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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File No. 1-13481
METRO-GOLDWYN-MAYER INC.
(Exact name of registrant as specified in its charter)
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Delaware 95-4605850
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2500 Broadway Street, Santa Monica, CA 90404
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 449-3000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock, par value $0.01 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the Registrant's best knowledge, in definitive proxy or information statements
incorporated by reference in Part II of this Form 10-K or any amendment to
this Form 10-K. [_]
The aggregate market value of the voting stock (based on the last sale price
of such stock as reported by the Dow Jones News Retrieval) held by non-
affiliates of the Registrant as of March 19, 1999 was $172,604,534.
The number of shares of the Registrant's common stock outstanding as of
March 19, 1999 was 150,873,728.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of Registrant's proxy statement for the annual meeting to
be held on May 11, 1999 (the "Proxy Statement"), to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the close of the Registrant's fiscal year, are incorporated by
reference under Part III of this Form 10-K.
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PART I
Item 1. Business
General
Metro-Goldwyn-Mayer Inc., a Delaware corporation (together, unless the
context indicates otherwise, with its direct and indirect subsidiaries, "MGM"
or the "Company"), is an entertainment company that is engaged primarily in
the development, production and worldwide distribution of theatrical motion
pictures and television programs. The Company, including Metro-Goldwyn-Mayer
Studios Inc. ("MGM Studios"), United Artists Corporation ("UA"), Orion
Pictures Corporation ("Orion"), G2 Films Inc. (formerly known as Goldwyn Films
Inc.) ("G2 Films") and its other subsidiaries, is one of only seven major film
and television studios worldwide. With over 5,000 film titles and over 8,900
episodes of television programming, the Company's library (the "Library")
constitutes the largest collection of feature films in the world. Motion
pictures in the Library have won over 215 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, Silence of the Lambs, Tom Jones and West Side Story.
The Library also includes 20 titles in the James Bond film franchise, five
titles in the Rocky film franchise and nine titles in the Pink Panther film
franchise. The Company is currently celebrating its 75th anniversary.
MGM's executive offices are located at 2500 Broadway Street, Santa Monica,
California 90404. The Company's telephone number is (310) 449-3000.
Background of the Company
Metro-Goldwyn-Mayer ("Old MGM") was established in 1924 through the merger
of Metro Pictures, Goldwyn Pictures and Louis B. Mayer Productions. A
corporation wholly owned by Kirk Kerkorian became Old MGM's controlling
shareholder in 1969. In 1981 Old MGM acquired UA, which had been formed in
1919 when Mary Pickford, Douglas Fairbanks, D.W. Griffith and Charlie Chaplin
joined forces to release their own motion pictures, as well as motion pictures
made by independent producers. In 1986 Turner Broadcasting System, Inc.
("Turner") acquired the businesses of Old MGM, and as part of that
transaction, Tracinda Corporation ("Tracinda") and certain of the former
stockholders of Old MGM concurrently acquired UA, including the UA library,
from Old MGM. Shortly thereafter, UA reacquired the Metro-Goldwyn-Mayer name
and logo and certain other assets from Turner. UA was then renamed MGM/UA
Communications Co. ("MGM/UA"). Turner retained the film library created
through the pre-1986 operations of Old MGM (the "Old MGM Library").
In November 1990 MGM/UA was acquired by Pathe Communications Corporation
("Pathe") and was renamed MGM-Pathe Communications Co. ("MGM-Pathe"), the
predecessor to MGM Studios. In May 1992 Credit Lyonnais Bank Nederland N.V.
("CLBN"), Pathe's principal lender, foreclosed on substantially all of the
stock of MGM-Pathe, following default by Pathe, and such stock was ultimately
transferred to Consortium de Realisation ("CDR"), a wholly owned subsidiary of
Credit Lyonnais S. A. ("CL").
In July 1993 Frank G. Mancuso was appointed as Chairman and Chief Executive
Officer of MGM Studios. In January 1996 CDR announced its intention to sell
MGM Studios.
Tracinda, senior management of MGM Studios and Seven Network Limited, a
company formed under the laws of Australia ("Seven"), formed the Company to
acquire all of the outstanding capital stock of MGM Studios and its
subsidiaries, including UA, in October 1996 for an aggregate consideration of
$1.3 billion (the "MGM Acquisition"). Tracinda is wholly-owned by Mr.
Kerkorian.
In July 1997 the Company acquired all of the outstanding capital stock of
Orion and its subsidiaries (the "Orion Companies"), including the entity
formerly known as The Samuel Goldwyn Company ("Goldwyn") and now known as G2
Films, from Metromedia International Group, Inc. (the "Orion Acquisition"). In
connection with the Orion Acquisition, the Company obtained the film and
television libraries of the Orion
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Companies consisting of approximately 1,900 film titles and 3,000 television
episodes. The Landmark Theatres owned by the Orion Companies were excluded
from the Orion Acquisition.
In November 1997 the Company completed an initial public offering, whereby
it issued and sold 9,000,000 new shares of common stock, $.01 par value per
share (the "Common Stock") at a price per share of $20, less an underwriting
discount, for net proceeds (after expenses of the initial public offering) to
the Company of $165 million (the "IPO"). Concurrent with the consummation of
the IPO, Tracinda purchased directly from the Company, at a purchase price of
$18.85 per share (equal to the per share price to the public in the IPO, less
the underwriting discount), 3,978,780 shares of the Common Stock for an
aggregate purchase price of $75 million (the "Tracinda Purchase").
On September 1, 1998, Tracinda and a Delaware corporation that is
principally owned by Tracinda (collectively, the "Tracinda Group") purchased
16,208,463 shares of the Common Stock from Seven, representing all of the
capital stock of the Company held by Seven, for a price per share of $24 and
an aggregate purchase price of $389 million.
In November 1998 the Company completed a rights offering (the "Rights
Offering"), whereby it 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) to the Company of $696.5 million. After
giving effect to the completion of the 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 the outstanding
Common Stock. In connection with the Rights Offering, the Company amended its
Amended and Restated Certificate of Incorporation to increase the number of
shares of the Common Stock authorized thereunder from 125,000,000 to
250,000,000. See "Item 4. Submission of Matters to a Vote of Securityholders."
In January 1999 the Company acquired from PolyGram N.V. and its subsidiaries
("PolyGram") certain film libraries and film-related rights (the "PFE
Libraries") for consideration of $235 million (the "PFE Library Acquisition").
The PFE Libraries contain over 1,300 feature films and are comprised of (i)
the Epic library, which consists of approximately 1,000 film titles acquired
between 1992 and 1997 by CLBN and CDR from various filmed entertainment
companies, (ii) the library of films released by PolyGram before March 31,
1996 and (iii) the Island/Atlantic and Vision/Palace libraries, which were
acquired by PolyGram. After giving effect to the PFE Library Acquisition, the
Library currently contains over 5,000 film titles and over 8,900 episodes of
television programming.
On March 12, 1999, the Company and Warner Home Video ("WHV") entered into an
agreement that terminates WHV's distribution of the Company's product in the
home video markets on January 31, 2000. In connection with such agreement, the
Company agreed to pay WHV $225 million, $112.5 million of which was paid on
March 12, 1999 and the remaining $112.5 million (plus interest at a rate of
eight percent per annum from March 1999) of which is payable in September
1999. For a further discussion, see "--Distribution--Home Video Distribution."
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 the Company (including Metro-Goldwyn-Mayer-Pictures Inc. ("MGM
Pictures"), United Artists Pictures Inc. ("UA Pictures"), Orion and G2 Films),
the major studios as defined by the Motion Picture Association of America
("MPAA") are The Walt Disney Company (including Buena Vista, Touchstone and
Miramax) ("Walt Disney"), Paramount Pictures Corporation ("Paramount"), Sony
Pictures Entertainment, Inc. (including Columbia (as defined below)) ("Sony
Pictures"),
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Twentieth Century Fox Film Corp. ("Fox"), Universal Studios, Inc.
