UNITED STATESSECURITIES & EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2004
OR
For the transition period from to
Commission File No. 0-16760
MGM MIRAGE
3600 Las Vegas Boulevard South, Las Vegas, Nevada 89109
(702) 693-7120
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.þ Yes o No
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):þ Yes o No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
MGM MIRAGE AND SUBSIDIARIES
I N D E X
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
The accompanying notes are an integral part of these consolidated financial statements.
1
2
3
NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION
MGM MIRAGE (the “Company”), formerly MGM Grand, Inc., is a Delaware corporation, incorporated on January 29, 1986. As of September 30, 2004, approximately 59% of the outstanding shares of the Company’s common stock was owned by Tracinda Corporation, a Nevada corporation wholly-owned by Kirk Kerkorian. MGM MIRAGE acts largely as a holding company and, through wholly-owned subsidiaries, operates and invests in casino resorts, which typically include casinos, hotels, restaurants and other resort amenities.
The Company owns and operates the following casino resorts in Las Vegas, Nevada: Bellagio, MGM Grand Las Vegas, The Mirage, Treasure Island (“TI”), New York-New York and the Boardwalk Hotel and Casino. The Company also owns a 50% interest in the joint venture that owns and operates Monte Carlo Resort & Casino in Las Vegas (50% owned and managed by Mandalay Resort Group) and a 50% interest in the limited liability company developing The Residences at MGM Grand (50% owned and managed by Turnberry Associates), adjacent to MGM Grand Las Vegas. The Residences is a condominium-hotel development and may consist of multiple condominium towers. Construction has begun on Tower 1 and Tower 2 is currently in the sales phase. The Company owns three resorts in Primm, Nevada, at the California/Nevada state line – Whiskey Pete’s, Buffalo Bill’s and the Primm Valley Resort – as well as two championship golf courses located near the resorts. The Company also owns Shadow Creek, an exclusive world-class golf course located approximately ten miles north of its Las Vegas Strip resorts.
The Company, through its wholly-owned subsidiary, MGM Grand Detroit, Inc., and its local partners formed MGM Grand Detroit, LLC, to develop a hotel, casino and entertainment complex in Detroit, Michigan. MGM Grand Detroit, LLC operates a casino in an interim facility located in downtown Detroit. See Note 9 for discussion of the development agreement with the City of Detroit. The Company also owns and operates Beau Rivage, a beachfront resort located in Biloxi, Mississippi, and a 50% interest in a limited liability company that owns Borgata, a casino resort at Renaissance Pointe, located in the Marina area of Atlantic City, New Jersey. Boyd Gaming Corporation owns the other 50% of Borgata and also operates the resort. Borgata opened in July 2003. The Company owns approximately 95 developable acres adjacent to Borgata, a portion of which consists of common roads, landscaping and master plan improvements which the Company designed and developed as required under the agreement with Boyd.
The Company is actively seeking future development opportunities in the United Kingdom, as more fully described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In January 2004, the Company contributed approximately $9 million to its joint venture with Newcastle United PLC, which is refundable if certain conditions are not met by January 2008. In addition, the Company has entered into other agreements related to possible future developments in the United Kingdom which are subject to implementation of proposed gaming law reforms, the grant of applicable planning permissions and the implementation of an appropriate taxation structure.
In June 2004, the Company entered into a joint venture agreement to develop, build and operate a hotel-casino resort in Macau S.A.R. The agreement is subject to, among other things, the approval of the government of Macau S.A.R., and other regulatory approvals, as well as the entry into a subconcession agreement with the holder of one of the existing concessions.
In January 2004, the Company reached agreement with the Board of Directors of Wembley plc (“Wembley”) on the terms of a proposed cash acquisition by the Company of Wembley. Wembley received a higher competing offer and, in May 2004, the Company announced that it would make no further bids for Wembley.
4
In June 2004, the Company entered into a definitive merger agreement with Mandalay Resort Group (“Mandalay”) under which the Company will acquire Mandalay for $71.00 in cash for each share of common stock of Mandalay. Mandalay owns and operates eleven properties in Nevada, including Mandalay Bay, Luxor, Excalibur, Circus Circus, and Slots-A-Fun in Las Vegas, Circus Circus-Reno in Reno, Colorado Belle and Edgewater in Laughlin, Gold Strike and Nevada Landing in Jean, and Railroad Pass in Henderson. Mandalay also owns and operates Gold Strike, a hotel/casino in Tunica County, Mississippi. In addition, Mandalay owns a 50% interest in Silver Legacy in Reno, a 50% interest in Monte Carlo in Las Vegas, a 50% interest in Grand Victoria, a riverboat in Elgin, Illinois, and a 53.5% interest in MotorCity in Detroit, Michigan. The total consideration is approximately $8.1 billion, including equity value of approximately $4.8 billion, convertible debentures with a redemption value of approximately $574 million, the assumption or repayment of other outstanding Mandalay debt with a fair value of approximately $2.6 billion as of September 30, 2004, and $100 million of estimated transaction costs. The transaction is subject to the approval of Mandalay stockholders as well as regulatory and other customary conditions. The transaction will be accounted for as a purchase and is anticipated to close during the first quarter of 2005.
As permitted by the rules and regulations of the Securities and Exchange Commission, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statements should be read in conjunction with the Company’s 2003 annual consolidated financial statements and notes thereto included in the Company’s Current Report on Form 8-K dated July 20, 2004.
