programming covered by the Turner license, the domestic free television rights revert to us between 2002 and 2005. We expect to receive relatively little revenue from the licensing of the product covered by the agreement with Turner in the domestic free television market until such product reverts to us. We believe that, due to the significant increases in licensing fees for domestic television since 1990, the expiration of the Turner license and our subsequent ability to freely license the library in this market, together with our ability to utilize these titles on MGM branded cable and satellite channels, will generate incremental revenue for us. See "--Film and Television Library."
Domestic Cable Television Investment. We entered into an agreement, dated January 31, 2001, with Cablevision Systems Corporation, Rainbow Media Holdings, Inc. and four of Rainbow's subsidiaries. Pursuant to the terms of the agreement, we will make an investment aggregating $825 million in two general partnerships
owned by Rainbow. As a result, we will acquire a 20 percent interest in each of these partnerships. The partnerships own and operate the cable television channels American Movie Classics, Bravo, the Independent Film Channel and WE: Women's Entertainment (formerly known as Romance Classics). See "--Recent Developments."
Network Television. In 2000, we concluded an agreement with ABC for it to license thirteen of the James Bond films in our library for a two-year exhibition term. ABC also has an option to license a fourteenth James Bond film.
International Pay and Free Television. We currently distribute our motion pictures and television product through pay television licenses in over 90 territories. We have output agreements with licensees in major territories, including Germany, France, the United Kingdom, Spain, Japan, Latin America and Brazil. In 2000, we received $93.8 million in revenue from international pay television distribution, accounting for eight percent of our total revenue for the year.
We currently distribute our motion pictures and television product through free television licenses in over 100 territories. In 2000, we received $165.0 million in revenues under these agreements, accounting for 13 percent of our total revenues for the year. These license arrangements typically provide licensees with the right to exhibit the licensed motion pictures on television for a specific number of airings over a period of three to seven years.
However, in connection with the acquisition of MGM/UA by Pathe in November 1990, MGM-Pathe entered into long-term licenses of pay and free television rights for theatrical and television movies and, in some cases, television series in its library at that time with United Communications (France) and F.O.R.T.A. (Spain). A similar agreement had been entered into in 1984 with Degeto Film (Germany). Substantially all of the license fees under these long- term licenses have already been paid to us, and therefore, we do not expect to receive significant revenue from these licenses in future periods. With respect to most of the motion pictures licensed to United Communications, the rights granted currently revert to us through 2003. The James Bond features were excluded from such license. With respect to most of the motion pictures licensed to F.O.R.T.A., the vast majority of free television rights have reverted to us. The distribution rights to the motion pictures and television series licensed under the original Degeto agreement were scheduled to return to us incrementally through 2010. In January 2000, however, we amended the Degeto agreement to reclaim non-exclusive pay television rights in Germany to the approximately 425 titles subject to the license, effective January 1, 2000, and to extend Degeto's now non-exclusive license period on a majority of such licensed titles by approximately 18 months. This recent agreement with Degeto now provides us with an opportunity to generate incremental revenue in Germany's pay television market. See "--Film and Television Library."
Additionally, Orion entered into certain long-term licenses covering a significant number of its library motion pictures in the international free and pay television markets. Orion had already received substantially all of the license fees under these licenses, prior to our acquisition of Orion, and therefore, we do not expect significant revenue from these licenses in future periods. Orion also licensed titles to Capitol Film and TV International (Germany), Compagnie Luxembourgeoise de Telediffusion (France), British Sky Broadcasting (the United Kingdom), Film Finance Group, Inc. and Principal Network Limited (Italy), Mitsubishi Corporation (Japan) and Televisio de Catalunya, S.A. (Spain). The distribution rights granted to Capitol Film and TV International revert to Orion in 2025. The distribution rights granted to Compagnie Luxembourgeoise de Telediffusion revert to Orion between 2009 and 2019. The distribution rights granted to British Sky Broadcasting currently are reverting to Orion, with such reversion being complete in 2002. The distribution rights granted to Film Finance Group, Inc. and Principal Network Limited revert to Orion through 2012. The distribution rights granted to Televisio de Catalunya, S.A. currently are reverting to Orion, with such reversion being complete in 2010. We believe that, due to the importance of France, Spain, the United Kingdom and Italy and the significant increases in licensing fees for television in these markets since 1990, the expiration of these licenses and our subsequent ability to freely license our library in these markets could create substantial incremental revenue.
The MGM/UA and Orion licenses discussed above (in "--Domestic Free Television" and "--International Pay and Free Television") cover a cross- section of the motion pictures in our library. Although we exploit the remaining titles in the library in these markets, they do not generate significant revenues.
In addition to licensing packages of films, we hold equity positions ranging from approximately five percent to 25 percent in joint ventures such as LAPTV, Telecine, Star Channel and Movie Network Channels, which are emerging international premium film satellite television networks broadcasting in different territories around the world. We have entered into license agreements with respect to each of LAPTV, Telecine, Star Channel and Movie Network Channels, licensing theatrical and television motion pictures to each of the ventures.
Branded Cable and Satellite Channels. We believe that pursuing our strategy of providing strategically pooled, branded MGM programming through the licensing of programming packages to cable networks and television broadcasters, as well as through the development of new channels of distribution that deliver our programming, will provide opportunities in the international marketplace as foreign countries continue to develop cable television infrastructures and satellite television becomes more available. We cannot assure you that we will have the financing that may be necessary for such acquisitions or investments, that we will consummate such transactions or that we will be able to realize any anticipated benefits from any such transactions.
In May 1998, MGM and an indirect subsidiary of United International Holdings combined our respective Latin American cable programming businesses into a joint venture to form MGM Networks Latin America. Under the terms of the joint venture, we acquired a 50 percent equity interest in the venture by contributing our branded Brazilian channel, which began operations in December 1997. In turn, UIH contributed its 100 percent interest in United Family Communications, which produces and distributes Casa Club TV to satellite and cable television distributors throughout Latin America and Brazil, for a 50 percent interest in the joint venture. We share equally in the profits of the venture and as of December 31, 2000, are obligated to fund 50 percent of the joint venture's expenses up to an additional $3.0 million. We have funded approximately $21.0 million to the venture as of December 31, 2000. We have a license agreement with MGM Networks Latin America, licensing certain motion pictures and trademarks to the venture. The joint venture is based in Coral Gables, Florida. MGM Latin America and MGM Brazil are general entertainment channels programmed by the joint venture primarily with MGM theatrical and television product. Casa Club TV is a lifestyle channel offering home and garden, food and other lifestyle programming. As of December 31, 2000, MGM Networks Latin America distributed its signal to approximately 11.5 million homes in 16 countries throughout Latin America.
In August 1999, we entered into an agreement with Tel-Ad (Israel), to establish a movie channel showcasing the MGM film library in the region. MGM Movie Channel is expected to be available on basic cable to more than 80 percent of total television households in Israel in the second quarter of 2001. We will hold a 35 percent equity interest in the channel. We have entered into a licensing agreement with the channel and will receive a branding fee for the channel's use of the MGM brand.
In December 2000, we entered into an agreement with Tel-Ad to launch a movie service in Turkey. The channel in Turkey launched on January 1, 2001, and we hold a 35 percent equity interest. The service is broadcast on Digiturk's digital satellite platform. MGM shall receive license fees for the programming as well as a branding fee for the channel's use of the MGM brand.
We have entered into an agreement with Zee TV (India) to launch an MGM branded library movie service in India (and its surrounding territories; Pakistan, Bangladesh, Nepal, Sri Lanka and Maldives). Upon the completion of certain conditions, we will own a thirty percent equity interest in the venture, which was launched on November 1, 2000. Zee TV will be broadcast on basic cable in India as part of a channel package called "Zee Networks." We will receive license fees for the MGM programming and a branding fee for the channel's use of the MGM brand.
Trademarks and Consumer Products
We own the registered trademarks Metro-Goldwyn-Mayer, MGM, United Artists, the MGM Lion Logo, UA, Orion, Cannon and variations thereof, as well as trademarks, logos and other representations of characters,
such as The Pink Panther, from motion pictures and television series we produced or distributed. In 2000, we received $11.2 million in revenue from the licensing of these trademarks, logos and other representations.
We believe that the MGM name and the MGM Lion Logo are among the most recognized in the world, evoking images of classic Hollywood. We believe that the name and logo represent assets of which the value has been substantially unrealized in the past. We plan to pursue a focused branded strategy that will capitalize upon our name and logo and seek licensing opportunities for such name and logo, as well as our other trademarks, in a range of product categories and distribution channels.
In February 1980, our predecessor-in-interest granted to a predecessor-in- interest to MGM Grand, Inc. an exclusive open-ended royalty-free license, which was amended in 1992 and further amended in 1998. Pursuant to the license, as amended, MGM Grand, Inc. (now known as MGM MIRAGE) has the right to use certain trademarks that include the letters "MGM," as well as logos and names consisting of or related to stylized depictions of a lion, in its resort hotel and/or gaming businesses and other businesses that are not related to filmed entertainment. In June 2000, in consideration of the payment to us of an annual royalty of $1.0 million, such license was further amended to permit MGM Grand, Inc. to use the letters "MGM" combined with the name "Mirage" in the same manner and to the same extent that it was permitted theretofore to use the name "MGM Grand." In 1986, MGM/UA granted MGM Grand Air, Inc. an exclusive open-ended royalty-free license to use one of its logos consisting of a stylized depiction of a lion in MGM Grand Air's airline business. See "Item 13. Certain Relationships and Related Transactions."
Competition
Motion picture production and distribution are highly competitive businesses. We face competition from companies within the entertainment business, as well as alternative forms of leisure entertainment. We compete with the other major studios, numerous independent motion picture and television production companies, television networks and pay television systems for the acquisition of literary properties, the services of performing artists, directors, producers and other creative and technical personnel and production financing. Numerous organizations with which we compete in the motion picture industry have significantly greater financial and other resources than MGM, while the independent production companies may have less overhead than MGM. Most of the other major studios are part of large diversified corporate groups with a variety of other operations, including television networks and cable channels, which can provide both means of distributing their products and stable sources of earnings that offset the fluctuations in the financial performance of their motion picture and television operations. See "--Distribution--Television Distribution."
In addition, our motion pictures compete for audience acceptance and exhibition outlets with motion pictures produced and distributed by other companies. As a result, the success of any of our motion pictures is dependent not only on the quality and acceptance of a particular picture, but also on the quality and acceptance of other competing motion pictures released into the marketplace at or near the same time. The number of films released by our competitors, particularly the other major film studios, in any given period may create an oversupply of product in the market, thereby potentially reducing our share of gross box office admissions and making it more difficult for our films to succeed.
Competition is also intense within the television industry. There are numerous suppliers of television programming, including the networks, the television production divisions of the major studios and independent producers, all of which compete actively for the limited number of available broadcast hours. Our programming competes with first-run programming, network reruns and programs produced by local television stations. Competition is also intense in supplying motion pictures and other programming for the pay television and home video markets. Numerous organizations with which we compete in the television industry have significantly greater financial and other resources than MGM.
The entertainment industry in general, and the motion picture and television industry in particular, are continuing to undergo significant changes, primarily due to technological developments. Due to this rapid growth
of technology, shifting consumer tastes and the popularity and availability of other forms of entertainment, it is impossible to predict the overall effect these factors will have on the potential revenue and profitability of feature- length motion pictures and television programming.