("Universal"), and Warner Bros. (including Turner, New Line Cinema and Castle
Rock Entertainment) ("Warner"). 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 dramatically from 157 in 1989
(34.3 percent of the total) to 221 in 1998 (45.1 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
offsets the variations in the financial performance of their 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 organizations 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 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, thereby increasing the costs to the Company of its motion
pictures. Production costs and marketing costs are rising at a faster rate
than increases in either domestic admissions to movie theaters or admission
ticket prices, leaving the Company 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
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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 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 businesses:
network production (i.e., television shows for ABC, CBS, NBC, Fox, UPN and 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 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 ("ROI")
than the network production business; however, non-network programming also
generally provides a lower ROI than 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
The Company is a premier global entertainment content company. The Company's
goal is to become a fully integrated global entertainment company and thereby
maximize the value of its assets, including the Library and its film and
television production units. To achieve this goal, the Company seeks to:
Build and Leverage the Library. The Company believes that the Library is its
most powerful asset and that the Library will continue to generate relatively
stable cash flows through the worldwide distribution of its
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titles. Management seeks to maximize the value of the Library by (i) producing
new motion pictures and television programs that will not only be successful
on their own, but will also increase the depth and breadth of the Library,
(ii) aggressively marketing and repackaging the Library's titles, (iii)
developing new distribution channels for delivering MGM branded programming,
(iv) capitalizing on developments in technology and (v) further penetrating
international markets as they grow. As opportunities arise, the Company may
acquire or form partnerships for new distribution channels for the Library.
Although the Company does not currently contemplate pursuing any library
acquisitions following its acquisition of the Orion library and the PFE
Libraries, the Company may elect to evaluate such opportunities as they arise.
Finally, the Company expects to the benefit from the early termination of
WHV's distribution of the Company's product in the home video markets, as well
as the reversion over time of certain rights to its Library that have been
previously licensed to others revert to the Company over time. See "--
Distribution."
Develop, Produce and Distribute Theatrical Motion Pictures. Through MGM
Pictures and UA Pictures, the Company plans to produce or co-produce and
distribute six to ten motion pictures annually across a variety of genres. The
Company intends to (i) actively manage its production and release schedules to
maximize overall performance of those motion pictures, (ii) tightly control
development and production expenditures while maintaining the artistic
integrity required to develop and produce successful feature films and (iii)
utilize the Library as an inexpensive source for sequels and remakes and the
expansion of certain well-tested, familiar film franchises. Additionally, the
Company plans to produce, acquire or distribute approximately two to four
specialty motion pictures annually through G2 Films. The Company may also
distribute motion pictures produced by others.
Develop, Produce and Distribute Television Programming. The Company intends
to focus primarily on the development and production of series for pay
television and the first-run syndication business and intends to use its
extensive Library as a source of ideas. Under its non-network television
programming strategy, the Company generally has been able to enter into
contracts during or shortly after completion of production of a series that
provide for the recovery over time of substantially all production costs for
the series. In addition to non-network television programming, the Company
also develops programs such as two-hour television movies and mini-series and
recently produced a series for network television, The Magnificent Seven. The
Company may also consider joint ventures, co-productions and other partnering
arrangements for certain of its series. See "--Production--Television
Production."
Leverage the MGM Brand Name. The Company believes that the MGM name and its
lion logo are among the most recognized in the world. The Company intends to
capitalize on the value inherent in its name and logo through the distribution
of branded programming and the selective development of high quality consumer
products.
The Company intends to continue to pursue its goal of becoming an integrated
global entertainment company. In connection with its pursuit of this goal, the
Company may consider various strategic alternatives, such as business
combinations with companies with strengths complementary to those of the
Company and other acquisitions, as such opportunities arise. The Company may
need to seek additional financing in order to complete any acquisitions.
Acquisitions involve numerous risks, including diversion of management's
attention away from the Company's operating activities. There can be no
assurance that the Company will not encounter unanticipated problems or
liabilities with respect to any acquisitions that have been or may be
completed by the Company or with the integration of an acquired company's
operations with those of the Company, and there can be no assurance that the
anticipated benefits of any acquisitions that have been or will be completed
by the Company will be achieved.
Film and Television Library
With the completion of the PFE Library Acquisition in January 1999, the
Library became the largest motion picture library in the world. The Company
currently owns or holds certain distribution rights to over 5,000 theatrical
motion pictures. The Library also contains over half of all Hollywood studio
feature films produced
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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. The Company believes 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 motion picture library in the world, the
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 the Company's Library have won
over 215 Academy Awards. Fourteen motion pictures in the Library have won the
Academy Award for Best Picture, including 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, Silence of the Lambs, Tom
Jones and West Side Story.
The Library also includes over 8,900 episodes from television series
previously broadcast on prime-time network television 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 series in the Library have won, among others,
59 Emmy awards and nine Golden Globe awards.
The Library includes titles from a wide range of genres, including dramas,
comedies, action-adventure movies, westerns and suspense thrillers. Management
believes that the Library's diversity, quality and extensive size provides the
Company with substantial competitive advantages. The Company seeks 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 the
Library. See "--Production--Motion Picture Production."
The Company will continue to implement its strategy of developing new
projects from existing Library assets. The Library represents a readily-
available, "market tested" source of development ideas. For example, the
Company had success with the film The Birdcage, a remake of La Cage aux
Folles, and plans to release a remake of another of its Library titles, The
Thomas Crown Affair, in June 1999. Furthermore, the Company has successfully
expanded the valuable film franchises within its Library, most notably the
James Bond franchise, with the commercial success of GoldenEye in 1995 and the
release of the latest James Bond film, Tomorrow Never Dies, in December 1997.
Tomorrow Never Dies has earned greater domestic box office receipts than any
other film in the James Bond film franchise. Additionally, the Company has
successfully developed television series based on Library motion pictures such
as: The Magnificent Seven based on the movie of the same name; 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. The Company also produced a
remake of Twelve Angry Men as a made-for-television movie for Showtime
Networks Inc. ("Showtime").
The Company, together with Danjaq LLC (collectively with its predecessors,
"Danjaq"), is the sole owner of all of the James Bond motion pictures.
Eighteen James Bond motion pictures in the Library, in addition to the
upcoming release The World Is Not Enough, are produced and distributed
pursuant to a series of agreements with Danjaq. The motion pictures are
produced by Danjaq, and the Company has 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 the Company
and Danjaq. Generally, the Company has the right to distribute each of the
pictures in all media worldwide in perpetuity or for a term of 15 years. Where
the Company's distribution rights are not perpetual, the rights revert to
joint control by the Company and Danjaq after expiration of the distribution
term. Danjaq owns any television series created that is based on the James
Bond motion pictures, and the Company has the distribution rights to such
series. Danjaq controls the merchandising rights with respect to the pictures,
with the Company being entitled to receive a portion of the revenues from all
merchandising licenses. Additionally, the Company controls 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
the Company and Danjaq. The agreements contain certain restrictions on the
sale or licensing by the Company of any of its rights in the pictures.
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Additionally, two James Bond motion pictures had previously been produced by
other parties. In 1967 Columbia Pictures Industries, Inc. ("Columbia") and
Famous Artists Productions Ltd. (a subsidiary of the Company) produced Casino
Royale pursuant to an earlier license from Ian Fleming and in 1983, Warner and
Taliafilm, Inc. produced Never Say Never Again. In 1998 the Company acquired
the rights to Never Say Never Again and, as more fully set forth below, the
Company and Danjaq recently acquired the rights to Casino Royale. With these
two acquisitions the Library now contains every James Bond motion picture ever
made and the Company is the only studio to hold such rights.