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company’s financial position as of September 30, 2004, and the results of its operations for the three and nine month periods ended September 30, 2004 and 2003. The results of operations for such periods are not necessarily indicative of the results to be expected for the full year. Certain reclassifications, which have no effect on previously reported net income, have been made to the 2003 financial statements to conform to the 2004 presentation.
NOTE 2 — DISCONTINUED OPERATIONS
In June 2003, the Company entered into an agreement to sell the Golden Nugget Las Vegas in downtown Las Vegas and the Golden Nugget Laughlin in Laughlin, Nevada (the “Golden Nugget Subsidiaries”), including substantially all of the assets and liabilities of those resorts, for approximately $215 million, subject to certain working capital adjustments. This transaction closed in January 2004, with net proceeds to the Company of $210 million. Also in June 2003, the Company ceased operations of PLAYMGMMIRAGE.com, its online gaming website (“MGM MIRAGE Online”). In February 2004, the Company entered into an agreement to sell the subsidiaries that own and operate MGM Grand Australia. This transaction closed in July 2004 with net proceeds to the Company of $136 million.
The results of the Golden Nugget Subsidiaries, MGM MIRAGE Online and MGM Grand Australia Subsidiaries are classified as discontinued operations in the accompanying consolidated statements of income for all periods presented. Net revenues of discontinued operations were $4 million and $70 million, respectively, for the three months ended September 30, 2004 and 2003, and $45 million and $206 million, respectively, for the nine months ended September 30, 2004 and 2003. Included in income from discontinued operations is an allocation of interest expense based on the ratio of the net assets of the discontinued operations to the total consolidated net assets and debt of the Company. Interest allocated to discontinued operations was $0.2 million and $3 million, respectively, for the three months ended September 30, 2004 and 2003, and $2 million and $9 million, respectively, for the nine months ended September 30, 2004 and 2003. Included in discontinued operations for the three and nine months ended September 30, 2004 is a gain on the sale of the MGM Grand Australia Subsidiaries of $74 million. Also included in discontinued operations for the nine months ended September 30, 2004 is a gain on the sale of the Golden Nugget Subsidiaries of $8 million. Included in discontinued operations for the nine months ended September 30, 2003 is a loss on disposal of MGM MIRAGE Online of $7 million.
5
The following table summarizes the assets and liabilities of discontinued operations as of December 31, 2003 (the Golden Nugget Subsidiaries and Online) included as assets and liabilities held for sale in the accompanying consolidated balance sheet:
NOTE 3 — INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The Company recorded its share of the results of operations of unconsolidated affiliates as follows:
In July 2004, the Company contributed land to The Residences at MGM Grand for construction of the first tower. The equity credit of $9 million is greater than the $3 million previous book value of the land, and the $6 million gain has been deferred until the earnings process is complete, which will occur when The Residences at MGM Grand recognizes revenue on the sale of the first tower’s units.
6
NOTE 4 — LONG-TERM DEBT
Long-term debt consisted of the following:
Total interest incurred for the three month periods ended September 30, 2004 and 2003 was $101 million and $86 million, respectively, of which $6 million and $1 million, respectively, was capitalized. Total interest incurred for the nine month periods ended September 30, 2004 and 2003 was $292 million and $261 million, respectively, of which $14 million and $13 million, respectively, was capitalized.
At September 30, 2004, the Senior Credit Facility consisted of a $2.5 billion senior revolving credit facility which matures in November 2008. Until August 2004, the Senior Credit Facility consisted of a $1.5 billion revolving credit facility and a $1.0 billion term loan.
In the first quarter of 2004, the Company issued $525 million of 5.875% senior notes due 2014. Of this amount, $225 million of the senior notes were issued pursuant to the Company’s shelf registration statement, which completed the available securities issuances under that registration statement, and $300 million of the senior notes were issued through a Rule 144A offering and subsequently exchanged for registered notes with identical terms.
In the third quarter of 2004, the Company issued $550 million of 6.75% senior notes due 2012 through a Rule 144A offering. The Company has filed a registration statement to register the Rule 144A notes under the Securities Act of 1933 as required by the indenture.
Also in the third quarter of 2004, the Company issued $450 million of 6.0% senior notes due 2009 through a Rule 144A offering. The Company has filed a registration statement to register the Rule 144A notes under the Securities Act of 1933 as required by the indenture.
The proceeds of the above offerings were used to reduce outstanding borrowings under the Senior Credit Facility.
7
In August 2003, the Company’s Board of Directors authorized the repurchase of up to $100 million of the Company’s public debt securities, and the Company repurchased $25 million of its senior notes. In March 2004, the Company repurchased $49 million of its senior notes for $52 million, leaving $26 million available for repurchase under the current authorization. The March 2004 repurchases resulted in a loss on early retirement of debt of $6 million, including the write-off of unamortized original issue discount, classified as “Other, net” in the accompanying consolidated statement of income.
The Company attempts to limit its exposure to interest rate risk by managing the mix of its long-term fixed rate borrowings and short-term borrowings under its bank credit facilities. In August 2003, the Company entered into interest rate swap agreements, designated as fair value hedges, which effectively converted $400 million of the Company’s fixed rate debt to floating rate debt. In March 2004, the Company terminated interest rate swap agreements with total notional amounts of $200 million and entered into additional interest rate swap agreements, designated as fair value hedges, with total notional amounts of $100 million, leaving interest rate swap agreements with total notional amounts of $300 million remaining as of September 30, 2004. At September 30, 2004, the fair value of the interest rate swap agreements was an asset of $0.3 million.