Employees and Labor Matters
As of December 31, 2000, we had approximately 973 full-time and part-time regular employees in our worldwide operations. Of that total, approximately 86 were primarily engaged in production and development, approximately 348 were primarily engaged in sales, marketing and distribution and approximately 539 were primarily engaged in management and administration. Approximately 158 of our employees are currently covered by employment contracts. We also hire additional employees on a picture-by-picture basis in connection with the production of our motion pictures and television programming. The salaries of these additional employees, as well as portions of the salaries of certain full-time employees who provide direct production services, are typically allocated to the capitalized cost of the related motion pictures or television programming. We believe that our employee and labor relations are good.
Approximately 21 of our current employees (and many of the employees or independent contractors that we hire on a project-by-project basis) are represented under industry-wide collective bargaining agreements with various unions, including the Writers Guild of America, the Directors Guild of America, the Screen Actors Guild, and the International Alliance of Theatrical Stage Employees. The motion picture and television programs produced by MGM Studios and the other major U.S. studios generally employ actors, writers and directors who are members of the Screen Actors Guild, the Writers Guild of America, and the Directors Guild of America, pursuant to industry-wide collective bargaining agreements. The collective bargaining agreement with the Writers Guild of America is due to expire on or about May 1, 2001 and the collective bargaining agreement with the Screen Actors Guild is due to expire on or about June 30, 2001. Negotiations to renew those agreements are underway, and there have been a number of public reports indicating that strikes by the Writers Guild of America and the Screen Actors Guild are a possibility in 2001. The Directors Guild of America collective bargaining agreement expires in mid-2002. Many productions also employ members of a number of other unions, including without limitation the International Alliance of Theatrical and Stage Employees and Teamsters. A strike by one or more of the unions that provide personnel essential to the production of motion pictures or television programs could delay or halt our ongoing production activities. Such a halt or delay, depending on the length of time involved, could cause delay or interruption in our release of new motion pictures and television programs and thereby could adversely affect our cash flow and revenues. Our revenues from motion pictures and television product in our library should not be affected and may partially offset the effects of a strike to the extent, if any, that television exhibitors buy more library product to compensate for interruption in their first-run programming.
Regulation
In 1994, the U.S. was unable to reach agreement with its major international trading partners to include audiovisual works, such as television programs and motion pictures, under the terms of the World Trade Organization. The failure to include audiovisual works under GATT allows many countries (including members of the European Union, which consists of Austria, Belgium, Denmark, Germany, Greece, Finland, France, Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, Sweden and the United Kingdom) to continue enforcing quotas that restrict the amount of U.S. produced television programming which may be aired on television in such countries. The European Union Council of Ministers has adopted a directive requiring all member states of the European Union to enact laws specifying that broadcasters must reserve, where practicable, a majority of their transmission time (exclusive of news, sports, game shows and advertising) for European works. The directive must be implemented by appropriate legislation in each member country. Under the directive, member states remain free to require broadcasters under their jurisdiction to comply with stricter rules. For example, France requires that original French programming constitute a required portion of all programming aired on French television. These quotas apply only to television programming. Several countries (including France, Italy and Korea) also have quotas on the theatrical exhibition of motion pictures. We cannot assure you that additional or more restrictive theatrical or television quotas will not be enacted or that countries with existing
quotas will not more strictly enforce such quotas. Additional or more restrictive quotas or more stringent enforcement of existing quotas could materially and adversely affect our business by limiting our ability to exploit fully our motion pictures internationally.
Distribution rights to motion pictures are granted legal protection under the copyright laws of the U.S. and most foreign countries, which laws provide substantial civil and criminal sanctions for unauthorized duplication and exhibition of motion pictures. We seek to take appropriate and reasonable measures to secure, protect and maintain or obtain agreements to secure, protect and maintain copyright protection for all of our motion pictures or television programming under the laws of applicable jurisdictions. Motion picture piracy is an international as well as a domestic problem. Motion picture piracy is extensive in many parts of the world, including South America, Asia (including Korea, China and Taiwan), the countries of the former Soviet Union and other former Eastern bloc countries. In addition to the MPAA, the Motion Picture Association, the American Film Marketing Association and the American Film Export Association monitor the progress and efforts made by various countries to limit or prevent piracy. In the past, these various trade associations have enacted voluntary embargoes of motion picture exports to certain countries in order to pressure the governments of those countries to become more aggressive in preventing motion picture piracy. In addition, the U.S. government has publicly considered trade sanctions against specific countries which do not take steps to prevent copyright infringement of U.S. produced motion pictures. There can be no assurance that voluntary industry embargoes or U.S. government trade sanctions will be enacted. If enacted, such actions could impact the amount of revenue that we realize from the international exploitation of our motion pictures depending upon the countries subject to such action and the duration of such action. If not enacted or if other measures are not taken, the motion picture industry (including MGM) may continue to lose an indeterminate amount of revenues as a result of motion picture piracy.
Article 85(1) of the Treaty of Rome prohibits certain agreements and concerted practices which prevent, restrict or distort trade within the European Union. In 1989, after several years of proceedings before the European Commission, UIP received an exemption from Article 85(1) with respect to its theatrical distribution activities in the European Union. In connection with this exemption, UIP gave certain undertakings to the European Commission. The 1989 exemption expired in 1993, and UIP filed an application seeking renewal of such exemption. In July 1996, the European Commission conducted unannounced visits of four of UIP's offices in Europe, interviewing officers and copying documents. These visits were based on complaints submitted to the European Commission by third parties, to the effect that UIP was acting in an anti-competitive manner and was not complying with certain of the undertakings given by it in connection with receiving the 1989 exemption. In addition, in January 1998, the Competition Directorate of the Commission of the European Communities issued a Statement of Objections in response to UIP's renewal application. The Statement of Objections indicated that, although a final decision had not been taken, the Commission was of the opinion that the exemption granted to UIP in 1989 should not be extended and that UIP should be required to cease operations in the European Union. UIP responded to the Statement of Objections in May 1998 and a hearing was held before the European Commission in late September 1998. In July 1999, the European Commission published an official notice in the Official Journal of the European Communities stating its intention to take a favorable view of the UIP case, subject to certain amendments to the various UIP agreements and certain additional understandings. In September 1999, the European Commission renewed UIP's exemption. On October 31, 2000, we completed our withdrawal from UIP. See "--Distribution--Theatrical Distribution."
On February 2, 1999, the United States Department of Justice (Antitrust Division), in the course of an antitrust investigation, issued a civil investigative demand to us, requiring us to produce certain documents and answer certain interrogatories concerning conduct, activities or proposed action in the motion picture exhibition industry. We believe that similar demands were issued to other major studios. We have complied with the civil investigative demand. See "Item 3. Legal Proceedings."
On June 1, 1999, former President Clinton asked the Department of Justice and the Federal Trade Commission ("FTC") to study the extent to which the video game, music and movie industries market violent content to children and whether those industries are abiding by their own voluntary rating systems and regulations. On January 3, 2000, we, along with the other major studios, received a request for information from
the FTC in connection with the study. On or about September 11, 2000, the FTC issued a "Report on the Marketing of Violent Entertainment to Children" (the "FTC Report"). The FTC Report was critical of what it alleged to be the marketing and promotion of violent entertainment content to children and teenagers by the motion picture, music recording, and computer and video game industries. On September 27, 2000, all of the MPAA member companies, of which we are one, agreed voluntarily to a series of initiatives designed to avoid inappropriately specifically targeting children under 17 in the advertising and marketing of films rated R for violence. A substantial number of our films are rated R and it is not known whether or to what extent the initiatives could affect the performance of such films.
Also on September 27, 2000, representatives of the MPAA member companies, including the Vice Chairman and Chief Operating Officer of MGM, appeared before the Senate Commerce Committee, which is charged with oversight of the FTC, to discuss the FTC Report and the MPAA initiatives. The Commerce Committee has indicated that it intends to monitor compliance by the MPAA companies with the voluntary initiatives, and the Committee and certain of its members have followed up with several additional requests for information to which the member companies have responded. In January 2001, the Senate Commerce Committee formally asked the FTC to conduct two follow-up reports in the Spring and Fall of 2001. See "Item 3. Legal Proceedings."
The Code and Ratings Administration of the MPAA assigns ratings indicating age-group recommendations for theatrical distribution of motion pictures. We have followed and will continue to follow the practice of submitting our pictures for such ratings. As a substantial number of our films are rated "R," under rules which are the theatrical exhibitors' responsibility to enforce, children under 17 may attend the applicable motion picture only if accompanied by an adult.
United States television stations and networks as well as foreign governments impose content restrictions on motion pictures that may restrict in whole or in part exhibition on television or in a particular territory. There can be no assurance that such restrictions will not limit or alter our ability to exhibit certain motion pictures in such media or markets.
On December 8, 2000, the Federal Court of Canada in Ottawa, Ontario, issued an Order directed to eighteen distributors (purporting to include one of our subsidiaries) and twenty-three exhibitors, requesting them to produce certain information relating to theatrical distribution and exhibition. The Court issued the Order upon application of the Commissioner of Competition in connection with the Commissioner's civil investigation into allegations that certain exhibitors and distributors have entered into arrangements, or have conducted the distribution and exhibition of motion pictures in an anticompetitive manner. We have retained Canadian counsel. See "Item 3. Legal Proceedings."
Item 2.
Item 2. Properties
We lease approximately 368,000 square feet of office space, as well as related parking and storage facilities, for our corporate headquarters in Santa Monica, California under several leases which generally expire in May 2003. We also lease approximately 27,000 square feet in New York City for our East Coast publicity, marketing and theatrical and television distribution offices under a lease that expires in June 2004. Additionally, we lease approximately 42,000 square feet of office space in Los Angeles, California, which has been used by Orion, under a lease that expires in January 2004. The current monthly rent for the above properties is approximately $1.4 million in the aggregate (in addition to taxes, insurance and certain expenses paid by us). In November 2000, we entered into a definitive agreement to lease up to approximately 427,000 square feet of office space for a fifteen-year period beginning in May 2003 in a building to be constructed in Century City and to be known as MGM Tower. We sublease to third parties the office space used by Orion prior to its acquisition by us. In addition, we maintain small home entertainment and domestic theatrical and television distribution branches in various locations in the United States and Canada and have small international television distribution offices in London and Sydney. Our current monthly rent for the warehouse and storage facilities that house, among other things, our film and video inventory, records, furniture and artwork, is approximately $585,000. We also lease studio facilities and stages from unaffiliated parties on an as-needed basis in connection with the production of specific motion picture and television projects.
Item 3.
Item 3. Legal Proceedings
On November 17, 1997, MGM and Danjaq filed an action entitled Danjaq, LLC, et al. v. Sony Corporation, Kevin McClory, et al. in federal court in Los Angeles (Case No. 97-8414ER (Mcx)) relating to a press release issued by Sony Pictures announcing plans to produce a series of new James Bond feature films based on alleged rights that Sony had acquired from Kevin McClory. Mr. McClory had been a producer of Thunderball. On July 29, 1998, the court preliminarily enjoined Sony Pictures and the other defendants from the production, preparation, distribution, advertising or other exploitation in the United States of a James Bond motion picture in any medium and from using the "James Bond" and the "James Bond 007" trademarks in the United States. On March 29, 1999, MGM and Danjaq entered into a settlement agreement with Sony Pictures and related parties that provided for a payment by the Sony parties and an agreement by the Sony parties which effectively makes permanent the court's July 1998 preliminary injunction. Under the terms of a separate agreement entered into on March 29, 1999, MGM and Danjaq acquired from Columbia all of Columbia's rights to Casino Royale and the Sony parties agreed to broaden the contractual prohibition regarding making or distributing James Bond films and the James Bond trademarks, as described above, throughout the world. Mr. McClory did not participate in the settlement and retained a counterclaim against MGM and Danjaq for copyright infringement. The trial with Mr. McClory commenced on March 28, 2000. On that date, the judge bifurcated the case to hear MGM's and Danjaq's laches defense before commencing the jury trial on Mr. McClory's counterclaim. The judge issued his ruling on this defense on March 31, 2000, finding that Mr. McClory's claim was barred by laches as a matter of law, and dismissed the entire case with prejudice. On May 2, 2000, Mr. McClory appealed the court's decision. The parties have submitted briefs to the appellate court and await the outcome of the appeal.