On October 13, 1997, Sony Pictures issued a press release announcing plans
by its Columbia Pictures division to produce a series of new James Bond
feature films based on works created by Ian Fleming, Kevin McClory and John
Whittingham. On November 17, 1997, the Company and Danjaq filed an action in
federal court in Los Angeles against Sony Corporation, Sony Pictures,
Columbia, John Calley, Kevin McClory and Spectre Associates, Inc. ("Spectre")
seeking declaratory and injunctive relief and/or damages for copyright
infringement, trademark dilution, slander of title, unfair competition,
inducing breach of contract and breach of fiduciary duties, and
misappropriation of trade secrets. On January 23, 1998, the Company and Danjaq
filed an amended complaint adding claims for trademark infringement, federal
unfair competition and California trademark dilution. Among other things, the
Company and Danjaq contend not only that Mr. McClory's rights were limited to
remaking Thunderball but that even those rights have expired under U.S. law
pursuant to the doctrine of Stewart v. Abend, 495 U.S. 207 (1990), and that
the rights during the current term of the copyright to make films using the
James Bond character and other aspects of Ian Fleming's James Bond novels were
acquired by Danjaq. The Company and Danjaq now co-own most of these rights. On
May 19, 1998, the Company and Danjaq filed a motion for preliminary injunction
on the copyright and trademark issues to preclude Sony Pictures from
preparation, production, distribution, advertising or other exploitation of a
James Bond motion picture. On July 29, 1998, that motion was granted and Sony
Pictures, Columbia and the other defendants were preliminarily enjoined 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. The defendants appealed the District Court's order granting the
preliminary injunction to the United States Court of Appeals for the Ninth
Circuit. On December 2, 1998, the Ninth Circuit affirmed the District Court's
order granting the preliminary injunction. Thereafter, defendants filed a
petition for rehearing en banc, which was denied by a three-judge panel of the
Ninth Circuit on December 28, 1998. On March 29, 1999, the Company and Danjaq
entered into a settlement agreement with Sony Pictures, Columbia and Mr.
Calley (the "Sony Parties") that provided for a payment by the Sony Parties
and pursuant to which the Sony Parties entered into an agreement which
effectively makes permanent the court's July 1998 preliminary injunction.
Specifically, the Sony Parties agreed (i) not to make or distribute any James
Bond motion pictures in the United States based on Thunderball or any other
purported rights deriving from Mr. McClory, and (ii) not to utilize the "James
Bond" and the "James Bond 007" trademarks in the United States. Mr. McClory
and Spectre did not participate in this settlement agreement. The Sony Parties
have reassigned their counterclaims for copyright infringement to Mr. McClory,
and the court has set a status conference for May 3, 1999 to allow Mr. McClory
time to inform the court whether or not he wishes to pursue that claim. See
"Item 3. Legal Proceedings."
Under the terms of a separate agreement entered into on March 29, 1999, the
Company and Danjaq acquired from Columbia all of Columbia's rights to the 1967
James Bond film entitled 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 in the prior paragraph, throughout
the world.
The Company seeks aggressively to market and distribute titles in the
Library in existing pay and free television, home video and other markets
worldwide. The Company believes that the size of the Library allows the
Company to minimize the over-exploitation of any title and therefore better
preserve the ongoing value of the Library by actively managing the rotation of
titles through such markets. During the most recent three-year period, the
Company exploited approximately 80 percent of the theatrical motion picture
titles and approximately 45 percent of the television title episodes in the
Library (excluding the titles in the PFE Libraries, which could
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not yet be reflected in such calculation because of the recent nature of their
acquisition by the Company). Rather than selling its titles on a single or
multi-picture basis, the Company strives to strategically pool its motion
picture and television titles into cohesive programming packages directed at
specific markets, including purchasers of large quantity programming and
services in emerging markets which may not have their own programming
capabilities.
The Company also seeks aggressively to market and distribute its titles
through developing technology. The Company believes that the development and
growth of direct broadcast satellite ("DBS") and other new distribution
systems may generate significant incremental profits for the industry as the
number of channels requiring content grows. The Company believes that, with
its extensive Library, including the recent addition of the PFE Libraries, and
its branded programming strategy, the Company is well positioned to benefit
from such growth and development.
The Company has differing types of rights to the various titles in the
Library. In some cases, the Company owns 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 the Company may have
obtained the right to distribute the title in certain media and territories
for a limited term. Even if a title is owned by the Company, the Company may
have granted rights to exploit the title in certain media and territories to
others. As of December 31, 1998, the Company owned outright, or had been
granted rights in perpetuity to, approximately 60 percent of the titles in the
Library (excluding the titles in the PFE Libraries, which could not yet be
reflected in such calculation because of the recent nature of their
acquisition by the Company). The Company's rights in the other Library titles
(excluding the titles in the PFE Libraries) are limited in time and, pursuant
to the terms of the existing arrangements, the rights granted to the Company
expire with respect to approximately six percent of the Library over the next
two years (i.e. through the end of 2000), with respect to another
approximately 13 percent over the six years thereafter (from 2001 to 2007),
and with respect to another approximately 18 percent thereafter (from 2008
on). The Company has generally been able to renew such rights on acceptable
terms; however no assurances can be made that it 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, the Company includes any title that the
Company has the right to distribute in any territory in any media for any
term.
Due to certain long-term pre-paid licenses entered into by prior management,
the Company does not expect to receive significant revenue with respect to
substantial portions of its Library from domestic free and certain major
international television markets for the next several years. As of December
31, 1998, the titles included in these licenses represent a cross-section of
the titles in the Library, including approximately 50 percent of the pre-1990
MGM and UA titles, which have been licensed in one or more of the U.S.,
France, Spain and Germany, and approximately 25 percent of the Orion titles,
which have been licensed in one or more of France, Spain, Germany and the
United Kingdom. See "--Distribution--Pay and Free Television Distribution."
The Company expects to benefit as certain rights to the Library that have been
previously licensed to others revert to the Company over time. See "--
Distribution."
In recent years the Company has derived approximately 40 percent of its
revenues from non-U.S. sources due to its distribution of motion picture and
television productions in foreign countries. As a result, the Company's
business is subject to certain risks inherent in international trade, many of
which are beyond its control, such as 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 and the instability of foreign economies
and governments. In addition, fluctuations in foreign exchange rates can
adversely affect the Company's business, results of operations and cash flows.
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."
9
Production
Motion Picture Production
The Company currently develops and produces theatrical motion picture
projects through two separate production entities, MGM Pictures and UA
Pictures. The Company operates these production units independently with
separate management teams and allows them to pursue independently the best new
projects on the creative side of the business. At the same time, the Company
supports the units with the benefits of centralized marketing, sales, legal,
physical production and distribution functions. Direct access to senior
management also expedites major decision-making. By utilizing its two separate
production units, management believes that the Company benefits from the
distinct creative talents and perspectives of each of its chief production
executives, resulting in greater diversity within its overall release slate.
Through these production units, the Company intends under its current
business plan to produce or co-produce and distribute six to ten motion
pictures annually across a variety of genres and budget ranges and may also
release additional pictures each year that are produced by other producers.
Both production units employ a development staff of creative executives who
work to refine concepts and scripts so that projects are developed to the
point that production decisions can be made. The creative staffs of both MGM
Pictures and UA Pictures currently have approximately 108 ongoing projects in
the aggregate, which are in various phases of development and pre-production.
The Company's current strategy is to have fewer projects in development at any
one time than the other major studios in order to concentrate its efforts and
assets on the projects that management believes could be the most commercially
successful. The Company believes that this strategy results in lower
development related write-offs and abandonment costs. Historically, the
Company's development related write-offs and abandonment costs amounted to
$24.1 million, $21.2 million, and $11.6 million in the years ended December
31, 1998, 1997 and 1996, respectively.
Additionally, the Company plans to release approximately two to four
specialty motion pictures each year through G2 Films. These motion pictures
will be produced or co-produced by G2 Films or acquired through negative
pickups or other distribution arrangements and will include motion pictures in
a variety of genres generally involving producers and directors, writers or
other talent who typically work outside of the studio system. The Company's
investment in such pictures is expected to be significantly less than the
Company's investment for pictures produced through MGM Pictures or UA
Pictures. The Company believes that this strategy of releasing independent
motion pictures will add greater diversity to the Company's 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.
In order to manage the financial risks inherent in motion picture
production, management has developed a rigorous budgeting and approval process
and strictly controls the cost of each motion picture through active
management involvement in all phases of the production process. When a project
is considered to have commercial potential, budgets are developed
independently by the physical production department to determine the below-
the-line cost of a motion picture. At a point early in this process, a
preliminary below-the-line estimate is combined with potential above-the-line
costs, such as talent costs and participations, to form a model of the total
cost of the motion picture. The Company then performs sensitivity analyses to
determine the motion picture's potential ROI. The ROI range is developed using
a preliminary cost model together with a revenue model based on the picture's
budget, genre, cast, international appeal and other factors. The Company
believes that, as a result of its focus on budgeting and controlling
production expenditures, it is able to avoid unnecessary cost-overruns and
excess expenditures.
