UNITED STATES
SECURITIES & EXCHANGE COMMISSION
FORM 10-Q
For the quarterly period ended June 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. x Yes o No
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act): x 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
The accompanying notes are an integral part of these consolidated financial statements.
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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 June 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 and a 50% interest in the limited liability company developing The Residences at MGM Grand, a 576-unit condominium tower adjacent to MGM Grand Las Vegas. 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 revised 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. See Note 2 for information regarding operations classified as discontinued operations.
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 and a tax structure acceptable to the Company.
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.
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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 June 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 June 30, 2004, and the results of its operations for the three and six month periods ended June 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 have been made to the 2003 financial statements to conform to the 2004 presentation, which have no effect on previously reported net income.
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 proceeds to the Company of A$195 million (approximately $140 million), plus certain working capital adjustments. The Company expects to report an after-tax gain from the sale of discontinued operations of approximately $50 million in the third quarter of 2004.
The results of the Golden Nugget Subsidiaries, MGM MIRAGE Online and MGM Grand Australia are classified as discontinued operations in the accompanying consolidated statements of income for all periods presented. Net revenues of discontinued operations were $14 million and $67 million, respectively, for the three months ended June 30, 2004 and 2003, and $41 million and $137 million, respectively, for the six months ended June 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 $1 million and $3 million, respectively, for the three months ended June 30, 2004 and 2003, and $2 million and $6 million, respectively, for the six months ended June 30, 2004 and 2003. Included in discontinued operations for the six months ended June 30, 2004 is a gain on the sale of the Golden Nugget Subsidiaries of $8 million. Included in discontinued operations for the three and six months ended June 30, 2003 is a loss on disposal of MGM MIRAGE Online of $7 million.
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The following table summarizes the assets and liabilities of discontinued operations as of June 30, 2004 (MGM Grand Australia), and December 31, 2003 (the Golden Nugget Subsidiaries and Online) included as assets and liabilities held for sale in the accompanying consolidated balance sheets:
NOTE 3 — INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The Company recorded its share of the results of operations of unconsolidated affiliates as follows:
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NOTE 4 — LONG-TERM DEBT
Long-term debt consisted of the following:
Total interest incurred for the three month periods ended June 30, 2004 and 2003 was $98 million and $86 million, respectively, of which $5 million and $6 million, respectively, was capitalized. Total interest incurred for the six month periods ended June 30, 2004 and 2003 was $190 million and $175 million, respectively, of which $8 million and $12 million, respectively, was capitalized.
At June 30, 2004, the Senior Credit Facility consisted of (1) a $1.5 billion senior revolving credit facility which matures on November 24, 2008; and (2) a $1.0 billion term loan.
During 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. The Company has filed a registration statement to register the Rule 144A notes under the Securities Act as required by the indenture. The proceeds of these offerings were used to reduce the amount outstanding under the Company’s $1.5 billion revolving credit facility.
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. During 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.
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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 June 30, 2004. At June 30, 2004, the fair value of the interest rate swap agreements was a liability of $8 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 June 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 June 30, 2004, the Company’s leverage and interest coverage ratios were 4.3:1 and 3.8:1, respectively.
NOTE 5 — SHARE REPURCHASES
During the six months ended June 30, 2004, the Company repurchased 7.9 million shares of its common stock for $344 million, leaving 0.1 million shares authorized for future purchase as of June 30, 2004 under the November 2003 authorization by the Board of Directors. 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.
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:
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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 June 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:
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 June 30, 2004 and 2003 and $2 million and $3 million, net of tax, for the six months ended June 30, 2004 and 2003, respectively.
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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 June 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 is 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.
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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 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 June 30, 2004 and December 31, 2003 and for the three and six month periods ended June 30, 2004 and 2003 is as follows:
CONDENSED CONSOLIDATING BALANCE SHEET INFORMATION
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS INFORMATION
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS INFORMATION
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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 proceeds to the Company of A$195 million (approximately $140 million), plus certain working capital adjustments. We expect to report an after-tax gain from the sale of discounted operations of approximately $50 million in the third quarter of 2004.