Under the terms of the interest rate swap agreements, the Company makes payments based on specified spreads over six-month LIBOR, and receives payments equal to the interest payments due on the fixed rate debt. The interest rate swap agreements qualify for the “shortcut method” allowed under Statement of Financial Accounting Standards No. 133, which allows an assumption of no ineffectiveness in the hedging relationship. As such, there is no income statement impact from changes in the fair value of the hedging instruments. Instead, the fair value of the instruments is recorded as an asset or liability on the Company’s balance sheet, with an offsetting adjustment to the carrying value of the related debt. The Company received $3 million upon termination of swap agreements in March 2004, which has been added to the carrying value of the related debt obligations and is being amortized and recorded as a reduction of interest expense over the remaining life of that debt.
The Company’s long-term debt obligations contain certain customary covenants. The Company’s Senior Credit Facility contains covenants that require the Company to maintain certain financial ratios. At September 30, 2004, the Company was required to maintain a maximum leverage ratio (average debt to EBITDA, as defined) of 5.5:1, which decreases periodically to 4.75:1 by December 2007. The Company must also maintain a minimum coverage ratio (EBITDA to interest charges, as defined) of 2.75:1. As of September 30, 2004, the Company’s leverage and interest coverage ratios were 4.2:1 and 3.8:1, respectively.
NOTE 5 — SHARE REPURCHASES
During the nine months ended September 30, 2004, the Company repurchased 8.0 million shares of its common stock for $349 million, completing the Company’s November 2003 authorization. In July 2004, the Company’s Board of Directors approved a new stock repurchase program, authorizing the purchase of up to an additional 10 million shares of the Company’s common stock, all of which remains available for repurchase at September 30, 2004.
NOTE 6 — INCOME PER SHARE OF COMMON STOCK
The weighted-average number of common and common equivalent shares used in the calculation of basic and diluted earnings per share consisted of the following:
8
NOTE 7 — COMPREHENSIVE INCOME
Comprehensive income consisted of the following:
NOTE 8 — STOCK OPTION PLANS AND STOCK-BASED COMPENSATION
A summary of the status of the Company’s stock option plans is presented below:
As of September 30, 2004, the aggregate number of shares subject to options available for grant under the Company’s stock option plans was 2.3 million.
The Company accounts for stock-based compensation, including employee stock option plans, in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and the Financial Accounting Standards Board’s Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25.” Had the Company accounted for these plans under the fair value method allowed by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”), the Company’s net income and earnings per share would have been reduced to recognize the fair value of employee stock options.
The following are required disclosures under SFAS 123 and SFAS 148:
9
The stock-based compensation included in the table above represents the after-tax amount of pro forma compensation related to stock option plans. Reported net income includes $1 million, net of tax, of amortization of restricted stock compensation for each of the three month periods ended September 30, 2004 and 2003 and $4 million, net of tax, for each of the nine month periods ended September 30, 2004 and 2003.
NOTE 9 – COMMITMENTS AND CONTINGENCIES
Detroit Development Agreement. MGM Grand Detroit, LLC has operated a casino facility in downtown Detroit since July 1999 and is planning a permanent casino facility under a revised development agreement with the City of Detroit entered into in August 2002. As part of the revised development agreement, MGM Grand Detroit, LLC paid the City of Detroit $44 million, agreed to provide letter of credit support for repayment of $50 million of bonds issued by the Economic Development Corporation of the City of Detroit, agreed to transfer assets of $3 million to the City and agreed to indemnify the City for up to $20 million related to the Lac Vieux and certain other litigation. The Lac Vieux litigation challenged the City of Detroit’s process of selecting MGM Grand Detroit, LLC and the other developers to develop casinos in Detroit. In addition to the above payments, the Company will pay the City 1% of gaming revenues (2% if annual revenues exceed $400 million) beginning January 1, 2006. In exchange for these payments, the Company obtained the right to construct its permanent facility at a location other than the originally planned riverfront location, was released from certain requirements related to the permanent casino, including lowering the requirement for the size of the hotel from 800 rooms to 400 rooms, and obtained modifications to certain other obligations.
The Company recorded an intangible asset (development rights, deemed to have an indefinite life) of approximately $115 million in connection with its payment obligations under the revised development agreement, based on the present value of the Company’s obligations. Management determined that the indemnification obligation met the accrual criteria under Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”, and the obligation was accrued as part of the payments under the revised development agreement. At September 30, 2004, the Company’s remaining obligation of $18 million under the indemnification is included in accrued liabilities and the Company’s obligation for the $50 million of bonds is included in other long-term liabilities.
The Company is currently in the process of obtaining land and developing plans for the permanent casino facility and currently expects the project to cost approximately $575 million (including land, capitalized interest and preopening expenses, but excluding the $115 million of payments to the City discussed above). The design, budget and schedule of the permanent facility are at an early stage, and the ultimate timing, cost and scope of the project are subject to risks attendant to large-scale projects. The ability to construct the permanent casino facility is currently subject to resolution of the Lac Vieux litigation. See Part II, Item 1, “Legal Proceedings”, for further information on the status of this litigation.
New York Racing Association. The Company has an understanding with the New York Racing Association (“NYRA”) to manage video lottery terminals (“VLT”) at NYRA’s Aqueduct horseracing facility in metropolitan New York. The Company would assist in the development of the facility, including providing project financing, and would manage the facility for a fee. The project is anticipated to cost $135 million. Work was halted on the VLT facility in August 2003 pending the outcome of an investigation of certain aspects of NYRA’s operations by Federal prosecutors. In December 2003, NYRA reached an agreement with the Justice Department whereby NYRA was indicted with prosecution deferred. NYRA agreed to pay a fine and the indictment will be dismissed with prejudice upon NYRA implementing certain reforms and otherwise complying with the terms of the agreement. The Company’s participation is subject to a definitive agreement, regulatory approvals and certain legislative changes by the State of New York.