The Company believes that it pursues fewer 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, than other major studios. In general, the
Company believes that its capital resources are better allocated to acquire
literary properties or the services of talent for a specific project than to
fund overhead. The Company's current business plan also calls for the
Company's annual release slates to be comprised of proportionately fewer large
budget "event" motion pictures than the current release slates of the other
major studios.
10
The Company does not own any studio facilities or stages but rather leases
facilities and sound stages on an "as needed" basis in connection with the
production of specific motion picture and television projects. The Company has
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 quality and 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 the Company's motion pictures will not be commercially successful,
resulting in costs not being recouped or anticipated profits not being
realized. In that connection, although Tomorrow Never Dies and The Man In The
Iron Mask performed better than anticipated, the Company's other major
theatrical releases in 1998 performed below expectations. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The following table details the Company's current 1999 release schedule.
Release Schedule
Approximate
Title Release Date Summary Principal Actors
----- ------------ ------- ----------------
At First Sight(2)....... Released Based on the true story Val Kilmer, Mira
by Oliver Sacks Sorvino, Kelly McGillis,
(Awakenings) of a blind Nathan Lane, Steven
man whose sight is Weber
restored and the effects
it has on him, his
sister and the woman he
loves.
Just the Ticket......... Released A story of love, Andy Garcia, Andie
redemption and faith MacDowell
centering on a ticket
scalper who must
confront his past in
order to hold onto the
girl he loves.
The Rage: Carrie 2(1)... Released A sequel to the 1976 Amy Irving, Emily Bergl,
horror thriller, The Jason
Rage: Carrie 2 is a London
supernatural thriller
about a teenage loner
whose telekinetic powers
awaken when she becomes
the focus of a cruel
high school joke.
The Mod Squad(2)........ Released A trio of juvenile Claire Danes, Giovanni
delinquents become Ribisi, Omar Epps, Josh
undercover cops to Brolin
infiltrate a drug ring
in the ultra-hip LA club
scene.
Molly(2)................ April 1999 A mentally challenged Elizabeth Shue, Aaron
young woman's genius is Eckhart
unleashed after
experimental surgery,
while her brother's
carefree lifestyle is
turned on its side when
he must care for her.
Tea With Mussolini...... May 1999 A coming-of-age tale Cher, Judi Dench, Joan
about an illegitimate Plowright, Maggie Smith,
child who struggles to Lily Tomlin
assert his independence
and find his way into a
life of art, taken from
the autobiography of
Franco Zeffirelli.
11
Approximate
Title Release Date Summary Principal Actors
----- ------------ ------- ----------------
One Man's Hero........... May 1999 An adventure about the Tom Berenger
legendary Saint Patrick
Battalion, who fought
for Mexico alongside
Pancho Villa in the
Mexican-American War.
The Thomas Crown June 1999 An adventure of a Pierce Brosnan, Rene
Affair(1)............... millionaire playboy who Russo
steals a priceless work
of art and then strikes
up a fiery romance with
the brilliant female
insurance investigator
who is on to his game.
Stigmata(2).............. July 1999 When a young woman Patricia Arquette,
becomes the focus of Gabriel Byrne
brutal assaults by an
unseen attacker, a
priest becomes more
concerned with saving
her life than denouncing
her claims.
Mr. Accident(3).......... August 1999 The janitor of a free- Yahoo Serious, Helen
range chicken farm meets Dallimore
the woman of his dreams
and joins her in trying
to thwart the tobacco
industry's nefarious
plans to addict new
customers through
nicotine-injected eggs.
Supernova(1)............. October 1999 Science-fiction thriller James Spader, Angela
about a medical Bassett, Lou Diamond
spaceship that responds Phillips, Robert Forster
to a distress signal and
takes on a mysterious
passenger.
The World Is Not November 1999 Michael Apted directs Pierce Brosnan, Denise
Enough(1)............... the Company's 19th Richards, Sophie Marceau
installment of the James
Bond series.
Flawless(2).............. December 1999 A tough, conservative Robert De Niro, Philip
security guard suffers a Seymour Hoffman
stroke and is assigned a
rehabilitative program
that includes singing
lessons with the drag
queen next door.
- --------
(1) Developed and produced by UA Pictures.
(2) Developed and produced by MGM Pictures.
(3) Developed and produced by G2 Films.
The Company may revise the release date of a motion picture as the
production schedule changes or in such a manner as the Company believes 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.
Television Production
The Company is 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 its television series production
operations in 1994, the Company has obtained commitments for approximately
1,030 hours of television programming, of which approximately 40 percent
remained to be aired as of December 31, 1998. Historically, the Company's
television activities were focused on the traditional network production
business and made-for-television movies, and many of the television programs
in the Library were produced as network series. However, since the networks
have substantially lowered the license fees as a
12
percentage of the budget for network television programming in recent years,
resulting in significantly larger production investment risks for the
producers of such programming, the Company altered its television strategy in
1994 when the Company's management re-established the Company's television
series production operations. See "--The Motion Picture and Television
Industry."
Since 1994 the Company has focused primarily on the development and
production of series for the first-run syndication business, which involves a
lower production investment risk for the Company, and movies and mini-series
for both network and off-network broadcasters. The Company's strategy is
designed to (i) minimize up-front capital investment through the production of
series for the first-run syndication business and through co-production
arrangements, (ii) 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, (iii) use valuable Library assets such as The
Magnificent Seven, The Outer Limits, Poltergeist, Stargate and All Dogs Go to
Heaven to develop recognizable products with enhanced marketability at a
reduced cost and (iv) develop alternative types of programming, such as
animated cartoon strips, talk shows, variety/magazine shows such as National
Enquirer and reality-based programming such as LAPD--Life on the Beat.
As part of its strategy, the Company has entered into a programming
arrangement with Showtime whereby the Company provides television series and
movies for premiere on Showtime. Showtime has agreed to license from the
Company exclusive U.S. pay television rights to the following television
series: (i) 122 hours (six seasons) of The Outer Limits (winner of the Cable
Ace award for Best Dramatic Series in 1995 and 1996) of which 32 hours
remained to be aired as of December 31, 1998; (ii) 66 episodes (three seasons)
of Poltergeist: The Legacy of which no episodes remained to be aired as of
December 31, 1998; (iii) 88 episodes (four seasons) of Stargate SG-1 of which
52 episodes remained to be aired as of December 31 1998; and (iv) two new
series (for a minimum commitment of 21 and 43 episodes each, respectively,
including a two-hour episode) to be produced by the Company for Showtime, with
one new series to commence broadcast in 2000 and one to commence in 2001.
Showtime has also committed to a two-hour pilot for Species, a possible
television series based on the theatrical motion picture of the same name. The
Company has also acquired worldwide (excluding Canada) distribution rights to
the Showtime series Dead Man's Gun (a Cable Ace nominee for Best Dramatic
Series in 1997). Twenty-two new episodes of such series will be produced,
giving the Company a minimum of 44 episodes that have not previously been
distributed outside North America. Following their initial exhibition cycle on
Showtime, the Company intends to exploit these programs further in other
markets. In this respect, the Company has recently 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.
The programming agreement with Showtime also includes a commitment by
Showtime to license seven made-for-television movies from the Company, five of
which remained to be produced and all of which remained to be aired as of
December 31, 1998.
Additionally, the Company has obtained a commitment from Paxson
Communications ("Paxson") to license 88 episodes of Flipper, a one-hour
series, which commitment includes a production order for 44 episodes. 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.
The Company also has obtained a commitment from Fox Family Worldwide to
license 40 episodes (of which 14 episodes are newly commissioned) of All Dogs
Go to Heaven, a half-hour animated series that began airing in fall 1998. The
Company has also entered into agreements to produce for U.S. broadcast
syndication (i.e. licenses to individual television stations) 40 half-hour
episodes of Robocop: Alpha Commando, an animated series based on the feature
motion picture Robocop, and 13 half-hour episodes of The Lionhearts, an
animated series based on Leo, the familiar MGM lion, and his cartoon "family."
In addition to National Enquirer, which will premiere in first-run
syndication in fall 1999, the Company intends to develop additional series for
first-run syndication for which production, if the Company elects to produce
such series, would begin no earlier than 2000.