The background of Mr. McClory's claims is as follows. Prior to 1959, Ian Fleming authored a number of novels depicting the adventures of James Bond, and commencing in 1959, Mr. Fleming and Kevin McClory collaborated on the development of certain plot lines and treatments and a script entitled Thunderball, featuring the James Bond character. Mr. Fleming thereafter wrote a novel of the same name. In 1961, Mr. McClory commenced litigation against Mr. Fleming with regard to the script, the novel and certain related rights. In 1962, prior to the settlement of the Fleming-McClory litigation, Mr. Fleming effectively granted to a predecessor-in-interest of Danjaq the exclusive worldwide rights to, among other things, make films based on Mr. Fleming's existing or future James Bond novels (other than Thunderball or Casino Royale) and to create original screenplays about the adventures of James Bond not based on Mr. Fleming's James Bond novels. This agreement further provides that the film rights to the Thunderball novel that were the subject of the Fleming-McClory litigation would also be transferred to Danjaq's predecessor to the extent Mr. Fleming was permitted to transfer such rights following completion of the litigation.
The Fleming-McClory litigation was resolved in 1963 by a settlement among Mr. Fleming, Mr. McClory and the other parties to the litigation in which Mr. McClory acknowledged that Mr. Fleming was the creator and proprietor of the James Bond character. Pursuant to that settlement, Mr. McClory was, in effect, given the film rights in the Thunderball documents and scripts attached to the settlement agreement, the rights to reproduce any part of Mr. Fleming's Thunderball novel in a film and to exhibit any such film in any manner whatsoever and the rights to use the James Bond character in the film Thunderball. We believe these rights, at most, gave Mr. McClory the right to make films of the story in the novel Thunderball (i.e. a "remake" of Thunderball). UA and Danjaq produced the film Thunderball with Kevin McClory in 1965. Mr. McClory has at various times since 1963 taken the position that he has broader rights to use the James Bond character than simply remake Thunderball, but since 1965 he has only made the 1983 film Never Say Never Again, which Mr. McClory claimed was a remake of the film Thunderball. MGM has since obtained the rights to Never Say Never Again.
We believe that another remake of Thunderball by Mr. McClory would not have a material adverse effect on our business or results of operations. However, a determination that Mr. McClory has broader rights to produce or exploit other films, television programs or other similar programs that are based, in whole or in part, on the James Bond character or that he has a right to any of the profits from the James Bond films that Danjaq and MGM have produced could have a material adverse effect on our business and results of operations.
On February 2, 1999, the United States Department of Justice (Antitrust Division), in the course of an antitrust investigation, issued a Civil Investigative Demand to us, requiring us to produce certain information concerning conduct, activities or proposed action in the motion picture exhibition industry. We believe that similar demands were issued to other major studios. We have complied with the civil investigative demand. See "Item 1. Regulation."
On June 1, 1999, former President Clinton asked the Department of Justice and the Federal Trade Commission to study the extent to which the video game, music and movie industries market violent content to children and whether those industries are abiding by their own voluntary rating systems and regulations. We, along with the other major studios voluntarily cooperated with the Federal Trade Commission's request for information in connection with the study. In September 2000, the FTC issued its report. In response we and the other major studios agreed to a 12-point initiative put forward by the MPAA, concerning the marketing of films rated "R" for violence. In September 2000, we and the other major studios sent representatives to testify before the Senate Commerce Committee, to explain our commitment to the new marketing initiatives, which we have been implementing and the Committee and certain of its members have followed up with several additional requests for information to which the member companies have responded. In January 2001, the Senate Commerce Committee formally asked the FTC to conduct two follow-up reports in the Spring and Fall of 2001. See "Item 1. Regulation."
On January 19, 2000, a complaint was filed naming Metro-Goldwyn-Mayer Home Entertainment Inc. as a defendant in a matter entitled Ronald Cleveland d/b/a Lone Star Videotronics, et al., v. Viacom Inc., et al. (Case No. 99CA0783-EP). The case was filed as a putative class action in the United States District Court for the Western District of Texas San Antonio Division. Viacom Inc., Paramount Home Video, Inc., Buena Vista Home Entertainment, Inc., Time Warner Entertainment Company, L.P. d/b/a Warner Home Video, Columbia Tri-Star Home Video, Inc., Universal Studios Home Video, Inc., and Twentieth Century Fox Home Entertainment, Inc. are also named as defendants in the action, which was originally filed against them on July 21, 1999. The plaintiffs claim that the defendant studios conspired with each other and with Blockbuster Inc. with respect to their home video rental distribution arrangements to discriminate illegally against independent video retailers in favor of Blockbuster, in violation of the Sherman Antitrust Act, the California Cartwright Act, the California Unfair Practices Act, and the California Unfair Competition Statute. We deny the material allegations of the complaint, and we will defend ourselves vigorously against plaintiffs' claims. The plaintiffs have not yet quantified their claim for damages, nor has a class been certified.
On January 26, 2000, American International Specialty Lines Insurance Company, or AISLIC, one of our insurers, filed an action entitled American International Specialty Lines Insurance Company v. Metro-Goldwyn-Mayer Inc., Danjaq, LLC et al. in Los Angeles Superior Court (Case No. BC 223707) seeking to rescind our primary errors and omissions policy for a recent three-year coverage period. AISLIC alternatively seeks a declaration that no coverage exists under the policy for certain claims tendered to AISLIC pursuant to the policy. AISLIC alleges that information pertinent to certain claims tendered by us to AISLIC was omitted from our application for insurance.
On April 10, 2000, MGM filed a cross-complaint against AISLIC, and its parent corporation, American International Group, Inc., for breach of the duty of good faith and fair dealing and breach of contract. AISLIC subsequently cross-complained for breach of contract and fraud. Danjaq also has filed a cross-complaint against AISLIC and AIG.
On July 14, 2000, another of MGM's insurers, Fireman's Fund, filed suit against AISLIC and AIG for equitable contribution, equitable indemnity and subrogation, and against MGM and Danjaq for reimbursement, allocation and declaratory relief, arising from the same circumstances as the AISLIC v. MGM suit. On September 27, 2000, the Court issued an order deeming Fireman's Fund Insurance Co. v. AIG, et al. (Case No. BC 233429) related to AISLIC v. MGM, with both matters to be handled by the same judge.
The cases were deemed "complex" litigation and referred to a new judge who held an initial status conference on January 16, 2001. The cases are still in the discovery phase. The parties are currently engaged in discovery and no trial date has been set.
On October 9, 2000, MGM Studios was served with the complaint in Citizens for Fair Treatment v. Time Warner Entertainment, et al. (Case No. 063137), an industry-wide action brought by a public interest organization, which claims that the seven major studios and New Line Cinema have violated California laws prohibiting deceptive, unfair and unlawful business practices by allegedly marketing "R" rated films to children under 17 years of age. The basis for the complaint is the findings of the Federal Trade Commission's September 2000 report concerning studio marketing practices. The complaint seeks restitution and disgorgement of all monies attributable to the alleged wrong-doing, as well as an injunction restraining and enjoining defendants from targeting and marketing R-rated films to children under 17. We deny the material allegations of the complaint, and we will defend ourselves vigorously against plaintiffs' claims.
Following our submission of a claim for coverage under the Contingent Extra Expense Insurance Policy issued in connection with the picture Red Corner, certain of the insurers disputed coverage and, on December 1, 2000, filed a lawsuit entitled HIH Casualty and General Insurance Ltd., et al., v. Metro- Goldwyn-Mayer Inc. and United Artists Corporation Limited in the Commercial Court in England, purporting to avoid the policy and/or seeking damages for alleged misrepresentations and/or non-disclosures. We have retained English counsel and will seek to enforce our rights pursuant to the policy.
On December 8, 2000, the Federal Court of Canada in Ottawa, Ontario, issued an Order directed to eighteen distributors (purporting to include one of our subsidiaries) and twenty-three exhibitors, requesting them to produce certain information relating to theatrical distribution and exhibition. The Court issued the Order upon application of the Commissioner of Competition in connection with the Commissioner's civil investigation into allegations that certain exhibitors and distributors have entered into arrangements, or have conducted the distribution and exhibition of motion pictures in an anticompetitive manner. We have retained Canadian counsel. See "Item 1. Regulation."
In addition, from time to time, we become involved in other litigation arising in the normal course of business, and we believe that none of such other litigation as is currently pending will have a material adverse effect on our financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Securityholders
None.
Executive Officers of the Company
Alex Yemenidjian, age 45, has been Chairman of the Board and Chief Executive Officer since April 1999 and has been a director since November 1997. Mr. Yemenidjian has served as a director of MGM Grand, Inc. (now known as "MGM MIRAGE") since 1989. Mr. Yemenidjian served as the President of MGM Grand, Inc. from July 1995 through December 1999. Mr. Yemenidjian has also served MGM Grand, Inc. in other capacities during such period, including as Chief Operating Officer from June 1995 until April 1999 and as Chief Financial Officer from May 1994 to January 1998. In addition, Mr. Yemenidjian served as an executive of Tracinda from January 1990 to January 1997 and from February 1999 to April 1999.
Christopher J. McGurk, age 44, has been Vice Chairman of the Board and Chief Operating Officer since April 1999. From November 1996 until joining MGM, Mr. McGurk served in executive capacities with Universal Pictures, a division of Universal Studios, most recently as President and Chief Operating Officer. Prior to joining Universal, Mr. McGurk spent eight years at The Walt Disney Company, including as President, Motion Pictures Group, Walt Disney Studios from 1994 to 1996 and as Executive Vice President and Chief Financial Officer from 1990 to 1994.
William A. Jones, age 59, has been Senior Executive Vice President and Secretary since June 1997 and, prior thereto, served as Executive Vice President--Corporate Affairs and Secretary since January 1995. Mr. Jones served as Executive Vice President, General Counsel and Secretary from May 1991 to January 1995 and as General Counsel and Secretary of our predecessors since 1983. Mr. Jones was a director of MGM-Pathe from June 1991 to January 1992.
Daniel J. Taylor, age 44, has been Senior Executive Vice President and Chief Financial Officer since June 1998 and, prior thereto, was Executive Vice President--Corporate Finance since August 1997. From May 1991 to July 1997, Mr. Taylor served as an executive of Tracinda. Prior thereto, Mr. Taylor served as Vice President--Taxes and in various other capacities at our predecessor from 1985 to May 1991.
Jay Rakow, age 48, has been Senior Executive Vice President and General Counsel since August 2000. From 1989 to l993 and from l996 to 2000, Mr. Rakow was a partner in the law firm of Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro. From 1993 to 1996, Mr. Rakow took a leave from the firm to become Senior Vice President and General Counsel of Paramount Pictures Corporation. Prior to 1989 Mr. Rakow was with the law firm of Wyman, Bautzer, Christensen, Kuchel & Silbert.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is listed with, and trades on, the New York Stock Exchange under the symbol "MGM." On February 12, 2001, the closing sale price per share of our common stock on the NYSE, as reported by the Dow Jones News Retrieval, was $20.52. The following table sets forth the high and low closing sale prices of the common stock on the NYSE, as reported by the Dow Jones News Retrieval, for our two most recent fiscal years.