Macau. In connection with the Company’s pending joint venture in Macau (see Note 1), the Company has committed to invest up to $280 million in the entity in the form of capital contributions and shareholder loans.
The Residences at MGM Grand. In July 2004, the venture obtained construction financing for up to $210 million for the development of the first tower. The Company has provided a guaranty for up to 50% of the interest and principal payment obligations on the construction financing as well as a completion guaranty. The Company recorded the value of the guaranty obligation, approximately $2 million, in other long-term liabilities.
10
NOTE 10 — PROPERTY TRANSACTIONS, NET
Net property transactions consist of the following:
During 2004, demolition costs relate primarily to the Bellagio expansion and standard room remodel projects and site preparation for The Residences at MGM Grand. During 2003, approximately $3 million of the write downs and substantially all of the demolition costs relate to preparation for KÀ, the new Cirque du Soleil show at MGM Grand Las Vegas. Substantially all of the remaining 2003 write-downs and impairments relate to other assets disposed of in connection with remodeling or expansion projects at MGM Grand Las Vegas.
NOTE 11 — CONSOLIDATING CONDENSED FINANCIAL INFORMATION
The Company’s subsidiaries (excluding MGM Grand Detroit, LLC and certain minor subsidiaries) have fully and unconditionally guaranteed, on a joint and several basis, payment of the Senior Credit Facility, the senior notes and the senior subordinated notes. Separate condensed financial statement information for the subsidiary guarantors and non-guarantors as of September 30, 2004 and December 31, 2003 and for the three and nine month periods ended September 30, 2004 and 2003 is as follows:
CONDENSED CONSOLIDATING BALANCE SHEET INFORMATION
11
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS INFORMATION
12
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS INFORMATION
13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Overview
Our operations consist of 11 wholly-owned casino resorts and 50% investments in two other casino resorts, including:
In February 2004, we entered into an agreement to sell the subsidiaries that own and operate MGM Grand Australia. This transaction closed in July 2004 with net proceeds to the Company of $136 million. We reported an after tax gain of $51 million upon the closing of the sale. We are evaluating the impact of provisions of the recently enacted American Jobs Creation Act of 2004 that provide tax relief on repatriated earnings of foreign subsidiaries. If we conclude that these provisions apply to our planned repatriation of the net proceeds from this transaction in a manner that we believe Congress intended, we will recognize a tax benefit of approximately $7 million as part of continuing operations in the quarter in which we reach this conclusion. Additional guidance from Congress and/or the United States Treasury Department may be necessary for us to make this determination.
In June 2004, we announced that we had entered into a definitive merger agreement with Mandalay Resort Group (“Mandalay”) under which we will acquire Mandalay for $71.00 in cash for each share of common stock of Mandalay. Mandalay owns and operates eleven properties in Nevada, including Mandalay Bay, Luxor, Excalibur, Circus Circus, and Slots-A-Fun in Las Vegas, Circus Circus-Reno in Reno, Colorado Belle and Edgewater in Laughlin, Gold Strike and Nevada Landing in Jean, and Railroad Pass in Henderson. Mandalay also owns and operates Gold Strike, a hotel/casino in Tunica County, Mississippi. In addition, Mandalay owns a 50% interest in Silver Legacy in Reno, a 50% interest in Monte Carlo in Las Vegas, a 50% interest in Grand Victoria, a riverboat in Elgin, Illinois, and a 53.5% interest in MotorCity in Detroit, Michigan. The total consideration is approximately $8.1 billion, including equity value of approximately $4.8 billion, convertible debentures with a redemption value of approximately $574 million, the assumption or repayment of other outstanding Mandalay debt with a fair value of approximately $2.6 billion as of September 30, 2004, and $100 million of estimated transaction costs. The transaction is anticipated to close during the first quarter of 2005.
We operate in one segment, the operation of casino resorts, which includes offering gaming, hotel, dining, entertainment, retail, convention services and other resort amenities. Slightly over half of our net revenues are derived from gaming activities, a lower percentage than many of our competitors, as our operating philosophy is to provide a complete resort experience for our guests, including non-gaming amenities which command a premium price based on their quality. We believe that we own several of the premier casino resorts in the world, and a main focus of our strategy is to continually reinvest in these resorts to maintain that competitive advantage.
14
We generate a majority of our net revenues and operating income from our resorts in Las Vegas, Nevada. In 2003, over 75% of our net revenues and operating income was generated by wholly-owned Las Vegas resorts. Earning a majority of our operating profit from our Las Vegas resorts exposes us to certain risks outside of our control, such as competition from other Las Vegas resorts, including several expanded resorts and a major new competitor expected to open in 2005, and the impact from expansion of gaming in California. We are also exposed to risks related to tourism and the general economy, including national and global economic conditions and terrorist attacks or other global events.
As a resort-based company, our operating results are highly dependent on the volume of customers at our resorts, which in turn impacts the price we can charge for our hotel rooms and other amenities. We also generate a significant portion of our operating income from high-end gaming customers, which can cause variability in our results. Key performance indicators related to revenue are:
A full description of our operations, key performance indicators and outlook can be found in our Annual Report on Form 10-K for the year ended December 31, 2003.