13
From time to time, the Company may produce series for network television on
a selective basis, which typically require deficit financing but generally
offer the potential for greater financial return. In its first sale of a
series to network television since 1994, the Company produced a two-hour pilot
and 21 episodes of The Magnificent Seven for CBS during the 1997/98 and
1998/99 broadcast seasons.
The Company may consider joint ventures, co-productions and other partnering
arrangements for certain of its existing or future series in order to minimize
the up-front capital investment and limit the financial risk to the Company
with respect to the production of such series.
Since the Company's ability to recover production costs and realize profits
on its television programs depends on various factors, including but not
limited to the programs' acceptance by the public, fluctuation in prevailing
advertising rates, and the ability to distribute the programs into licenses
subsequent to their first-run license, there can be no assurance that the
Company can recover the production costs or realize profits on any television
series. Thus, there is a substantial risk that some or all of the Company's
television projects will not be commercially successful, resulting in costs
not being recouped or anticipated profits not being realized. See "--
Distribution" and "--Competition."
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
the admissions paid at the box office, which generally includes a fixed amount
per week, as well as a percentage of the admissions that escalates over time.
A studio's or other producer's (or third party distributor's) share is
approximately 50 percent of gross box office admissions, although such
percentage, which has generally decreased in recent years, varies depending
upon factors such as the number and box office performance of such studio's or
other producer's recent releases.
The Company intends to release a slate of films appealing to a wide variety
of audiences. By strategically timing the release of its motion pictures
throughout the year, the Company intends to avoid some of the risks posed when
a motion picture is inappropriately released during the most crowded and
competitive box office seasons. The Company believes that this strategy is
unlikely to have a negative impact on its ability to generate home video
rentals.
All motion pictures that are released theatrically by the Company in the
U.S. and Canada, whether produced by MGM Pictures, UA Pictures, G2 Films or
third parties, are marketed and distributed by Metro-Goldwyn-Mayer
Distribution Co. Additionally, the Company generally distributes its motion
pictures in theatrical markets outside of the U.S. and Canada through United
International Pictures B.V. ("UIP"), a partnership owned equally by the
Company, Paramount and Universal. UIP is the world's largest theatrical motion
picture distribution company outside the U.S., with distribution activities in
over 50 countries. UIP has a cost sharing arrangement that requires each
partner to be responsible for one-third of UIP's annual operating overhead.
UIP charges each partner a distribution fee of 35 percent of gross theatrical
receipts until the fee equals one-third of the annual operating costs of the
partnership, and thereafter a negotiated percentage of any additional gross
receipts as a fee for incremental use of the organization. Each partner bears
all of its own releasing costs and retains all cash flow from its pictures
after payment of fees.
The Company can elect to withdraw from UIP on November 1 of any year with at
least one year's prior notice (although the Company has no current intention
to withdraw). If the Company, or either other partner, withdraws, that partner
is entitled to one-third of the book value of UIP less one-third of the
estimated winding down costs of the partnership. Both Universal and Paramount
have agreed not to withdraw from the partnership until after 2001; however,
the Company believes that either party's exit from UIP would not have a
material adverse effect on the Company's financial condition or results of
operations, as the Company would expect to distribute its motion pictures in
these territories by either modifying and downsizing the UIP structure or
finding or developing satisfactory alternative methods for international
distribution. There can be no assurance, however,
14
that such alternatives would not result in decreased revenues or
profitability. The partners are prohibited from transferring their respective
partnership interests. UIP received a "Statement of Objections" from the
Competition Directorate of the Commission of European Communities in January
1998. A hearing was held before the European Commission in September 1998. See
"--Regulation."
Co-Production and Distribution Agreements. In addition to producing feature
motion pictures independently, the Company occasionally enters into co-
production agreements, split rights deals and similar arrangements under which
the Company retains certain distribution rights with respect to a picture and
shares the cost of production with a partner that obtains other rights
(generally outside of the U.S. and Canada). While such agreements limit the
Company's risk relating to a motion picture's performance as they reduce the
Company's production costs, such agreements also limit profitability. The
Company also acquires rights to distribute films through negative pickup
arrangements under which the Company acquires a completed motion picture, or
certain rights therein, from a third party. Under co-production agreements,
split rights deals or negative pickup arrangements, the Company may be
committed to spend specified amounts for prints and advertising. Additionally,
the Company occasionally enters into "rent-a-system" arrangements under which
the Company provides 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. The Company's 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 media plans and marketing
materials well in advance of a motion picture's scheduled theatrical release.
The media 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 more significant materials
are sent to exhibitors. Finally, a national 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, such as colleges. 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 the Company's in-house
staff, although outside agencies are frequently retained to provide creative
input.
Home Video Distribution
The Company's marketing and distribution strategy in the home video market
domestically and internationally is to (i) market its motion picture and
television titles in cohesive packages, (ii) create branded product lines,
(iii) adapt to a maturing home video market and (iv) release new motion
pictures into the home entertainment market at the time of the year that it
believes will generate the most sales without diminishing revenues from other
markets. Under current management, the Company has repackaged and repriced a
number of Library titles through the creation of various branded lines.
Examples of these branded lines include MGM's Movie Time, Contemporary
Classics, Screen Epics, Vintage Classics and Musicals. The Company believes
this strategy has resulted in increased shelf space in video retail stores and
that this increased visibility has led to increased sales of Library titles.
This strategy has also been used to expand the sales and distribution of the
Orion catalog titles. The addition of the PFE Libraries in January 1999 is
expected to enhance the longevity and sales potential of the existing branded
lines and to contribute to the creation of new branded lines. Additionally, in
connection with new films which it releases into the market, the Company often
releases 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
upcoming worldwide re-release of the James Bond video catalog in connection
with the fall 1999 theatrical
15
release of the Company's nineteenth installment of the James Bond series, The
World Is Not Enough. The Company intends to continue this strategy of
packaging groups of films or film franchises and releasing them in connection
with the releases of its most highly visible new films.
MGM Home Entertainment Inc. ("Home Entertainment") manages the marketing and
distribution of both current feature motion pictures and Library product of
MGM Studios and its 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 (collectively,
the "Parties") entered into an agreement (as amended, the "WHV Agreement")
with the predecessor to WHV. Under the WHV Agreement, the Parties granted to
WHV certain home video distribution rights with respect to new motion pictures
and the motion picture library of MGM/UA, UA Pictures and their respective
affiliates, subject to certain limited exceptions, throughout the world for a
distribution fee expressed as a percentage of worldwide home video revenues
(as determined under the WHV Agreement) and reimbursement of certain
distribution expenses. The WHV Agreement was originally scheduled to expire in
May 2003, with the home video rights of each of the films still covered by the
WHV Agreement at that time reverting to MGM Studios or its affiliates five
years after the film's initial availability in the U.S. home video market. On
March 12, 1999 the Company, WHV and Turner entered into an agreement to
accelerate the expiration of the WHV Agreement. The Parties restructured the
terms of the WHV Agreement, which will function as an interim distribution
agreement (the "Transitional Video Agreement"), under which WHV will
distribute certain of the Company's product in the home video marketplace
while the Company establishes its own home video distribution network. The
Transitional Video Agreement expires on January 31, 2000. In addition to
accelerating the expiration of the WHV Agreement, (i) the Company agreed to
pay WHV $225 million, $112.5 million of which was paid on March 12, 1999 and
the additional $112.5 million (plus interest at a rate of eight percent per
annum from March 1999) of which is payable in September 1999, (ii) the Company
reconveyed as of January 1, 1999 to WHV the right that the Company had 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 WHV Agreement, and
(iii) the Company, WHV and Turner released any claims against each other
arising out of the WHV Agreement and the Turner video distribution agreements
including claims previously advanced by WHV with respect to the Orion library.
Under the Transitional Video Agreement, all security interests in favor of WHV
over the assets of the Company have been released and the restrictive
provisions previously contained in the WHV Agreement have been terminated,
including restrictions on the acquisition and disposition of film rights and
the requirement that the product of future affiliates of the Company be
distributed under the WHV Agreement. WHV will distribute on home video the
motion pictures that the Company elects to make available in the home video
market throughout the world for a distribution fee determined under the
Transitional Video Agreement and reimbursement of certain distribution
expenses. In general, the percentage varies from 10 percent to 15 percent
based upon the amount of worldwide home video revenues during the term and
other factors. MGM Studios and its affiliates maintain direct control of all
significant elements of distribution such as the determination of release
dates, marketing, return policies and pricing for these home video releases.