As of February 12, 2001, there were 218,137,488 shares issued and outstanding and in excess of 2,000 beneficial holders of our common stock, including individual participants in security position listings.
We have not paid any dividends to date on the common stock and currently intend to retain any earnings to provide funds for the operation and expansion of our business and for the servicing and repayment of indebtedness. Therefore, we do not intend to pay cash dividends on our common stock for the foreseeable future. Furthermore, as a holding company with no independent operations, our ability to pay cash dividends will be dependent upon the receipt of dividends or other payments from our subsidiaries. In addition, our principal credit facility contains certain covenants which, among other things, restrict the payment of dividends by us. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Any determination to pay cash dividends on the common stock in the future will be at the sole discretion of MGM's Board of Directors.
Item 6.
Item 6. Selected Consolidated Financial Data
Our selected consolidated financial data presented below have been derived from our audited consolidated financial statements. Our audited consolidated financial statements for the years ended December 31, 1997, 1998, 1999 and 2000, and the period from October 11 to December 31, 1996, and the audited consolidated financial statements of MGM Studios (predecessor) for the period from January 1 to October 10, 1996 were audited by Arthur Andersen LLP, independent public accountants.
- -------- (1) Reflects the consolidated balance sheet and results of operations of the combined entity resulting from our acquisition of MGM Studios.
(2) Reflects the consolidated balance sheet and results of operations of the combined entity resulting from the acquisition of Orion.
(3) Reflects the effect of the $225.0 million contract termination settlement with Warner Home Video and $214.6 million of restructuring and other charges for the year ended December 31, 1999.
(4) The proceeds from the sale of MGM Studios were insufficient to recover the net asset value of MGM Studios on the date of the disposition by Consortium de Realisation. Accordingly, MGM Studios recorded a provision for impairment of intangible assets of $563.8 million.
(5) "EBITDA" is defined as earnings before interest, taxes, depreciation and non-film amortization. While management considers EBITDA to be an important measure of comparative operating performance, it should not be construed as an alternative to operating income or cash flows from operating activities (as determined in accordance with generally accepted accounting principles); EBITDA does not reflect cash necessary or available to fund cash requirements, and the items excluded from EBITDA, such as depreciation and non-film amortization, are significant components in assessing our financial performance. Other significant uses of cash flows are required before cash will be available to us, including debt service, taxes and cash expenditures for various long-term assets. Our calculation of EBITDA may be different from the calculation used by other companies and, therefore, comparability may be limited. See "Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with "Item 6. Selected Consolidated Financial Data" and our consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10-K.
General
We are engaged primarily in the development, production and worldwide distribution of theatrical motion pictures and television programming. See "Item 1. Business."
Sources of Revenue
The principal sources of motion picture industry revenue are the domestic and international distribution of motion pictures, including theatrical exhibition, home video and television (network, syndication, basic cable, pay and pay-per-view). Over the last decade, the relative contributions of these components of revenues have changed dramatically. Although revenues from domestic theatrical distribution have increased, growth in total motion picture industry revenues has resulted predominantly from increased revenues derived from the distribution of motion pictures internationally as well as from other media and distribution channels.
Our feature films are exploited through a series of sequential domestic and international distribution channels, typically beginning with theatrical exhibition. Thereafter, feature films are first made available for home video generally six months after theatrical release; for pay television, one year after theatrical release; and for syndication, approximately three to five years after theatrical release. Our television programming is produced for initial broadcast on either pay, syndicated or network television in the United States, followed by international territories and, in some cases, worldwide video markets.
We distribute our motion picture and television productions in foreign countries and, in recent years, have derived approximately 40 percent of our revenues from foreign sources. Approximately 25 percent of our revenues are denominated in foreign currencies. In addition, we incur certain operating and production costs in foreign currencies. As a result, fluctuations in foreign currency exchange rates can adversely affect our business, results of operations and cash flows. We, in certain instances, enter into foreign currency exchange contracts in order to reduce exposure to changes in foreign currency exchange rates that affect the value of our firm commitments and certain anticipated foreign currency cash flows. These contracts generally mature within one year. We do not enter into foreign currency contracts for speculative purposes. Realized gains and losses on contracts that hedge anticipated future cash flows were not material in any of the periods presented herein. We had no significant foreign currency exchange contracts outstanding at December 31, 2000. See "Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We have only limited involvement in derivative financial instruments and do not use them for trading purposes. Certain amounts borrowed under our credit facility are at variable interest rates and we are thus subject to market risk resulting from interest rate fluctuations. We enter into interest rate swaps in part to alter interest rate exposures. Interest rate swaps allow us to raise long-term borrowings at floating rates and effectively swap them into fixed rates that are lower than those available to us if fixed-rate borrowings were made directly. Under interest rate swaps, we agree with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate amounts calculated by reference to an agreed notional principal amount.
The following table provides information about our interest rate swaps outstanding at December 31, 2000:
We have also entered into additional forward interest rate swap contracts commencing in 2001 for a notional value of $325.0 million at an average pay rate of approximately 6.208 percent, which expire in July 2003. At December 31, 2000, these forward contracts had an estimated fair value of $(2.7) million.
Because approximately 25 percent of our revenues are denominated, and we incur certain operating and production costs in foreign currencies, we are subject to market risks resulting from fluctuations in foreign currency exchange rates. In certain instances, we enter into foreign currency exchange contracts in order to reduce exposure to changes in foreign currency exchange rates that affect the value of our firm commitments and certain anticipated foreign currency cash flows. We currently intend to continue to enter into such contracts to hedge against future material foreign currency exchange rate risks. We had no foreign currency exchange contracts outstanding at December 31, 2000.
Item 8.
Item 8. Financial Statements and Supplementary Data
The Report of Independent Public Accountants, our Consolidated Financial Statements and Notes thereto appear in a separate section of this Form 10-K (beginning on page 51 following Part IV). The index to our Consolidated Financial Statements is included in Item 14.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
PART III
Item 10.
Item 10. Directors and Executive Officers of Registrant
The information required by Item 10 is set forth in the Proxy Statement under the caption "Election of Directors" and incorporated herein by reference except that the information regarding our executive officers is included in Part I under the heading "Executive Officers of the Company."
Item 11.
Item 11. Executive Compensation
The information required by Item 11 is set forth in the Proxy Statement under the caption "Executive Compensation" and is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is set forth in the Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management" and is incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is set forth in the Proxy Statement under the caption "Certain Relationships and Related Transactions" and is incorporated herein by this reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this report:
1. Consolidated Financial Statements
The financial statements listed in the accompanying Index to Financial Statements are filed as part of this Form 10-K at pages 51 to 76.
2. Financial Statement Schedules
The financial statement schedules listed in the accompanying Index to Financial Statements are filed as part of this Form 10-K at pages 77 to 83.
3. Exhibits
The exhibits listed in the accompanying Exhibit Index on pages 84 to 86 are filed as part of this Form 10-K.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended December 31, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
February 12, 2001
METRO-GOLDWYN-MAYER INC.
/s/ Alex Yemenidjian By: _________________________________ Alex Yemenidjian Chairman of the Board of Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Metro-Goldwyn-Mayer Inc.:
We have audited the accompanying consolidated balance sheets of Metro-Goldwyn- Mayer Inc. (a Delaware corporation) and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations and comprehensive income (loss), stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Metro- Goldwyn-Mayer Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States.
Arthur Andersen LLP
Los Angeles, California February 8, 2001
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
METRO-GOLDWYN-MAYER INC.
CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
METRO-GOLDWYN-MAYER INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (in thousands, except share and per share data)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
METRO-GOLDWYN-MAYER INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share data)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
METRO-GOLDWYN-MAYER INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000
Note 1--Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation. The accompanying consolidated financial statements include the accounts of Metro-Goldwyn-Mayer Inc. ("MGM"), Metro-Goldwyn-Mayer Studios Inc. and its majority owned subsidiaries ("MGM Studios") and Orion Pictures Corporation and its majority owned subsidiaries ("Orion") (collectively, the "Company"). MGM is a Delaware corporation formed on July 10, 1996 specifically to acquire MGM Studios, and is majority owned by an investor group comprised of Tracinda Corporation and a corporation that is principally owned by Tracinda (collectively, "Tracinda") and certain current and former executive officers of the Company. The acquisition of MGM Studios by MGM was completed on October 10, 1996, at which time MGM commenced principal operations. The acquisition of Orion was completed on July 10, 1997. The Company completed the acquisition of certain film libraries and film related rights that were previously owned by PolyGram N.V. and its subsidiaries ("PolyGram") on January 7, 1999.
As permitted by Statement of Financial Accounting Standards ("SFAS") No. 53, "Financial Reporting by Producers and Distributors of Motion Pictures," the Company has presented an unclassified consolidated balance sheet. Certain reclassifications have been made to amounts reported in prior periods to conform with current presentation.
Business. The Company is engaged primarily in the development, production and worldwide distribution of theatrical motion pictures and television programs. The Company also distributes films produced or financed, in whole or in part, by third parties. The Company's business units have been aggregated into three reportable operating segments: feature films, television programming and other operating activities (see Note 12). Operating units included in the other operating segment include licensing and merchandising, interactive media and music, as well as the Company's equity investments.
Motion picture and television production and distribution is highly speculative and inherently risky. There can be no assurance of the economic success of such motion pictures and television programming since the revenues derived from the production and distribution (which do not necessarily bear a direct correlation to the production or distribution costs incurred) depend primarily upon their acceptance by the public, which cannot be predicted. The commercial success of a motion picture also depends upon the quality and acceptance of other competing films released into the marketplace at or near the same time, the availability of alternative forms of entertainment and leisure time activities, general economic conditions and other tangible and intangible factors, all of which can change and cannot be predicted with certainty. The theatrical success of a motion picture is a very important factor in generating revenues from such motion picture in other media.
The success of the Company's television programming also may be impacted by, among other factors, prevailing advertising rates, which are subject to fluctuation. Therefore, there is a substantial risk that some or all of the Company's motion picture and television projects will not be commercially successful, resulting in costs not being recouped or anticipated profits not being realized.
Principles of Consolidation. The consolidated financial statements include the accounts of MGM, MGM Studios, Orion and all of their majority-owned and controlled subsidiaries. The Company's investments in related companies which represent a 20% to 50% ownership interest over which the Company has significant influence but not control are accounted for using the equity method (see Note 5). All significant intercompany balances and transactions have been eliminated.
Cash and Cash Equivalents. The Company considers all highly liquid debt instruments, purchased with an initial maturity of three months or less, to be cash equivalents. Included in other assets at December 31, 2000
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and 1999 is approximately $7,680,000 and $2,143,000, respectively, of cash restricted by various escrow agreements. The carrying value of the Company's cash equivalents approximated cost at each balance sheet date.
Marketable Securities. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders' equity. The Company has no investments in marketable securities as of December 31, 2000.
Revenue Recognition. Revenues from theatrical distribution of feature films are recognized on the dates of exhibition. Revenues from direct home video distribution are recognized, net of an allowance for estimated returns, together with related costs, in the period in which the product is available for sale by the Company's customers. Under revenue sharing arrangements, the Company also participates in consumer rental revenues generated in the home video market by rental establishments and records revenue as earned. Revenues from television licensing, together with related costs, are recognized when the feature film or television program is available to the licensee for telecast. Long-term non-interest-bearing receivables arising from licensing agreements are discounted to present value.