Financial Results
The following discussion is based on our consolidated financial statements for the three and nine months ended September 30, 2004 and 2003. On a consolidated basis, the most important factors and trends contributing to our operating performance for the quarter were:
As a result of the above factors and trends, our net revenues increased 6% in the quarter and 9% for the nine months over the same prior-year periods. Our operating income in 2004 increased 40% and 51% for the quarter and year-to-date, respectively, due to the strong revenue trends and the operating leverage obtained from the increased pricing of rooms and other amenities, along with the income from Borgata, which was not open in the full prior year nine month period. In addition, strong collections of gaming markers and an improved outlook on existing accounts led to decreases in the provision for doubtful accounts in the three and nine month periods.
Income from continuing operations increased 84% and 90% over the 2003 three and nine month periods, respectively. On a diluted per share basis, income from continuing operations doubled for both the quarter and nine months, due to the increase in income from continuing operations and a lower weighted average number of shares outstanding resulting from share repurchases throughout 2003 and the first half of 2004.
15
Operating Results – Detailed Revenue Information
The following table presents detail of our net revenues:
The increase in table games revenues in the nine months was driven by volume increases, as we experienced strong volumes during the key Chinese New Year and Super Bowl periods and hosted a baccarat tournament at MGM Grand Las Vegas in April. Table games hold percentages were within a normal range for all periods, though towards the low end of the normal range in both three month periods, and did not vary significantly between the current year periods and prior year periods. Slot revenues continued to show strong year-over-year gains, a trend that started in 2003. This is the result of strong visitation, the additional traffic generated by new resort amenities, the impact of our Players Club rewards program, which was implemented in our major resorts over 2002 and 2003, and the implementation of cashless gaming technology in 2003.
Non-casino revenue increased in 2004 primarily due to increased spending by guests, strong conference and group business, and higher room rates in all segments. In the third quarter of 2004, REVPAR was $117, up 9% from the prior year quarter. For the nine months, REVPAR increased 9% to $121. At our Las Vegas resorts, REVPAR was $134 in the 2004 quarter and $141 in the 2004 nine months, increases of 10% and 11%, respectively. These REVPAR increases were driven almost entirely by higher rates, as occupancy was up only slightly compared to prior year. Entertainment, retail and other revenue was positively impacted by the inclusion of Zumanity for a full period and the $6 million of business interruption proceeds recorded in the second quarter for the Bellagio power outage, offset by the closure of the Siefgried & Roy show in October 2003.
Operating Results – Details of Certain Charges
Preopening and start-up expenses consisted of the following:
16
Property transactions, net consisted of the following:
During 2004, demolition costs relate primarily to the Bellagio expansion and standard room remodel projects and site preparation for The Residences at MGM Grand. Net (gains) losses on fixed asset disposals include net recoveries, in excess of carrying amount, of $1.1 million related to equipment damaged in the power outage at Bellagio. During 2003, approximately $3 million of the write downs and substantially all of the demolition costs relate to preparation for KÀ, the new Cirque du Soleil show at MGM Grand Las Vegas. Substantially all of the remaining 2003 write-downs and impairments relate to other assets disposed of in connection with remodeling or expansion projects at MGM Grand Las Vegas.
Non-operating Results
Net interest expense increased to $95 million and $278 million in the 2004 quarter and nine months, respectively, from $85 million and $248 million in the 2003 quarter and nine months, due to the issuance of fixed rate debt in the first and third quarters of 2004, higher variable market interest rates and higher debt levels in 2004.
For the third quarter of 2004, our effective income tax rate on continuing operations was 37%, higher than the prior year’s rate of 36%. The current year rate was impacted by non-deductible costs related to funding support of a ballot initiative in Michigan. In addition, we recorded substantially offsetting tax adjustments. In the third quarter of 2004, the statute of limitations expired for our 2000 tax return, and we reversed $6 million of previously recorded tax reserves related to that tax year. We also recorded $7 million, net of Federal tax benefit, of additional state deferred taxes related to capital investments in New Jersey. The effective tax rate was 37% for the year-to-date periods in both 2004 and 2003.
Discontinued Operations
Income from discontinued operations was $51 million in the third quarter of 2004, almost entirely consisting of the gain on the sale of the MGM Grand Australia Subsidiaries. Income from discontinued operations for the nine months of $62 million also includes the operating results of the MGM Grand Australia Subsidiaries through July 2004 and the $4 million after tax gain on the sale of the Golden Nugget Subsidiaries. Prior year results of discontinued operations include the operating results of the MGM Grand Australia Subsidiaries and the Golden Nugget Subsidiaries, and the loss on disposal of MGM MIRAGE Online of $7 million in June 2003.
Factors Affecting Future Results
Effective September 1, 2004, the gaming tax rate in Michigan increased from 18% to 24%, provided that once our subsidiary begins operation of the permanent casino complex the rate will be reduced to 19%, and if our subsidiary does not complete a permanent casino complex by July 2009, the rate will increase on a graduated basis to 27%. Taxable gaming revenues for MGM Grand Detroit were approximately $403 million for the year ended December 31, 2003 and approximately $330 million for the nine months ended September 30, 2004.
17
KÀ opens at MGM Grand Las Vegas in late November 2004 and the Bellagio expansion opens in late December 2004, affecting both operating results and depreciation expense. The issuance of fixed rate debt in the third quarter of 2004, proceeds of which were used to repay lower-rate credit facility borrowings, will cause interest expense to increase in the fourth quarter compared to the prior year period.