Laser disc and digital video disc ("DVD") distribution rights are also covered
by the Transitional Video Agreement.
Even with the WHV Agreement in effect, the Company's home video sales have
increased since 1993. From 1993 to 1998, the Company increased its annual
worldwide home video gross revenue from feature films by 102 percent, from
$243.0 million to $491.2 million. The Company believes that this increase is a
result of more effective and efficient marketing by the Company, the
distribution of more current product, the distribution of more titles due to
the Orion Acquisition, the renegotiation by the Company of key vendor
relationships and a reorganization of the Company's distribution
infrastructure. Management believes that the agreement reached with WHV to
accelerate the expiration of the WHV Agreement is an important step in
enabling the Company to manage home video distribution in a more cost-
effective manner and further increase sales and profitability.
The Company has recently begun entering into revenue sharing agreements for
certain of its rental titles, pursuant to which the Company leases titles to
rental establishments and receives a percentage of the consumer rental
revenues generated from such titles. The Company anticipates that it will
continue to enter into more of
16
such agreements in the future. Although no assurance can be given, in part
because of the recent introduction of these arrangements in the industry, the
Company believes that such arrangements may increase its revenues from the
home video rental market, by allowing the Company to participate in increased
revenues from successful titles, although such revenues will be received over
a longer period.
The Company had licensed to Hallmark Entertainment Distribution Company,
Inc. ("Hallmark") the right to distribute in the U.S. home video market
substantially all of the library of G2 Films and Goldwyn. In February 1999,
Hallmark's rights under such license reverted to the Company.
During 1998, the Company has released 15 Orion films to the rental market,
including features Ulee's Gold, Fall, The Locusts and Retroactive, as well as
the Company's television productions, Twelve Angry Men and the two-hour pilot
of Stargate SG-1. The Company has also released under the Orion banner certain
titles produced by Playboy Entertainment, the distribution rights to which
were obtained as part of the Orion Acquisition.
The Company intends to capitalize on developing technologies such as DVD, a
high-quality mass-produced delivery system for video and audio data. The
Company believes that DVD is a promising technology that could generate
significant incremental profits for the industry because, among other things,
the format may be more attractive to retail purchasers than videocassettes.
The Company was among the first major studios to make titles available on DVD
and, as of December 31, 1998, ranked fourth in total DVD market share behind
Warner, Sony Pictures and Universal. Tomorrow Never Dies has become the
largest selling DVD title yet released. The Company believes that it is well
positioned to benefit if DVD is successful, since the high quality of DVD is
expected to create additional demand for the many classic or familiar
"collectible" titles in the Library. As DVD is a developing technology, it is
uncertain when and if DVD will become a substantial revenue source; however
the Company was encouraged by the progress of the format in 1998 and believes
that DVD may increasingly provide incremental profits to the Company in the
future.
Pay and Free Television Distribution
General. The Company generally licenses its 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. The
Company believes 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.
The Company intends to enter into relatively short-term licenses of its
Library motion pictures for pay and free television in packages that are
strategically designed for the relevant marketplace. The Company has created a
proprietary database for use by its salesforce which contains detailed
information on each of the Company's films, including dates of availability,
media controlled by the Company, sales history, genre, format, length, stars,
soundtrack, etc. This information can be utilized by the sales force in order
to create strategically designed packages of motion pictures based on one or
more various criteria. The Company believes that this system is one of the
most advanced in the entertainment business and provides its sales force with
an advantage in a competitive marketplace that requires large amounts of
diverse content and is becoming more receptive to packaged programming.
Domestic Pay Television. The Company and Showtime have entered into a
theatrical motion picture output agreement requiring the Company's future
theatrical motion pictures to air on Showtime's pay television network. The
first output period expires upon the first to occur of August 31, 2001 or the
delivery of 150 pictures (other than specialty pictures) under the agreement.
As of December, 1998, the Company had delivered 36 pictures to Showtime. The
second output period commences on September 1, 2001 and expires upon the first
to occur of December 31, 2003 or the delivery of 65 additional pictures (other
than specialty pictures). Additionally, the agreement requires the Company's
future specialty motion pictures (i.e., pictures released under the G2 Films
logo) to air on Showtime's pay television network. The output period for
specialty motion pictures expires upon the first to occur of December 31, 2003
or the delivery of 50 specialty motion pictures. The license fees for each
picture are determined according to a formula based on U.S. theatrical rentals
of such picture, with special provisions applicable to the specialty motion
pictures.
17
Orion and Home Box Office ("HBO") have entered into a theatrical motion
picture output agreement requiring future theatrical motion pictures produced
and distributed by Orion (excluding pictures produced by G2 Films and
distributed under both the prior and current G2 Films and Goldwyn logo) to air
on HBO's pay television network. The license fees for each picture are
determined according to a formula based on U.S. theatrical rentals of such
picture. The agreement expires on December 31, 2001, but HBO has the right to
extend the agreement through December 31, 2006.
Domestic Free Television. The Company distributes its feature motion
pictures to U.S. and Canadian networks, local television stations in the U.S.
and Canada and basic cable networks. The Company also generates revenue by
granting syndication licenses on a barter basis. Barter syndication allows the
television stations to license the Company's product in exchange for a portion
of the local commercial air time. The Company, in turn, sells the inventory of
commercial air time to advertisers on a national basis, while the television
stations retain a portion of the commercial air time for local advertisers.
The Company has used outside barter companies to sell television spots to
advertisers in the past, but the Company commenced its 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) 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 license, the domestic free television rights revert to the Company
between 2000 and 2003. The Company expects 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 the
Company. The Company believes that, due to the significant increases in
licensing fees for domestic television since 1990, the expiration of the
Turner license and the subsequent ability of the Company to freely license the
Library in this market will generate incremental revenue for the Company. See
"--Film and Television Library."
International Pay and Free Television. The Company currently distributes its
motion pictures and television product through pay television licenses in over
90 territories. The Company has output agreements with licensees in major
territories, including Germany, France, the United Kingdom, Spain, Italy,
Japan and Brazil. In 1998, the Company received $52.1 million in revenue from
international pay television distribution, accounting for four percent of the
Company's total revenue for the year.
The Company currently distributes its motion pictures and television product
through free television licenses in over 100 territories. In 1998 the Company
received $147.4 in revenues under these agreements, accounting for 12 percent
of the Company's 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 the Company, and therefore, the
Company does 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 revert to the Company between 2000 and
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 free television rights
revert to the Company between 1997 and 2000. With respect to most of the
motion pictures and television series licensed to Degeto Film, the
distribution rights granted revert to the Company between 1999 and 2010. See
"--Film and Television Library."
Additionally, Orion has entered into certain long-term licenses covering a
significant number of its library motion pictures in the international free
and pay television markets. Orion has already received substantially all
18
of the license fees under these licenses, and therefore, the Company does not
expect significant revenue from these licenses in future periods. Orion has
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) 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 2003 and 2013. 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 between 1999 and 2012. The
distribution rights granted to Televisio de Catalunya, S.A. currently are
reverting to Orion, with such reversion being complete in 2010. The Company
believes that, due to the importance of France, Spain, Germany, 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
subsequent ability of the Company to freely license its Library in these
markets could create substantial incremental revenue for the Company.
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 the Library. Although the Company exploits
the remaining titles in the Library in these markets, they do not generate
significant revenues.
In addition to licensing packages of films, the Company holds equity
positions ranging from approximately five percent to 25 percent in joint
ventures such as LAPTV, Telecine, Star Channel and MovieVision, which are
emerging international premium film satellite television networks broadcasting
in different territories around the world. The Company has entered into
license agreements with respect to each of LAPTV, Telecine, Star Channel and
MovieVision, licensing theatrical and television motion pictures and, in some
cases, television series to each of the ventures.
The Company believes its 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 the Company's programming, will
provide opportunities in the international marketplace as foreign countries
continue to develop cable television infrastructures and satellite television
becomes more available.