Accounting for Film and Television Costs. Except for purchase accounting adjustments, film costs include the costs of production, prints, pre-release and other advertising expected to benefit future periods and capitalized overhead and interest. These costs, as well as participations and talent residuals, are charged against earnings on an individual film basis in the ratio that the current year's gross film revenues bear to management's estimate of total remaining ultimate gross film revenues as of the beginning of the current year from all sources. The cost allocated to films revalued in purchase accounting (including the MGM, Orion and PolyGram film libraries) is being amortized over their estimated economic lives not to exceed 20 years.
Film costs are stated at the lower of unamortized cost or estimated net realizable value on an individual film basis. Revenue and cost forecasts are continually reviewed by management and revised when warranted by changing conditions. When estimates of total revenues and costs indicate that a feature film or television program will result in an ultimate loss, additional amortization is recognized to the extent required to produce a zero gross margin over the remaining life of the film or television program.
Property and Equipment. Except for purchase accounting adjustments, property and equipment are stated at cost. Property and equipment acquired as part of the acquisitions of MGM Studios and Orion are stated at estimated fair market value at the date of acquisition. Depreciation of property and equipment is computed under the straight-line method over the expected useful lives of applicable assets, ranging from three to five years. Leasehold improvements are amortized under the straight-line method over the shorter of the estimated useful lives of the assets or the terms of the related leases. When property is sold or otherwise disposed of, the cost and related accumulated depreciation is removed from the accounts, and any resulting gain or loss is included in income. The costs of normal maintenance, repairs and minor replacements are charged to expense when incurred.
Goodwill. The excess cost of acquisition over the fair market values of identifiable net assets acquired (goodwill) is amortized over an estimated useful life of 40 years using the straight-line method. The Company has adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and certain identifiable intangibles to be disposed of. The carrying value of existing assets is reviewed when events or changes in circumstances indicate that an impairment test is necessary in order to determine if an impairment has occurred. When factors indicate that such assets should be evaluated for possible impairment, the Company estimates the future cash flows expected to result from the use of the assets and their eventual disposition, and compares the amounts to the carrying value of the assets to determine if an impairment loss has occurred. Accumulated amortization of goodwill was $56,303,000 and $41,569,000 as of December 31, 2000 and 1999, respectively.
Income Taxes. In accordance with SFAS No. 109, "Accounting for Income Taxes," deferred tax assets and liabilities are recognized with respect to the tax consequences attributable to differences between the financial statement carrying values and tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. Further, the effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period that includes the enactment date.
Foreign Currency Translation. Foreign subsidiary assets and liabilities are translated into United States dollars at the exchange rates in effect at the balance sheet date. Revenues and expenses of foreign subsidiaries are translated into United States dollars at the average exchange rates that prevailed during the period. The gains or losses that result from this process are included as a component of the accumulated other comprehensive income balance in stockholders' equity. Foreign currency denominated transactions are recorded at the exchange rate in effect at the time of occurrence, and the gains or losses resulting from subsequent translation at current exchange rates are included in the accompanying statements of operations.
Financial Instruments. The carrying values of short-term trade receivables and payables approximate their estimated fair values because of the short maturity of these instruments. The carrying values of receivables with maturities greater than one year have been discounted at LIBOR plus 2.50 percent (approximately 9.06 percent and 8.63 percent at December 31, 2000 and 1999, respectively), which approximates the Company's current effective borrowing rates.
The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. They are used to manage well-defined interest rate risks. The Company enters into interest rate swaps to lower funding costs, to diversify sources of funding, or to alter interest rate exposures arising from mismatches between assets and liabilities. Interest rate swaps allow the Company to raise long-term borrowings at floating rates and effectively swap them into fixed rates that are lower than those available to the Company if fixed-rate borrowings were made directly. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed notional principal amount. See "New Accounting Pronouncements."
Accounts and Contracts Receivable. At December 31, 2000, accounts and contracts receivable aggregated $439,031,000 (before allowance for doubtful accounts), of which approximately $246,240,000 is due within one year. Concentration of credit and geographic risk with respect to accounts receivable is limited due to the large number and general dispersion of accounts which constitute the Company's customer base. The Company performs credit evaluations of its customers and in some instances requires collateral. At December 31, 2000, there were no significant customers accounting for greater than ten percent of the Company's accounts and contracts receivable. At December 31, 1999, approximately 17 percent of the Company's accounts and contracts receivable arose from an exclusive home video servicing agreement with Warner Home Video (see Note 3).
Earnings Per Share. The Company computes earnings per share in accordance with SFAS No. 128, "Earnings Per Share" ("EPS"). The weighted average number of shares used in computing basic earnings or
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
loss per share was 204,797,589, 158,015,955 and 75,816,326 in the years ended December 31, 2000, 1999 and 1998, respectively. Dilutive securities of 5,515,685 related to stock options have been included in the calculation of diluted EPS for the year ended December 31, 2000. Dilutive securities of 2,220,972 and 1,642,556 are not included in the calculation of diluted EPS for the years ending December 31, 1999 and 1998, respectively, because they are antidilutive.
Comprehensive Income. The Company computes comprehensive income pursuant to SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for the reporting and display of comprehensive income and its components in financial statements and thereby reports a measure of all changes in equity of an enterprise that result from transactions and other economic events other than transactions with owners.
Use of Estimates in the Preparation of Financial Statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Management estimates ultimate revenues and costs for feature films and television programs for each market based on anticipated release patterns, public acceptance and historical results for similar products. Actual results could differ from those estimates.
New Accounting Pronouncements. Effective January 1, 2000, the Company adopted the Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." The SAB provides guidance on the recognition, presentation and disclosure of revenue in financial statements, including certain criteria for gross versus net recording of sales transactions. The adoption of SAB No. 101 did not materially impact the Company's results of operations.
The Company adopted the Emerging Issues Task Force ("EITF") Issue No. 00-02, "Accounting For Web Site Development Costs" in 2000. The EITF provides guidance on accounting for costs incurred to develop a web site. The adoption of the EITF did not have a material impact on the Company's financial statements.
In June 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 139, which, effective for financial statements for fiscal years beginning after December 15, 2000, rescinds FASB No. 53. The companies that were previously subject to the requirements of SFAS No. 53 shall now follow the guidance in American Institute of Certified Public Accountants Statement of Position ("SOP") 00-2, "Accounting by Producers or Distributors of Films," issued in June 2000. SOP 00-2 establishes new accounting and reporting standards for all producers and distributors that own or hold the rights to distribute or exploit films. SOP 00-2 provides that the cumulative effect of changes in accounting principles caused by its adoption should be included in the determination of net income in conformity with Accounting Principles Board Opinion No. 20, "Accounting Changes." The Company adopted SOP 00-2 beginning January 1, 2001 and will reflect the results of this change in the 2001 first quarter results. Based on the Company's estimates at this time, the effect of adopting SOP 00-2 as of January 1, 2001 will result in a one-time, non-cash cumulative effect charge to earnings of approximately $375,000,000 to $400,000,000, primarily to reduce the carrying value of its film inventory. The new rules also require that advertising costs be expensed as incurred as opposed to the old rules which allowed advertising costs to be capitalized as part of film costs and amortized using the film forecast model. Due to the significant advertising costs incurred in the early stages of a film's release, the Company anticipates that the new rules will significantly impact its results of operations for the foreseeable future.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, "Deferral of the Effective Date of FASB No. 133, Accounting for Derivative Instruments and Hedging Activities," and by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities--an Amendment of FASB No. 133," which is effective for all quarters of fiscal years beginning after June 15, 2000. This statement establishes accounting and reporting
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company intends to adopt SFAS No. 133 beginning January 1, 2001. The Company does not expect the adoption of SFAS No. 133 to materially impact its results of operations.
Note 2--Acquisitions, Restructuring and Other Charges
PFE Library Acquisition. On January 7, 1999, the Company acquired certain film libraries and film related rights (the "PFE Libraries") containing over 1,300 feature films that were previously owned by PolyGram for $235,000,000 (the "PFE Library Acquisition"), plus acquisition related costs of $1,201,000. The Company funded the PFE Library Acquisition through an advance on the Revolving Facility (as defined in Note 7) and utilization of cash on hand.
Restructuring and Other Charges. In association with a restructuring program implemented by the Company in September 1998, the Company recorded a charge against earnings of $13,182,000 representing severance and other costs, of which $13,091,000 has been paid through December 31, 2000. This charge included the termination of 114 employees across all divisions of the Company.
In June 1999, the Company incurred certain restructuring and other charges, in association with a change in senior management and a corresponding review of the Company's operations, aggregating $214,559,000 million, including (i) a $129,388,000 million reserve for pre-release film cost write-downs and certain other charges regarding a re-evaluation of film properties in various stages of development and production, which has been included as a charge in film and television production and distribution expenses, and (ii) $85,171,000 million of severance and other related costs, of which $9,013,000 million has been classified in general and administrative expenses, as well as the estimated costs of withdrawing from the Company's arrangements with United International Pictures B.V. ("UIP") on November 1, 2000. The severance charge in 1999 included the termination of 46 employees, including the Company's former Chairman and Vice Chairman, across all divisions of the Company. As of December 31, 2000, the Company has utilized all $129,388,000 of the pre- release film cost write-down reserves and has paid $52,377,000 of the severance and related costs.
In June 2000, the Company reduced previously charged reserves by $5,000,000 due to a negotiated settlement with UIP regarding the Company's withdrawal from the joint venture. Additionally, in June 2000, the Company incurred severance and other related charges of $1,285,000 related to the closure of a foreign sales office.
Note 3--WHV Contract Settlement
On March 12, 1999, the Company agreed to accelerate the expiration of the right of Warner Home Video ("WHV") to distribute the Company's product in the home video marketplace under an agreement executed in 1990 (the "WHV Agreement"). In consideration for the early expiration of the WHV Agreement, the Company paid WHV $225,000,000 in 1999. The parties restructured the terms of the WHV Agreement, which functioned as an interim distribution agreement (the "Transitional Video Agreement"), under which WHV distributed certain of the Company's product in the home video marketplace. Additionally, the Company reconveyed to Turner Entertainment Co., Inc. ("Turner"), an affiliate of WHV, the right that the Company had to distribute in the home video markets worldwide until June 2001, 2,950 Turner titles that had been serviced under the WHV Agreement. The Transitional Video Agreement expired on January 31, 2000, at which time the Company commenced distribution of its home video product in the domestic market. The Company contracted with Twentieth Century Fox Home Entertainment, Inc. to distribute its home video product internationally beginning on February 1, 2000. The Company recorded a pre-tax contract termination charge for the year ended December 31, 1999 for $225,000,000 for costs in connection with the early expiration of WHV's rights under the WHV Agreement.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 4--Film and Television Costs
Film and television costs, net of amortization, are summarized as follows (in thousands):
Interest costs capitalized to theatrical productions were $15,453,000, $15,845,000 and $16,775,000 during the years ended December 31, 2000, 1999 and 1998, respectively.
Based on the Company's estimates of projected gross revenues as of December 31, 2000, approximately 70 percent of unamortized film costs applicable to released theatrical films and television programs, excluding acquired film libraries, will be amortized during the four years ending December 31, 2004. For acquired film libraries, approximately $1.2 billion of net film costs as of December 31, 2000 remain to be amortized under the income forecast method over an average remaining life of 16.4 years.