Our effective tax rate for the fourth quarter may be positively impacted by the potential $7 million benefit related to repatriating the MGM Grand Australia sale proceeds, offset partially by continued non-deductible funding of a ballot initiative in Michigan.
Liquidity and Capital Resources
Cash Flows – Operating Activities
Trends in our operating cash flows tend to follow trends in our operating income, excluding non-cash charges, since our business is primarily cash-based. Cash flow from operations in the nine months ended September 30, 2004 increased from 2003, resulting from the increase in operating income, excluding non-cash charges, offset by increased interest and tax payments and the fact that Borgata’s income is not resulting in cash flow (Borgata has not yet made any distributions). At September 30, 2004, we held cash and cash equivalents of $356 million, higher than normal due to cash held in Australia after the sale of the MGM Grand Australia Subsidiaries The Company may repatriate these funds in the fourth quarter.
Cash Flows – Investing Activities
Capital expenditures of $526 million through September 30, 2004 were significantly higher than the $358 million spent in 2003, due largely to major projects at our existing resorts. These projects included:
Remaining 2004 capital expenditures were for general property improvements. Remaining 2003 capital expenditures consisted primarily of construction of the new theatre at New York-New York and implementation of new slot technology, along with general property improvements.
Investments in unconsolidated affiliates for the 2004 period primarily represent our contribution to our joint venture with Newcastle United PLC, which is refundable if certain conditions are not met by January 2008.
We received net proceeds of $210 million upon the closing of the sale of the Golden Nugget Subsidiaries in January 2004. The proceeds were used to reduce outstanding borrowings under our bank credit facility. We received net proceeds of $136 million upon the closing of the sale of the MGM Grand Australia Subsidiaries in July 2004. Once repatriated, the proceeds will be used to fund capital expenditures in the United States or to reduce outstanding borrowings under our bank credit facility in order to enhance our capital structure.
18
Cash Flows – Financing Activities
In February and March 2004, we issued $525 million of 5.875% Senior Notes, due 2014. In August 2004, we issued $550 million of 6.75% Senior Notes, due 2012. In September 2004, we issued $450 million of 6% Senior Notes due 2009 at a premium to yield 5.65%. Through September 30, 2004, we repaid a net $1.5 billion on our bank credit facilities and repurchased $49 million of our existing senior notes for $52 million, resulting in a loss on early retirement of debt of $6 million (including the write-off of unamortized original issue discount), which is classified as “Other, net” in the accompanying consolidated statement of income.
We repurchased 8.0 million shares of our common stock during the first nine months of 2004 at a total cost of $349 million, completing our November 2003 authorization. Our share repurchases are conducted under repurchase programs approved by our Board of Directors and publicly announced. At September 30, 2004, we had 10 million shares available for repurchase under a new 10 million share repurchase program, approved by the Board of Directors in July 2004. We received $90 million of proceeds from the exercise of employee stock options in the first nine months of 2004. As of September 30, 2004, we had approximately $2.3 billion of available liquidity under our bank credit facilities.
Other Factors Affecting Liquidity
We have received commitments from our lenders to increase the capacity of our senior credit facility to $7 billion, providing the necessary financing for the pending Mandalay acquisition.
The proposed joint venture in Macau, the proposed investments in the United Kingdom and any other development activity will require significant additional sources of funds beyond expected operating cash flow and current availability under our senior credit facility. We may raise additional funds through increased bank financing, the issuance of notes or the issuance of equity.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements. To prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, we must make estimates and assumptions that affect the amounts reported in the consolidated financial statements. We regularly evaluate these estimates and assumptions, particularly in areas we consider to be critical accounting estimates, where changes in the estimates and assumptions could have a material impact on our results of operations, financial position and, generally to a lesser extent, cash flows. Senior management and the Audit Committee of the Board of Directors have reviewed the disclosures included herein about our critical accounting estimates, and have reviewed the processes to determine those estimates.
A complete description of our critical accounting policies and estimates can be found in our Annual Report on Form 10-K for the year ended December 31, 2003. We present below a discussion of our policies related to income taxes, which has been updated from the discussion included in our Annual Report.
Income taxes
We are subject to income taxes in the United States, and in several states and foreign jurisdictions. We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109 requires the recognition of deferred tax assets, net of applicable reserves, related to net operating loss carryforwards, tax credits and certain temporary differences. The standard requires recognition of a future tax benefit to the extent that realization of such benefit is more likely than not. Otherwise, a valuation allowance is applied.
19
Our income tax returns are subject to examination by the Internal Revenue Service (“IRS”) and other tax authorities. While positions taken in tax returns are sometimes subject to uncertainty in the tax laws, we do not take such positions unless we have “substantial authority” to do so under the Internal Revenue Code and applicable regulations. We may take positions on our tax returns based on substantial authority that are not ultimately accepted by the IRS.
We assess such potential unfavorable outcomes based on the criteria of Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“SFAS 5”). We establish a tax reserve if an unfavorable outcome is probable and the amount of the unfavorable outcome can be reasonably estimated. We assess the potential outcomes of tax uncertainties on a quarterly basis. In determining whether the probable criterion of SFAS 5 is met, we presume that the taxing authority will focus on the exposure and we assess the probable outcome of a particular issue based upon the relevant legal and technical merits. We also apply our judgment regarding the potential actions by the tax authorities and resolution through the settlement process.