In April 1998, the Company and its 50 percent equity partner, an indirect
subsidiary of Tele-Communications, Inc., decided to terminate their joint
venture in MGM Gold (Asia). MGM Gold (Asia) was a 24-hour satellite and cable
delivered service based and distributed in Asia that featured programming from
the Library. The recent economic deterioration in Southeast Asia, which has
resulted in diminished growth in multi-channel television households, and
slower than anticipated penetration in India and China were the primary
factors influencing the decision to cease the operations of the joint venture.
As of December 31, 1998, the Company had invested $13.2 million in the
venture. The Company anticipates that the formal dissolution of the venture
will be concluded shortly and that the Company will not incur any additional
costs with respect to the venture.
In May 1998 the Company and an indirect subsidiary of United International
Holdings ("UIH") combined their Latin American cable programming businesses
into a joint venture to form MGM Networks Latin America. Under the terms of
the joint venture, the Company acquired a 50 percent equity interest in the
venture by contributing its branded Brazilian channel MGM Gold Brazil, which
began operations in December 1997. In turn, UIH contributed its 100 percent
interest in United Family Communications, which produces and distributes The
Family Channel Latin America and Casa Club TV to satellite and cable
television distributors throughout Latin America and Brazil, for a 50 percent
interest in 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 $24.0 million, of which the Company
had funded approximately $12.4 million as of December 31, 1998. The Company
has entered into license agreements with MGM Networks Latin America, licensing
certain motion pictures and trademarks to the venture. The joint venture is
based in Coral Gables, Florida.
19
Over the next 12 months, The Family Channel Latin America will be re-branded
and reintroduced as MGM Latin America and MGM Brazil. MGM Latin America and
MGM Brazil are general entertainment channels programmed primarily with MGM
theatrical and television product. Casa Club TV is a women's and children's
channel offering home and garden, cooking and children's programming. As of
December 31, 1998, MGM Networks Latin America distributed its signal to
approximately 3.4 million homes in 15 countries throughout Latin America.
Trademarks and Consumer Products
The Company owns the registered trademarks Metro-Goldwyn-Mayer, MGM, United
Artists, UA, Orion and variations thereof, as well as trademarks, logos and
other representations of characters, such as The Pink Panther, from motion
pictures and television series produced or distributed by the Company. In 1998
the Company received $10.7 million in revenue from the licensing of these
trademarks, logos and other representations.
The Company believes that the MGM name and its lion logo are among the most
recognized in the world, evoking images of classic Hollywood. The Company
believes that the name and logo represent assets the value of which has been
substantially unrealized in the past. The Company plans to pursue a focused
branded strategy that will capitalize upon the Company's name and logo and
seek licensing opportunities for such name and logo, as well as other
trademarks of the Company, in a range of high quality product categories
(including gifts and apparel), distribution channels and venues.
In February 1980 Old MGM 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. 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/UA 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. See "Item 13. Certain Relationships and Related Transactions."
In June 1985 Old MGM granted to Walt Disney Productions ("Disney
Productions") an exclusive long-term worldwide license (the "Disney License")
to use all trademarks, trade names and logos and names of or related to MGM
Studios that do not include "United Artists" or "UA" and materials from
certain MGM and UA motion pictures and television programming in movie theme
parks of Disney Productions that include a working movie production studio, as
long as Disney Productions makes the annual license payments. The Disney
License becomes non-exclusive with respect to the licensed trademarks, trade
names and logos on May 1, 2004 and is subject to early termination under
certain circumstances. Additionally, if Disney Productions did not develop a
movie theme park in any given territory by June 27, 1994, the Disney License
requires that Disney Productions reconvey all the licensed rights in that
territory to MGM Studios. MGM Studios requested the reconveyance of the
licensed rights in all territories except the U.S., and Disney Productions
reconveyed those rights in 1995 for all territories except the U.S. and
Western European territories in 1995. The Company filed a lawsuit against
Disney Enterprises, Inc. ("Disney") to compel the reconveyance of the licensed
rights in Western Europe and for termination of the Disney License and
received a jury verdict in its favor with respect to the rights in Western
Europe in November 1997. The court granted summary adjudication in favor of
Disney denying the Company the right to terminate Disney's U.S. rights under
the Disney License. The Company appealed this aspect of the decision. In an
unpublished opinion filed February 16, 1999, the Court of Appeal affirmed the
trial court's summary adjudication in favor of Disney on this issue. The
Company filed a petition for rehearing on March 3, 1999, which was denied on
March 11, 1999. On March 26, 1999, the Company filed a Petition for Review of
the Appellate Court's decision with the Supreme Court of the State of
California.
For additional information regarding the Company's operating segments, see
the Company's Consolidated Financial Statements and the Notes thereto.
20
Competition
Motion picture production and distribution are highly competitive
businesses. The Company faces competition from companies within the
entertainment business, as well as alternative forms of leisure entertainment.
The Company competes 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 the
Company competes in the motion picture industry have significantly greater
financial and other resources than does the Company, while the independent
production companies may have less overhead than the Company. 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--Pay and Free
Television Distribution."
In addition, the Company's 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 the Company's 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
the Company's competitors, particularly the other major film studios, in any
given period may create an oversupply of product in the market, thereby
potentially reducing the Company's share of gross box office admissions and
may make it more difficult for the Company's 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. The Company's 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 the Company competes in the television industry have
significantly greater financial and other resources than does the Company.
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 from and profitability of
feature-length motion pictures and television programming.
Employees
As of December 31, 1998, the Company had approximately 870 full-time and
part-time regular employees in its worldwide operations. Of that total,
approximately 130 were primarily engaged in production and development,
approximately 310 were primarily engaged in sales, marketing and distribution
and approximately 430 were primarily engaged in management and administration.
Approximately 160 of the Company's employees are currently covered by
employment contracts. The Company also hires additional employees on a
picture-by-picture basis in connection with the production of the Company's
motion pictures and television programming. The salaries of these additional
employees, as well as portions of the salaries of certain full-time employees
of the Company who provide direct production services, are typically allocated
to the capitalized cost of the related motion pictures or television
programming. The Company believes that its employee and labor relations are
good.
Approximately 30 of the Company's current employees (and many of the
employees that the Company hires on a project-by-project basis) are
represented under industry-wide collective bargaining agreements with various
unions, including the Writers Guild of America (the "WGA"), the Directors
Guild of America (the "DGA")
21
the Screen Actors Guild ("SAG"), and the International Alliance of Theatrical
Stage Employees. A strike, job action or labor disturbance by the members of
any of these organizations may have a material adverse effect on the
production of a motion picture or television program within the United States.
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 General Agreement on Trade and Tariffs
Treaty ("GATT"). 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
generally apply only to television programming and not to theatrical
exhibition of motion pictures, but quotas on the theatrical exhibition of
motion pictures could also be enacted in the future. There can be no assurance
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 the
business of the Company by limiting the ability of the Company to exploit
fully its 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. The Company seeks to take appropriate and
reasonable measures to secure, protect and maintain or obtain agreements to
secure, protect and maintain copyright protection for all of its 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 the Company realizes from the
international exploitation of its 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 the
Company) 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 although UIP has filed an application
seeking renewal of such exemption, such renewal has not yet been granted. In
July 1996 the European Commission conducted unannounced visits of four of
UIP's offices in Europe, interviewing officers and copying documents.
22
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, on January 16,
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 indicates that, although a final
decision has not been taken, the Commission is 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 on May 15, 1998 and a hearing was held before the
European Commission in late September 1998. There can be no assurances that
the 1989 exemption will be renewed or renewed on terms acceptable to UIP. If
the 1989 exemption is not renewed at all or not renewed on terms satisfactory
to UIP and UIP ceases or reduces operations, the Company believes that it will
be able to find or develop satisfactory alternative methods for international
distribution, although such alternatives may result in decreased revenues and
profitability from such 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 ("CID") to the Company, requiring it to produce certain
documents and answer certain interrogatories concerning conduct, activities or
proposed action in the motion picture exhibition industry. The Company
believes that similar demands were issued to other major studios. The Company
is in the process of complying with the CID. While the Company has
communicated with the Department of Justice regarding the investigation, the
Company believes it is too early to determine the Department of Justice's
intentions and whether the Company is a target of the investigation.