Note 5--Investments and Advances to Affiliates
Until November 1, 2000, distribution in foreign theatrical and certain pay television markets was performed by UIP, in which the Company had a one-third interest. The Company included in its financial statements the revenues and related costs associated with its films distributed by UIP. The distribution fees paid to UIP by the Company are included in film and television production and distribution expense. Due to timing differences there are no taxable earnings and, therefore, there is no tax provision on undistributed earnings. Due to the termination of the distribution arrangements with UIP on November 1, 2000, there were no profits in UIP realized in the year ended December 31, 2000. The Company's share of the net profits in UIP in the years ended December 31, 1999 and 1998 were $5,568,000 and $7,391,000, respectively.
On November 1, 2000, the Company contracted with Twentieth Century Fox Film Corporation ("Fox") for distribution of the Company's film releases in international theatrical and non-theatrical markets in territories in which the Company owns or controls the right to perform distribution services in such territories. Under the terms of the agreement, the Company pays Fox a distribution fee based on gross annual film rentals. The Company has the option to terminate the agreement on January 31, 2003 for a fee ranging from $10,000,000 to $15,000,000, which includes any distribution fees owed to Fox for the year prior to the termination date.
In May 1996, the Company entered into a joint venture agreement with Encore International, Inc., an indirect subsidiary of Telecommunications, Inc., to develop MGM Gold Networks (Asia) ("MGM Gold"), a satellite and cable delivery channel based in Asia whose operations were terminated in April 1998. In addition,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
in May 1998, the Company acquired a 50 percent interest in a Latin American cable programming joint venture, MGM Networks Latin America ("MGM Latin America"), for certain assets contributed by the Company to the joint venture. The Company shares equally in the profits of the venture and is obligated to fund 50 percent of the joint venture's expenses up to a maximum of approximately $24,000,000, of which the Company had funded approximately $21,000,000 as of December 31, 2000. The Company's share of MGM Gold's and MGM Latin America's start-up losses in the years ended December 31, 2000, 1999 and 1998 were $3,388,000, $6,952,000 and $9,296,000, respectively.
Additionally, the Company holds minority equity interests in various television channels located in certain international territories for which the Company realized its share of profits (losses) aggregating $5,341,000, $627,000 and $(3,240,000) in the years ended December 31, 2000, 1999 and 1998, respectively.
Investments are summarized as follows (in thousands):
Note 6--Property and Equipment
Property and equipment are summarized as follows (in thousands):
Note 7--Bank and Other Debt
Bank and other debt is summarized as follows (in thousands):
On October 15, 1997, the Company entered into an amended and restated credit facility with a syndicate of banks aggregating $1.3 billion (the "Amended Credit Facility") consisting of a six year $600,000,000 revolving credit facility (the "Revolving Facility"), a $400,000,000 seven and one-half year term loan ("Tranche A Loan") and a $300,000,000 eight and one-half year term loan ("Tranche B Loan") (collectively, the "Term Loans"). The Amended Credit Facility was subsequently amended and restated on July 21, 2000, with less restrictive operating and financial covenants. The Amended Credit Facility contains provisions allowing, with
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the consent of the requisite lenders and subject to syndication thereof, for an additional $200,000,000 tranche, raising the potential amount of Amended Credit Facility to $1.5 billion. The Revolving Facility and the Tranche A Loan bear interest at 2.25 percent over the adjusted LIBOR rate, as defined (8.81 percent at December 31, 2000). The Tranche B Loan bears interest at 2.50 percent over the Adjusted LIBOR rate (9.06 percent at December 31, 2000). Scheduled amortization of the Term Loans under the Amended Credit Facility commences with $33,000,000 in 2001, $73,000,000 in 2002, $103,000,000 in 2003, $103,000,000 in 2004 and $103,000,000 in 2005, with the remaining balance due at maturity. The Revolving Facility matures on September 30, 2003, subject to extension under certain conditions.
The Company has entered into three year fixed interest rate swap contracts in relation to a portion of the Amended Credit Facility for a notional value of $575,000,000 at an average rate of approximately 7.82 percent, which expire in various times no later than July 2003. The Company has also entered into additional forward interest rate swap contracts commencing in 2001 for a notional value of $325,000,000 at an average rate of approximately 8.71 percent, which expire in July 2003. At December 31, 2000, the Company would be entitled to receive approximately $469,000 if all such swap contracts were terminated.
The Company's borrowings under the Amended Credit Facility are secured by substantially all the assets of the Company. The Amended Credit Facility contains various covenants including limitations on dividends, capital expenditures and indebtedness, and the maintenance of certain financial ratios.
Lease and other borrowings. Capitalized lease and other borrowings relate principally to contractual liabilities and computer equipment financing at interest rates of ranging from approximately nine to ten percent.
Maturity schedule. Credit facilities, lease and other borrowings as of December 31, 2000 are scheduled to mature as follows (in thousands):
Note 8--Stockholders' Equity
Seven Sale. On September 1, 1998, Tracinda purchased from Seven Network Limited, a former stockholder ("Seven"), 16,208,463 shares of the Common Stock, representing all of the capital stock of the Company beneficially owned by Seven, for a price per share of $24 and an aggregate purchase price of $389,003,000 (the "Seven Sale"). With the consummation of the Seven Sale, Tracinda and 250 Rodeo, Inc., an affiliate of Tracinda ("250 Rodeo"), increased their beneficial ownership of the Company to approximately 89.5 percent.
1998 Rights Offering. On October 26, 1998, the Company issued to the holders of record of the Common Stock, at no charge to such holders, transferable subscription rights (the "Rights") to subscribe for 84,848,485 shares (the "Shares") of the Common Stock for $8.25 per share (the "1998 Subscription Price") (the "1998 Rights Offering"). Holders of the Common Stock received 1.289 Rights for each share of the Common Stock held as of October 26, 1998. Rights holders were allowed to purchase one share of the Common Stock at the 1998 Subscription Price for each whole Right held (the "Basic Subscription Privilege"). Rights
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
holders who exercised the Basic Subscription Privilege in full also had the opportunity to purchase additional shares at the 1998 Subscription Price pursuant to an Oversubscription Privilege, as defined. Pursuant to the 1998 Rights Offering, Tracinda and 250 Rodeo each committed to exercise the Basic Subscription Privilege with respect to all of the Subscription Rights distributed to it (subject to certain conditions). The Rights pursuant to the 1998 Rights Offering expired on November 16, 1998. The 1998 Rights Offering was fully subscribed (including shares issued pursuant to the Oversubscription Privilege), and the Company issued the Shares for total net proceeds of $696,500,000 (gross proceeds of $700,000,000 less applicable fees and expenses of approximately $3,500,000). The net proceeds from the 1998 Rights Offering were used to repay in full the amounts outstanding under a bridge loan, and then to repay borrowings outstanding under the Revolving Facility.
In connection with the 1998 Rights Offering, the Company also amended its Amended and Restated Certificate of Incorporation in order to increase the number of shares of the Common Stock authorized from 125,000,000 to 250,000,000 (the "Amendment"). The Amendment was approved by the Board of Directors of the Company and Tracinda (which represents a majority of the outstanding Common Stock) on October 22, 1998 and was effective prior to the closing of the 1998 Rights Offering.
1999 Rights Offering. On October 15, 1999, the Company issued to its stockholders of record of the common stock, at no charge to such holders, transferable subscription rights to subscribe for an aggregate of 49,714,554 shares of the common stock for $14.50 per share (the "1999 Subscription Price") (the "1999 Rights Offering"). Holders of the common stock received 0.328 Rights for each share of the common stock held as of October 15, 1999. Rights holders were allowed to purchase one share of the common stock at the 1999 Subscription Price for each whole Right held. Rights holders who exercised their Rights also had the opportunity to purchase additional Shares at the 1999 Subscription Price pursuant to an Oversubscription Privilege, as defined. The Rights pursuant to the 1999 Rights Offering expired on November 8, 1999. The 1999 Rights Offering was fully subscribed (including shares issued pursuant to the Oversubscription Privilege), and the Company issued the Shares for total net proceeds of $715,238,000 (gross proceeds of $720,861,000 less applicable fees and expenses of $5,623,000). The net proceeds from the 1999 Rights Offering were used to repay in full the amounts outstanding under a bridge loan and the Revolving Facility, with the balance retained as cash for general operating purposes.
Private Placements. On May 26, 2000, pursuant to a Form S-3 shelf registration statement (the "Shelf Registration Statement") filed with the Securities and Exchange Commission, the Company completed the sale of 4,890,000 shares of its common stock at $25 per share to various third party investors for aggregate net proceeds of $121,539,000. On August 15, 2000, the Company, pursuant to the Shelf Registration Statement, issued an additional 473,800 shares of its common stock at $25 per share to third party investors for aggregate net proceeds of $11,845,000.
1996 Incentive Plan. The Company has an Amended and Restated 1996 Stock Incentive Plan (the "1996 Incentive Plan"), which allows for the granting of stock awards aggregating not more than 30,000,000 shares. Awards under the 1996 Incentive Plan are generally not restricted to any specific form or structure and may include, without limitation, qualified or non-qualified stock options, incentive stock options, restricted stock awards and stock appreciation rights (collectively, "Awards"). Awards may be conditioned on continued employment, have various vesting schedules and accelerated vesting and exercisability provisions in the event of, among other things, a change in control of the Company. Outstanding stock options under the 1996 Incentive Plan generally vest over a period of five years and are not exercisable until vested.
In connection with the 1998 Rights Offering, the per share exercise price of the stock options granted to certain executive officers and other senior employees of the Company (the "Executive Repricing Participants") aggregating 3,164,604 options were reduced from between $20.00 and $24.00 to $14.90, and for approximately 400 other employees the exercise price of 2,027,900 stock options was reduced from $20.00 to $14.90, for 10,400 options from $22.00 to $14.90, for 103,800 options from $21.50 to $14.90 and for 19,800 options from $19.63 to $14.90 (collectively, the "Options Repricing").
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock option transactions under the 1996 Incentive Plan were as follows:
In 1999 Tracinda exercised 156,251 options, not included in the 1996 Incentive Plan, at an exercise price of $6.41 per share. Additionally, Celsus Financial Corporation, an entity wholly-owned by a Director of the Company, holds 177,814 options (as adjusted) at an exercise price of $5.63 per share (as adjusted). These options expire on October 10, 2002, and are fully vested and exercisable.
The following table summarizes information about the outstanding options as of December 31, 2000 under the 1996 Incentive Plan :
The Company applies Accounting Principles Board ("APB") Opinion No. 25, "Accounting For Stock Issued to Employees," and related interpretations in accounting for its plan. Had compensation cost for the plan been determined consistent with FASB Statement No. 123, the Company's net loss would have been the following pro forma amounts (in thousands, except per share data):
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of each option grant was estimated using the Black-Scholes model based on the following assumptions: the weighted average fair value of stock options granted in the year ended December 31, 2000, 1999 and 1998 was $12.54, $8.03 and $4.62, respectively. The dividend yield was 0 percent in all periods, and expected volatility was 56.3 percent, 59.5 percent and 40.5 percent for the years ended December 31, 2000, 1999 and 1998, respectively. Also, the calculation uses a weighted average expected life of 5.0 years in each year, and a weighted average assumed risk-free interest rate of 6.2 percent, 5.6 percent and 4.9 percent for the years ended December 31, 2000, 1999 and 1998, respectively.