We maintain required tax reserves until such time as the underlying issue is resolved. When actual results differ from reserve estimates, we adjust the income tax provision and our tax reserves in the period resolved. For tax years that are examined by taxing authorities, we adjust tax reserves in the year the tax examinations are settled. For tax years that are not examined by taxing authorities, we adjust tax reserves in the year that the statute of limitations expires. Our estimate of the potential outcome for any uncertain tax issue is highly judgmental, and we believe we have adequately provided for any reasonable and foreseeable outcomes related to uncertain tax matters. In the third quarter of 2004, the statute of limitations expired for our 2000 tax return, and we reversed $6 million of previously recorded tax reserves related to that tax year.
We classify reserves for tax uncertainties within “other accrued liabilities” in the accompanying consolidated balance sheets, separate from any related income tax payable or deferred income taxes. Reserve amounts may relate to the deductibility of an item, as well as potential interest associated with those items.
Recently Issued Accounting Standards
There are no accounting standards issued before September 30, 2004 but effective after September 30, 2004, which are expected to have a material impact on our financial reporting.
Market Risk
Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and commodity prices. Our primary exposure to market risk is interest rate risk associated with our variable rate long-term debt. We attempt to limit our exposure to interest rate risk by managing the mix of our long-term fixed rate borrowings and short-term borrowings under our bank credit facilities.
In the third quarter of 2003, we entered into interest rate swap agreements, designated as fair value hedges, which effectively convert $400 million of our fixed rate debt to floating rate debt. In March 2004, the Company terminated interest rate swap agreements with total notional amounts of $200 million and entered into additional interest rate swap agreements, designated as fair value hedges, with total notional amounts of $100 million, leaving interest rate swap agreements with total notional amounts of $300 million remaining as of September 30, 2004. Under the terms of these agreements, we make payments based on specified spreads over six-month LIBOR, and receive payments equal to the interest payments due on the fixed rate debt. The interest rate swap agreements qualify for the “shortcut method” allowed under Statement of Financial Accounting Standards No. 133, which allows an assumption of no ineffectiveness in the hedging relationship. As such, there is no income statement impact from changes in the fair value of the hedging instruments.
20
The following table provides information about our interest rate swaps as of September 30, 2004:
* Interest rates are determined in arrears. These rates have been estimated based on implied forward rates in the yield curve.
As of September 30, 2004, after giving effect to the interest rate swaps discussed above, long-term fixed rate borrowings represented approximately 91% of our total borrowings. This ratio is higher than our typical mix of fixed and floating rate debt. However, we anticipate a more normal mix upon the closing of the Mandalay acquisition and funding of our $7 billion credit facility. Assuming a 100 basis-point change in LIBOR, our annual interest cost would change by approximately $5 million.
Safe Harbor Provision
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information included in this report contains statements that are forward-looking, such as statements relating to plans for future expansion and other business development activities, as well as other capital spending, financing sources, the effects of regulation (including gaming and tax regulations) and competition. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to competition, development and construction activities, dependence on existing management, leverage and debt service (including sensitivity to fluctuations in interest rates), domestic or international economic conditions (including sensitivity to fluctuations in foreign currencies), pending or future legal proceedings, changes in federal or state tax laws or the administration of such laws, changes in gaming laws or regulations (including the legalization of gaming in certain jurisdictions) and application for licenses and approvals under applicable jurisdictional laws and regulations (including gaming laws and regulations).
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We incorporate by reference the information appearing under “Market Risk” in Part I, Item 2 of this Form 10-Q.
Item 4. Controls and Procedures
Our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) have concluded that the design and operation of our disclosure controls and procedures are effective as of September 30, 2004. This conclusion is based on an evaluation conducted under the supervision and with the participation of Company management. Disclosure controls and procedures are those controls and procedures which ensure that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported in a timely manner and in accordance with Securities and Exchange Commission rules and regulations.
During the quarter ended September 30, 2004, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to affect, our internal control over financial reporting.
21
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Poulos Slot Machine Litigation
For a complete description of the facts and circumstances surrounding this litigation, see our Annual Report on Form 10-K for the year ended December 31, 2003.
In June 2002, the U.S. District Court in Nevada ruled that the plaintiffs met the prerequisite requirements for class-action status, but the Court denied the plaintiff’s motion for class action certification, saying that the proposed class lacked the cohesiveness required to settle common claims against the casino industry. The court had previously stayed discovery pending resolution of these class certification issues. In August 2004, the Ninth Circuit Court of Appeals affirmed the District Court’s ruling denying class-action status for the case. In November 2004, the District Court set a discovery deadline of April 2005 and a trial date in September 2005.
Boardwalk Shareholder Litigation
On September 28, 1999, a former stockholder of our subsidiary which owns and operates the Boardwalk Hotel and Casino filed a first amended complaint in a putative class action lawsuit in District Court for Clark County, Nevada against Mirage and certain former directors and principal stockholders of the Boardwalk subsidiary. The complaint alleged that Mirage induced the other defendants to breach their fiduciary duties to Boardwalk’s minority stockholders by devising and implementing a scheme by which Mirage acquired Boardwalk at significantly less than the true value of its shares. The complaint sought an unspecified amount of compensatory damages from Mirage and punitive damages from the other defendants, whom we are required to defend and indemnify.