The Code and Ratings Administration of the MPAA assigns ratings indicating
age-group suitability for theatrical distribution of motion pictures. The
Company has followed and will continue to follow the practice of submitting
its pictures for such ratings. As a substantial number of the Company's films
are rated "R," under rules enforced by theatrical exhibitors, children under
certain ages 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 which 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 the
Company's ability to exhibit certain motion pictures in such media or markets.
Item 2. Properties
The Company leases approximately 375,000 square feet of office space, as
well as related parking facilities, for its corporate headquarters in Santa
Monica, California under several leases which generally expire in May 2003.
The Company also leases approximately 27,000 square feet in New York City for
its East Coast publicity, marketing and theatrical and television distribution
offices under a lease that expires in June 2004. Additionally, the Company
leases approximately 40,000 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 $1.1 million in the aggregate (in addition to taxes, insurance
and certain expenses paid by the Company). The Company has subleased the
office space used by Orion prior to its acquisition by the Company. In
addition, the Company maintains relatively small domestic theatrical and
television distribution branches in Boca Raton, Chicago, Montreal, San Juan
and Toronto and has small international television distribution offices in
London and Sydney. In 1998 the Company closed its Paris office and
consolidated its European distribution operations to its London office. The
Company also leases studio facilities and stages from unaffiliated parties on
an as-needed basis in connection with the production of specific motion
picture and television projects.
The Company believes that its current facilities are adequate to conduct its
business operations for the foreseeable future.
23
Item 3. Legal Proceedings
In the matter entitled Estate of Jim Garrison, et al. v. Warner Bros., Inc.,
et al., which was filed as a putative class action in Los Angeles County
Superior Court in November 1995 against, among others, MGM Pictures and UA
Pictures and the other major studios, the court denied class certification in
August 1996 with respect to the plaintiffs' claims for breach of contract,
breach of implied covenant, unjust enrichment, imposition of constructive
trust and declaratory relief and, initially, granted class certification with
respect to plaintiffs' claims for price fixing under the Sherman Antitrust
Act, price fixing under state law, boycott/concerted refusal to deal under the
Sherman Antitrust Act and boycott/concerted refusal to deal under state law.
The court subsequently announced that its grant of the plaintiffs' class
certification motion might have been "inadvertent" and issued an order on its
own motion requesting briefing on the issue whether the class should be
decertified. After such briefing and by Order dated May 26, 1998, the court
decertified the plaintiff class with respect to plaintiffs' remaining claims
for price fixing under the Sherman Antitrust Act, price fixing under state
law, boycott/concerted refusal to deal under the Sherman Antitrust Act and
boycott/concerted refusal to deal under state law. The plaintiffs have
announced their intention to proceed against all defendants, including MGM
Pictures and UA Pictures, on their legal theories but solely as to the Warner
Bros. motion picture "JFK." Trial has been set for October 18, 1999. The
defendants filed motions for summary judgment. By Order entered January 28,
1999, the court denied defendants' motions in part and continued defendants'
motions in part, reopening discovery limited to certain issues related to one
motion and ordering supplemental briefing regarding those issues. In March
1999, the parties lodged with the court a stipulation and proposed order
dismissing the case with prejudice. The Company anticipates that the court
will order the case dismissed shortly.
In May 1996 MGM Studios initiated an action in Los Angeles County Superior
Court against Disney to compel the reconveyance of rights granted to Disney
Productions with respect to Western European territories under the Disney
License. See "Item 1. Business--Trademarks and Consumer Products." MGM Studios
also claims that Disney Productions' breach of the reconveyance obligation
entitles MGM Studios under the terms of the Disney License to terminate the
Disney License altogether. The Company believes that if the Disney License is
terminated, the loss of revenue to the Company will be minimal, and the
Company may be able to relicense or otherwise exploit these rights on more
favorable terms. Trial proceedings with respect to such action began in
October 1997, and the Company has received a jury verdict in its favor with
respect to the Western European rights on November 5, 1997. The court granted
summary adjudication in favor of Disney denying the Company the right to
terminate Disney's U.S. rights under the Disney License. The Company appealed
this aspect of the decision. In an unpublished opinion filed February 16,
1999, the Court of Appeal affirmed the trial court's summary adjudication in
favor of Disney. The Company filed a petition for rehearing on March 3, 1999,
which was denied on March 11, 1999. On March 26, 1999, the Company filed a
Petition for Review of the Appellate Court's decision with the Supreme Court
of the State of California.
In the two consolidated litigations entitled Turner Broadcasting System,
Inc. et al. vs. Tracinda Corporation and Turner Broadcasting System, Inc., et
al. vs. Metro-Goldwyn-Mayer Inc., (Base File CV-S-97-415), in April 1998 the
Company moved to dismiss the Amended Complaint against it on jurisdictional
grounds. In such litigation, MGM Studios, as successor-in-interest to UA, and
Tracinda are defendants in consolidated actions in the United States District
Court for the District of Nevada. Turner alleges that, as a result of Turner's
1986 acquisition of a predecessor-in-interest to MGM Studios and related
transactions, there was a $260 million tax loss and that the defendants are
contractually obligated to pay over to Turner any resulting tax benefits
attributable to that loss that Tracinda has received or will be allowed. The
Company has not claimed and will not receive any such tax benefits. The
Internal Revenue Service has disallowed both Turner's and Tracinda's tax
claims, which are now subject to appeal from the United States Tax Court.
Based upon information to date, the Company's management believes that it is
unlikely that the Turner litigation will have a material adverse effect on the
Company's financial condition or results of operations. The Nevada court has
stayed the action against MGM Studios pending a final decision in the tax
court proceedings.
Orion is a defendant in a matter entitled Sidney Sapsowitz et al. v. John W.
Kluge, Metromedia International Group, Inc., and Orion Pictures Corp., et al.,
which was filed in June 1997. The plaintiffs claim a "finder's
24
fee" of $28.5 million in connection with the Orion Acquisition. Pursuant to
the terms of agreements executed in connection with the Orion Acquisition, the
Company has indemnification from Metromedia International Group, Inc. with
respect to the payment of any finder's fee. As a result, management believes
that the Sapsowitz litigation will not have any material adverse effect on the
Company's financial condition or results of operations.
In December 1998, the action entitled Samuel Goldwyn, Jr., et al. v. Metro-
Goldwyn-Mayer Studios Inc., et al., which had been pending in the Los Angeles
County Superior Court and in which the Company had been a defendant, was
dismissed by agreement between the parties. The plaintiff's complaint,
originally served in October 1997, had alleged, among other things, fraud and
deceit, breach of various agreements, breach of fiduciary duty, trademark
infringement and unfair competition. The complaint had sought, among other
relief, damages in excess of $5 million, an injunction against the defendants'
use of the trademarks covered by the trademark license, injunctive relief
preventing the Company from using the "Goldwyn" name in connection with the
licensing or exhibition of any new film that had not been acquired by G2
Films, termination of a distribution agreement and unspecified punitive
damages.
On November 17, 1997, the Company and Danjaq filed an action in federal
court in Los Angeles against Sony, Sony Pictures, Columbia, John Calley, Kevin
McClory and Spectre seeking declaratory and injunctive relief and/or damages
for copyright infringement, trademark dilution, slander of title, unfair
competition, inducing breach of contract and breach of fiduciary duties, and
misappropriation of trade secrets, based on Sony Pictures' publicized
assertion on October 13, 1997 that it had the right (together with Mr.
McClory) to create its own James Bond film franchise.
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. In that
connection, Mr. McClory ultimately acquired from Mr. Fleming certain rights to
make a feature film using the James Bond character in these plot lines. 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. Flemings'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. Flemings'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. The Company believes these rights, at most, give Mr. McClory the
right to make films of the story in the novel Thunderball (i.e. a "remake" of
Thunderball). Mr. McClory produced the film Thunderball (with UA and Danjaq)
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.
The complaint filed in November 1997 by the Company and Danjaq seeks various
forms of legal relief based on the Company's position that the defendants do
not have any legal right to produce or distribute a franchise of James Bond
films, or any James Bond films, in the United States. On January 23, 1998, the
Company and Danjaq filed an amended complaint adding claims for trademark
infringement, federal unfair competition
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