Senior Management Bonus Plan and Other Options. The Company has a Senior Management Bonus Plan (the "Senior Management Bonus Plan") under which 2,420,685 bonus interests ("Bonus Interests") have been granted to certain senior employees. Subject to certain vesting and other requirements, each Bonus Interest held by the Executive Repricing Participants entitles the holder to receive a cash payment if (a) the sum of the average closing price of Common Stock during the 20 trading days plus, in certain circumstances, per share distributions on the Common Stock (together, the "Price") preceding a Determination Date, as defined, is greater than (b) $14.90 and less than $29.80 (adjusted for stock splits, reverse stock splits and similar events). With respect to Bonus Interests held by all others, each Bonus Interest entitles the holder to receive a cash payment if the Price preceding a Determination Date, as defined, is greater than $24.00 and less than $48.00 (adjusted for stock splits, reverse stock splits and similar events). The cash payment will be equal to (i) the vested portion of the Bonus Interest at the Determination Date multiplied by (ii) the amount by which the Price at the Determination Date is less than $29.80, with respect to Executive Repricing Participants, or $48.00 with respect to all others, multiplied by (iii) 1.61, with respect to the Executive Repricing Participants only (in each case, a maximum of $24.00 per Bonus Interest). Once a payment is made in respect of the vested portion of a Bonus Interest, no further payment is due in respect of that portion. If at any Determination Date the Price equals or exceeds $29.80, with respect to Executive Repricing Participants, or $48.00, with respect to all others, no payments will thereafter be due in respect of any then-vested portion of a Bonus Interest. Bonus Interests vested 20 percent at October 1, 1997 and 1/60 each month thereafter. At December 31, 2000, there were 2,293,634 Bonus Interests outstanding, of which 2,147,927 were vested.
Pursuant to an employment termination agreement, in August 1999 the Company repriced stock options of a former executive officer aggregating 1,745,680 shares. Such options were repriced to $14.90 and became fully vested and exercisable. These options are being accounted for as a variable option grant.
The Company has expensed $2,650,000 and $25,328,000 for obligations under these plans for the years ended December 31, 2000 and 1999, respectively, of which $25,328,000 is included in restructuring and other charges related to employees terminated in 1999. There were no charges related to these plans in the year ended December 31, 1998.
Employee Incentive Plan. In January 2000 the Company approved the adoption of an employee incentive plan (the "Employee Incentive Plan") for eligible employees (the "Participants"), subject to stockholder approval. In the case of certain named executive officers of the Company (the "Named Executive Officers"), bonus awards are determined solely by the Section 162(m) Subcommittee of the Compensation Committee of the Board of Directors (the "Subcommittee") as follows: (a) objective performance goals, bonus targets and performance measures are pre-established by the Subcommittee at a time when the actual performance relative to the goal remains substantially uncertain and may be based on such objective business criteria as the Subcommittee may determine, including film performance and EBITDA, among others; (b) the Subcommittee may exercise discretion to reduce an award to a Named Executive Officer by up to 25% so long as such reduction does not result in an increase in the amount of the bonus of any other Participant; and (c) prior to the payment of any bonus to any of the Named Executive Officers, the Subcommittee will certify to the Company's Board of Directors or the Executive Committee that the objective pre-established performance goals upon which such
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
bonus is based have been attained and that the amount of each bonus has been determined solely on the basis of the attainment of such goals (subject to the exercise of the negative discretion discussed above). The Company has expensed $14,000,000 for obligations under this plan for the year ended December 31, 2000.
Additionally, the Company issued a stock bonus to certain employees aggregating $2,154,000 and $1,235,000 in the years ended December 31, 2000 and 1999, respectively.
Note 9--Income Taxes
The Company's domestic and foreign tax liability balances consist of the following (in thousands):
The income tax effects of temporary differences between book value and tax basis of assets and liabilities are as follows (in thousands):
At December 31, 2000, the Company and its subsidiaries for U.S. federal income tax purposes had net operating loss carryforwards of $49,804,000, $163,568,000, $91,511,000 and $10,977,000, which expire in 2019, 2018, 2012 and 2011, respectively. Under U.S. tax rules enacted in 1997, net operating losses generated in tax years beginning before August 6, 1997 may be carried forward for 15 years while losses generated in subsequent tax years may be carried forward 20 years. Presently, there are no limitations on the use of these carryforwards.
At December 31, 2000, the Company has determined that $396,000 of deferred tax assets do not satisfy the recognition criteria set forth in SFAS No. 109. Accordingly, a valuation allowance has been recorded by the Company for this amount.
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Details of the provision for income taxes are as follows (in thousands):
The following is a summary reconciliation of the federal tax rate to the effective tax rate:
The Company has various foreign subsidiaries formed or acquired to produce or distribute motion pictures outside the United States. In the opinion of the Company, the earnings of these subsidiaries are not permanently invested outside the United States. Pursuant to APB No. 23, "Accounting For Income Taxes--Special Areas," tax expense has accordingly been provided for these unremitted earnings.
Note 10--Retirement Plans
The Company has a non-contributory retirement plan (the "Basic Plan") covering substantially all regular full-time, non-union employees. Benefits are based on years of service and compensation, as defined. The Company's disclosures are in accordance with SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revised employers' disclosures about pension and post-retirement benefit plans.
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of December 31, 2000, the Company has amended the Basic Plan to cease benefit accruals. This amendment resulted in a curtailment, the effect of which has been presented in the following tables. Reconciliation of the funded status of the plans and the amounts included in the Company's consolidated balance sheets are as follows (in thousands):
The unrecognized net asset is being amortized over the estimated remaining service life of 19.4 years. Domestic pension benefits and expense were determined under the entry age actuarial cost method.
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pension cost includes the following components (in thousands):
A significant number of the Company's production employees are covered by union sponsored, collectively bargained multi-employer pension plans. The Company contributed approximately $11,577,000, $6,884,000 and $8,890,000, respectively, for such plans for the years ended December 31, 2000, 1999 and 1998. Information from the plans' administrators is not sufficient to permit the Company to determine its share of unfunded vested benefits, if any.
The Company also provides each of its employees, including its officers, who have completed one year of service with the Company the opportunity to participate in the MGM Savings Plan (the "Savings Plan"). The Company contributed approximately $1,285,000, $1,350,000 and $1,435,000, respectively, to the Savings Plan in the years ended December 31, 2000, 1999 and 1998.
Note 11--Related Party Transactions
In February 1980, a predecessor-in-interest to the Company granted to a predecessor-in-interest to MGM Grand, Inc. an exclusive open-ended royalty- free license, which was amended in 1992 and further amended in 1998. Pursuant to the license, as amended, MGM Grand Inc. (now known as "MGM MIRAGE") has the right to use certain trademarks that include the letters "MGM," as well as logos and names consisting of or related to stylized depictions of a lion, in its resort hotel and/or gaming businesses and other businesses that are not related to filmed entertainment. In 1986 MGM granted MGM Grand Air, Inc. ("Grand Air") an exclusive open-ended royalty-free license to use one of its logos consisting of a stylized depiction of a lion in Grand Air's airline business. The Company did not receive any monetary compensation for these licenses. In June 2000, in consideration of the payment to the Company of an annual royalty of $1,000,000, such license was further amended to permit MGM Grand, Inc. to use the letters "MGM" combined with the name "Mirage" in the same manner and to the same extent that it was permitted theretofore to use the name "MGM Grand." Tracinda owns a majority of the outstanding common stock of MGM MIRAGE, the parent of both MGM Grand Hotel, Inc. ("Grand Hotel") and Grand Air. Additionally, the Company and affiliates of Tracinda occasionally conduct cross-promotional campaigns, in which the Company's motion pictures and the affiliates' hotels are promoted together; however, the Company believes that the amounts involved are immaterial.
The Company and Grand Hotel have an ongoing relationship whereby Grand Hotel can utilize key art, still photographs of artwork and one minute film clips from certain of the Company's motion picture releases on an as-needed basis. The Company did not receive any monetary compensation for the use of these assets.
The Company periodically sells to Grand Hotel and certain of its affiliates, on a wholesale basis, videocassettes and other merchandise such as baseball caps, clothing, keychains and watches bearing the Company's trademarks and logos for resale to consumers in retail shops located within Grand Hotel's hotels. During the years ended December 31, 2000, 1999 and 1998, the Company recognized revenues of $6,000, $17,000 and $24,000, respectively, for such videocassettes and merchandise.
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
From time to time, the Company charters airplanes from Tracinda for use in the Company's business. The Company believes that the terms of the charter arrangements are no less favorable to the Company than those that could be obtained from unrelated third parties. During the years ended December 31, 2000, 1999 and 1998, the aggregate of the payments made to Tracinda for such charters were approximately $98,000, $149,000 and $3,000, respectively.
In 1995, the Company licensed to a subsidiary of Seven, a former beneficial owner of more than 5 percent of the Company's Common Stock, the right to distribute certain motion picture and television product in the Australian free television market. This agreement was amended on September 9, 1997. The product licensed includes certain library pictures and theatrical motion pictures and television series, miniseries and made-for-television movies produced or distributed by the Company during the term of the agreement. The license fees for the library product are at a rate which the Company believes is arm's-length. The term of the output portion of the agreement is 15 years. The license fees for output product television series, television movies and television mini-series are on a "most favored nations" basis with prices paid by the Seven subsidiary for comparable programming. During the years ended December 31, 2000, 1999 and 1998, the Company recognized revenues of $5,298,000, $5,475,000 and $5,651,000, respectively, under this agreement. Management believes that the terms of this agreement are consistent with the terms of comparable television license arrangements with third parties.
In 1994, in connection with the formation of Movie Network Channels, a joint venture in which the Company has a non-controlling interest and a subsidiary of Seven had a non-controlling interest until April 1999, the Company licensed to the joint venture certain of its current theatrical and television motion pictures, as well as a number of its library pictures, for distribution on Australian pay television. The agreement expires on June 30, 2005, with all motion pictures covered by the agreement reverting to the Company within one year after that date, but both the Company and Movie Network Channels have the right to extend the license for a further four years. The Company receives a license fee for each picture that is based on the number of Movie Network Channel's subscribers. The Company recognized such license fee revenues of $3,273,000, $3,261,000 and $3,678,000 during the years ended December 31, 2000, 1999 and 1998, respectively. The Company believes that the terms of the agreement are no less favorable to the Company than those contained in its licenses with unaffiliated licensees.
Seven has agreed to reimburse the Company for losses that the Company may incur in connection with the distribution of an Australian film with respect to which the Company has acquired distribution rights from an unrelated third party.
The Company has equity interests ranging from five percent to 50 percent in certain television channels located in various international territories, in which the Company licenses certain library pictures and theatrical motion pictures and television series, miniseries and made-for-television movies produced or distributed by the Company during the terms of the agreements. The Company recognized aggregate license fees under these agreements of $23,861,000, $12,072,000 and $8,824,000 during the years ended December 31, 2000, 1999 and 1998, respectively.
The Company had an exclusive producer overhead arrangement with FGM Entertainment for the services of Frank Mancuso, Jr., the son of the Company's former Chairman of the Board and Chief Executive Officer, which was terminated on August 2, 1999. FGM Entertainment, a company wholly owned by Mr. Mancuso, Jr., received $400,000 each year, subject to five to ten percent annual increases, for overhead expenses, as well as a development fund and a production fund to pay for the costs of developing and producing projects. Pursuant to this arrangement, the Company paid Mr. Mancuso, Jr. approximately $1,043,000 and $2,429,000 during the years ended December 31, 1999 and 1998, respectively. Pursuant to the termination agreement, the Company's obligation to fund overhead ceased, Mr. Mancuso Jr. acquired a feature film produced by the Company for $3,000,000, and Mr. Mancuso Jr. obtained the right to acquire certain projects developed by him pursuant to a turnaround arrangement.