In June 2000, the court granted our motion to dismiss the complaint for failure to state a claim upon which relief may be granted. The plaintiff appealed the ruling to the Nevada Supreme Court. The parties filed briefs with the Nevada Supreme Court, and oral arguments were conducted in October 2001. In February 2003, the Nevada Supreme Court overturned the District Court’s order granting our motion to dismiss the complaint and remanded the case to the District Court for further proceedings on the elements of the lawsuit involving wrongful conduct in approving the merger and/or in the valuation of the merged corporation’s shares. The Nevada Supreme Court affirmed the District Court’s dismissal of the plaintiff’s claims for lost profits and mismanagement. The Nevada Supreme Court’s ruling relates only to the District Court’s ruling on our motion to dismiss and is not a determination of the merits of the plaintiff’s case. The plaintiff filed an amended complaint, and in October 2003, the District Court certified the action as a class action.
The parties have undertaken written discovery and have taken the deposition of the class representative, Harvey Cohen. As a result of Cohen’s deposition, the Company has filed a Motion to Decertify the Class which is scheduled to be heard on November 16, 2004. Additional discovery and depositions are underway in the meantime. The trial date for this action is currently set for January 31, 2005. We will continue to vigorously defend our position that the Plaintiffs’ claims are without merit.
Detroit Slot Machine Litigation
For a complete description of the facts and circumstances surrounding this litigation, see our Annual Report on Form 10-K for the year ended December 31, 2003 and our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.
In April 2004, the Michigan Court of Appeals, an intermediate appellate court, affirmed the trial court’s dismissal of the plaintiff’s claims. The Michigan Court of Appeals held that the plaintiff’s claims are exempt from the Michigan Consumer Protection Act because the operation of the slot machines was specifically authorized by the Michigan Gaming Control Board, and that the plaintiff’s common law claims are pre-empted by the Michigan Act. The Plaintiff did not seek review of the appellate court decision by the Michigan Supreme Court and, therefore, the decision of the Michigan Court of Appeals is final.
22
Lac Vieux Litigation
For a complete description of the facts and circumstances surrounding the case of Lac Vieux Desert Band of Lake Superior Chippewa Indians v. Michigan Gaming Control Board, et. al., see our Annual report on Form 10-K for the year ended December 31, 2003. As of December 31, 2003, the casino developers, including our subsidiary, were prohibited from developing permanent casino complexes under an injunction issued by the 6th Circuit Court of Appeals.
In December 2003, the Tribe and the owners of the two other casinos filed a joint motion with the 6th Circuit Court requesting approval of the terms of a partial settlement, asserted to have resolved the case among the filing parties. The settlement calls for exemption of those developers from a reselection process and other related relief, in exchange for cash payments to the Tribe, but purports to continue the Tribe’s appeal as it relates to our subsidiary. In a subsequent filing, the settling parties requested that issues pertaining to this partial settlement be remanded to the District Court for consideration. Our subsidiary filed a responsive motion with the 6th Circuit Court requesting dismissal of the appeal as moot, or, upon denial of such relief, expedited decision of our cross appeal and a full briefing on the issues surrounding the proposed partial settlement.
In February 2004, the 6th Circuit Court remanded the proposed settlement to the District Court for review and approval. In remanding the case, the 6th Circuit Court directed that the non-settling parties should not be prejudiced by the actions of the settling parties.
In April 2004, the District Court issued a ruling approving the proposed settlement among Lac Vieux, Greektown Casino and Detroit Entertainment/Atwater. As to the position of the Company’s subsidiary in the case, the District Court’s settlement opinion observed that Lac Vieux’s proposed relief of rebidding of the subsidiary’s casino development would be inequitable to our subsidiary, since our subsidiary was not eligible for, did not seek and did not receive any preferential treatment in the casino selection process. The District Court also stated that Lac Vieux’s agreement in the settlement not to pursue rebidding of the developments of the two parties who did receive preferences strengthens our subsidiary’s legal position that a rebidding of only one casino development would make the rebidding process even more inequitable as to our subsidiary.
In May 2004, our subsidiary filed a notice of appeal to the 6thCircuit Court of the District Court’s approval of the proposed consent judgment in order to preserve certain issues regarding the appropriateness of remedies for further briefing and argument should the Tribe prevail in its appeal and our subsidiary not prevail in its cross-appeal. Our subsidiary followed with a motion for scheduling of review of all matters remaining before the 6th Circuit Court. Aside from review of the District Court’s approval of the settlement, several other matters in the litigation remain pending before the 6th Circuit, including our subsidiary’s motion to dismiss Lac Vieux’s appeal on the grounds that the settlement makes the appeal moot; Lac Vieux’s continuing appeal and request for a rebid as to our subsidiary’s Detroit casino development; our subsidiary’s cross-appeal of the District Court’s denial of the subsidiary’s request for declaratory ruling that it should not be subject to rebid because it never received a preference in the developer selection process; and the injunction prohibiting construction of permanent casino complexes pending further action by the 6th Circuit Court.
In June 2004, the 6th Circuit Court issued an order directing the parties to file letter briefs stating their respective positions on questions posed by that court concerning what parties and issues would remain to be decided if the 6th Circuit Court approved the settlement and dissolved the injunction. All parties filed letter briefs in response to the 6th Circuit Court’s directive. In July 2004, the 6thCircuit Clerk notified all parties that nothing further need be filed and that the panel of judges assigned to the appeals will proceed as expeditiously as possible to dispose of the questions presented. The timetable for the 6th Circuit’s further review of this case is uncertain. Our subsidiary intends to continue to vigorously defend its positions in this case.
23
Item 2. Changes in Securities and Use of Proceeds
Our share repurchases are only conducted under repurchase programs approved by our Board of Directors and publicly announced. The following table includes information about our share repurchases for the quarter ended September 30, 2004:
Item 6. Exhibits and Reports on Form 8-K
24
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
26