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In December 1999, the Company agreed to provide a production company owned by Mr. Coppola, a director of the Company and a member of the Company's Executive Committee, certain office space and office furnishings/equipment at no charge for a two-year period, as consideration for creative services provided by Mr. Coppola in connection with certain of the Company's film product.
In March 2000, the Company entered into an agreement in principle with a subsidiary of American Zoetrope ("Zoetrope"), a production company owned by Mr. Coppola, for the financing and distribution in the United States and Canada of lower budget theatrical motion pictures to be produced by Zoetrope over a three-year period. Under the agreement, the Company has an exclusive "first look" on projects developed by Zoetrope with a budget (or anticipated budget) of less than $12,000,000 and, subject to certain conditions being met, the Company will acquire distribution rights in the United States and Canada as well as certain other ancillary rights on up to ten qualifying pictures produced by Zoetrope in exchange for an amount equal to no more than $2,500,000 per picture. In addition, the Company has agreed to spend a minimum of between approximately $1,000,000 to $2,250,000 per qualifying picture in marketing and release costs.
Note 12--Segment Information
The Company applies the disclosure provisions of SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." The Company's business units have been aggregated into three reportable operating segments: feature films, television programming and other (see Note 1). The factors for determining the reportable segments were based on the distinct nature of their operations. They are managed as separate business units because each requires and is responsible for executing a unique business strategy. Income or losses of industry segments and geographic areas exclude interest income, interest expense, goodwill amortization, income taxes and other unallocated corporate expenses. Identifiable assets are those assets used in the operations of the segments. Corporate assets consist of cash, certain corporate receivables and intangibles. Summarized financial information concerning the Company's reportable segments is shown in the following tables (in thousands):
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents the details of other operating segment income (loss):
The following is a reconciliation of reportable segment income (loss) to income (loss) from operations before provision for income taxes:
The following is a reconciliation of reportable segment assets to consolidated total assets:
The Company's foreign activities are principally motion picture and television production and distribution in territories outside of the United States and Canada. Net foreign assets of subsidiaries operating in foreign countries are not material in relation to consolidated net assets. Revenues earned from motion picture and television films produced in the United States by territory were as follows:
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 13--Commitments and Contingencies
Leases. The Company has operating leases for offices and equipment. Certain property leases include provisions for increases over base year rents as well as for escalation clauses for maintenance and other building operations. Rent expense was approximately $17,264,000, $16,528,000 and $15,011,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
Employment Agreements. The Company has employment agreements with various principal officers and employees. The agreements provide for minimum salary levels as well as, in some cases, bonuses.
Creative Talent Agreements. The Company has entered into contractual agreements for creative talent related to future film production. Such amounts are scheduled to be paid through 2002.
Future minimum annual commitments under non-cancelable operating leases, employment agreements, and creative talent agreements as of December 31, 2000 are as follows (in thousands):
Litigation. The Company, together with other major companies in the filmed entertainment industry, has been subject to numerous antitrust suits brought by various motion picture exhibitors, producers and others. In addition, various legal proceedings involving alleged breaches of contract, antitrust violations, copyright infringement and other claims are now pending, which the Company considers routine to its business activities.
In the opinion of Company management, any liability under pending litigation is not expected to be material in relation to the Company's financial condition or results of operations.
Note 14--Supplementary Cash Flow Information
The Company paid interest, net of capitalized interest, of $43,936,000, $74,054,000 and $66,887,000 during the years ended December 31, 2000, 1999 and 1998, respectively. The Company paid income taxes of $12,829,000, $13,037,000 and $7,137,000 during the years ended December 31, 2000, 1999 and 1998, respectively.
During the year ended December 31, 2000, the Company issued to its employees a stock grant of 47,300 shares of common stock valued at $2,154,000. During the year ended December 31, 1999, the Company issued to its employees a stock grant of 42,300 shares of common stock valued at $1,235,000.
Net cash provided by operating activities for the year ended December 31, 1999 reflects a $225,000,000 payment to WHV representing the consideration paid by the Company for the early expiration of the WHV Agreement (see Note 3).
METRO-GOLDWYN-MAYER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 15--Quarterly Financial Data (Unaudited)
Certain quarterly information is presented below (in thousands):
The Company regularly reviews, and revises when necessary, its total revenue estimates on an individual title basis. These revisions can result in significant quarter-by-quarter fluctuations in film write-downs and amortization.
Note 16--Subsequent Events
Cable Investment. On February 1, 2001, the Company agreed to invest $825,000,000 in cash for a 20 percent interest in two general partnerships which own and operate the American Movie Channel, Bravo, the Independent Film Channel and WE: Women's Entertainment (formerly Romance Classics) (the "Cable Channels"). These partnerships are now 100 percent owned by Rainbow Media Holdings, Inc., a 74 percent subsidiary of Cablevision Systems Corporation ("Rainbow Media"). The proceeds of the $825,000,000 investment will be used as follows: (1) $365,000,000 will be used to repay bank debt of the partnerships; (2) $295,500,000 will be used to repay intercompany loans from Cablevision and its affiliates; and (3) $164,500,000 will be added to the working capital of the partnerships. The Company's investment is to be made no later than April 2, 2001.
While the Company will not be involved in the day-to-day operations of the Cable Channels, the Company's approval will be required before either partnership may: (1) declare bankruptcy or begin or consent to any reorganization or assignment for the benefit of creditors; (2) enter into any new transaction with a related party; (3) make any non-proportionate distributions; (4) amend the partnership governing documents; or (5) change its tax structure.
The Company will have the right to participate on a pro rata basis in any sale to a third party by Rainbow Media of its partnership interests, and Rainbow Media can require the Company to participate in any such sale.
If a third party invests in either partnership, the Company's interest and that of Rainbow Media will be diluted on a pro rata basis. Neither the Company nor Rainbow Media will be required to make additional capital contributions to the partnerships. However, if Rainbow Media makes an additional capital contribution and the Company does not, the Company's interest in the partnerships will be diluted accordingly. If the partnerships fail to attain certain financial projections provided to the Company by Rainbow Media for the years 2002 through 2005, inclusive, the Company will be entitled, 30 days after receipt of partnership financial statements for 2005, to require Rainbow Media to acquire the Company's partnership interests for fair market value, as determined pursuant to the agreement. The Company is forming a wholly-owned subsidiary which will make the above-described investment, will serve as a general partner of the applicable Rainbow Media companies and will be the MGM entity which holds the aforesaid partnership interests and rights attendant thereto.
Sale of Common Stock. In February 2001, pursuant to a Form S-3 shelf registration statement filed on May 5, 2000 with the Securities and Exchange Commission, the Company sold 10,660,590 shares of its common stock for gross proceeds of $220,461,000. The Company intends to use the proceeds of this sale to help finance the investment in the Cable Channels.
Sale of Preferred Stock to Tracinda. On February 7, 2001, the Company sold 15,715,667 shares of Series B preferred stock ("Preferred Stock") to Tracinda for $325,000,000. The Company intends to use the net proceeds of this sale to help finance the investment in the Cable Channels. The Preferred Stock does not bear dividends but has a liquidation preference of $0.01 per share. The Preferred Stock will become convertible, at the option of the holder, into common stock on a share-for-share basis upon stockholder approval of the issuance of the common stock to Tracinda. Tracinda will have a demand registration right for the common stock it receives upon conversion of the Preferred Stock. The Company expects to obtain stockholder approval of the issuance of the common stock to Tracinda at its next annual meeting of stockholders scheduled to be held on May 2, 2001. The Tracinda Group currently beneficially owns approximately 82.2 percent of the Company's outstanding common stock (83.4 percent assuming conversion of the Preferred Stock).
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Metro-Goldwyn-Mayer Inc.:
We have audited in accordance with auditing standards generally accepted in the United States, the financial statements of Metro-Goldwyn-Mayer Inc. included in this Report on Form 10-K and have issued our report thereon dated February 8, 2001. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying schedules are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.
Arthur Andersen LLP
Los Angeles, California February 8, 2001
SCHEDULE I: FINANCIAL INFORMATION OF REGISTRANT
METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
BALANCE SHEETS (in thousands, except share data)
The accompanying Notes to Financial Statements are an integral part of these statements.
METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (in thousands, except share data)
The accompanying Notes to Financial Statements are an integral part of these statements.
METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share data)
The accompanying Notes to Financial Statements are an integral part of these statements.
METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
STATEMENTS OF CASH FLOWS (in thousands)
The accompanying Notes to Financial Statements are an integral part of these statements.
METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
NOTES TO FINANCIAL STATEMENTS
December 31, 2000
Note 1--Basis of Presentation
The accompanying financial statements include the accounts of Metro-Goldwyn- Mayer Inc ("MGM", or "the Company") presented on a separate company (parent only) basis. MGM is a Delaware corporation formed on July 10, 1996 specifically to acquire MGM Studios, and is majority owned by an investor group comprised of Tracinda Corporation and a corporation that is principally owned by Tracinda Corporation, and certain current and former executive officers of the Company. The acquisition of MGM Studios by MGM was completed on October 10, 1996, at which time MGM commenced principal operations. MGM acquired Orion Pictures Corporation and its majority owned subsidiaries on July 10, 1997.
Note 2--Bank Debt
On October 15, 1997, MGM Studios entered into an amended and restated credit facility with a syndicate of banks aggregating $1.3 billion (the "Amended Credit Facility"). Concurrent with the Amended Credit Facility, MGM Studios repaid $739,653,000 of bank debt and accrued interest on behalf of the Company. For additional information regarding the Registrant's borrowings under debt agreements and other borrowings, see Note 7 to the Consolidated Financial Statements.
METRO-GOLDWYN-MAYER INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (In thousands)
- -------- (1) Includes $5,000 recovery of prior year reserves for contract termination costs.
EXHIBIT INDEX
- -------- * Management contract or compensatory plan.
** Filed without Schedules.
(1) Filed herewith.
(2) Filed as an exhibit to the Company's Registration Statement on Form S-1, as amended (File No. 333-35411) and incorporated herein by reference.
(3) Filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 31, 1997 (File No. 001-13481) and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Form S-8 (File No. 333-52953) and incorporated herein by reference.
(5) Filed as an exhibit to the Company's Registration Statement on Form S-1, as amended (File No. 333-60723) and incorporated herein by reference.
(6) Filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 31, 1998 (File No. 001-13481) and incorporated herein by reference.
(7) Filed as an exhibit to the Company's Registration on Form S-8 (File No. 333-83823) and incorporated herein by reference.
(8) Filed as an exhibit to the Company's Form 10-Q for the quarter ended June 30, 1999 (File No. 001-13481) and incorporated herein by reference.
(9) Filed as an exhibit to the Company's Registration Statement on Form S-3 (File No. 333-82775) and incorporated herein by reference.
(10) Filed as an exhibit to the Company's Form 10-Q for the quarter ended September 31, 1999 (File No. 001-13481) and incorporated herein by reference.
(11) Filed as an appendix to the Company's Proxy Statement for the annual meeting held on May 4, 2000 and incorporated herein by reference.
(12) Filed as an exhibit to the Company's Form 10-Q for the quarter ended September 30, 2000 (File No. 001-13481) and incorporated herein by reference.