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 June 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.
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. However, 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 potential 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:
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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 six months ended June 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 10% in the quarter and 11% for the six months over the same prior year periods. Our operating income in 2004 increased 52% and 56% for the quarter and year-to-date, respectively, due to the strong revenue trends and the operating leverage obtained from the increased room and pricing, along with the income from Borgata, which was not open in the prior year periods. Several of our resorts set records for net revenues and operating income performance in a single quarter, driven by new amenities and significant increases in room rates earned during the quarter.
Income from continuing operations increased 87% and 93% over the 2003 quarter and six month periods, respectively. On a diluted per share basis, income from continuing operations increased 94% for the quarter and 103% for the six months, as we had a lower weighted average number of shares outstanding resulting from share repurchases throughout 2003 and the first half of 2004.
Operating Results – Detailed Revenue Information
The following table presents detail of our net revenues:
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Increases in table games revenues in both the quarter and six months were 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 and varied very little 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 and 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. For both the quarter and six months ended June 30, 2004, REVPAR was $123 compared to $111 in the 2003 second quarter and $112 in the 2003 six month period, increases of 11% for the quarter and 10% for the six months. At our Las Vegas resorts, REVPAR was $142 in the 2004 quarter and $144 in the 2004 six months, increases of 12% in both periods over prior year. These REVPAR increases were driven almost entirely by higher rates, as occupancy was up only slightly compared to prior year. Other revenue includes business interruption proceeds of $6 million for the Bellagio power outage. Based on information from the Company’s insurance provider, this amount is a reasonable estimate of the minimum amount the Company should receive upon final settlement of the claim. Therefore, the Company expects that further recoveries may be recorded in future periods.
Operating Results – Details of Certain Charges
Preopening and start-up expenses consisted of the following:
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 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 $93 million and $182 million in the 2004 quarter and six months, respectively, from $80 million and $163 million in the 2003 quarter and six months, due to higher debt levels and lower capitalized interest. In 2003, we were capitalizing interest related to our investment in Borgata.
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The effective income tax rate was 36% in both the quarter and year-to-date periods in 2004, which was lower than the 37% rate in the 2003 quarter and 38% rate in the 2003 year-to-date period due to higher income levels and stable amounts of non-deductible items.
Discontinued Operations
Income from discontinued operations increased to $3 million in the second quarter of 2004 from a loss of $1 million in the year-ago period, due to the 2003 loss on disposal of MGM MIRAGE Online of $7 million, offset by not having the results of the Golden Nugget Subsidiaries. For the six months, income from discontinued operations increased from $2 million to $12 million, due to the MGM MIRAGE Online loss in 2003 and the $5 million after-tax gain on sale of the Golden Nugget Subsidiaries in 2004, offset by not having a full period of results of the Golden Nugget Subsidiaries in 2004.
Factors Affecting Future Results
In August 2004, the Michigan state legislature approved an increase to the gaming tax rate in Michigan from 18% to 24%, effective September 1, 2004, 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%. The legislation still requires approval from the Governor of Michigan. Taxable gaming revenues for MGM Grand Detroit were approximately $403 million for the year ended December 31, 2003 and approximately $225 million for the six months ended June 30, 2004.
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 six months ended June 30, 2004 increased from 2003, resulting from the increase in operating income, excluding non-cash charges. The increase in operating cash flow was not as significant, on a relative basis, as the increase in operating income due to Borgata’s income not resulting in cash flow (Borgata has not yet made any distributions) and the timing of hotel sales on credit, primarily to large groups. At June 30, 2004, we held cash and cash equivalents of $186 million.
Cash Flows – Investing Activities
Capital expenditures of $347 million through June 30, 2004 were significantly higher than the $222 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. Capital expenditures in the prior year period primarily consisted 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 quarter primarily represent our contribution to our joint venture with Newcastle United PLC, which is refundable if certain conditions are not met by January 2008, and required contributions to The Residences at MGM Grand, our joint venture with Turnberry Associates.
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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.
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Cash Flows – Financing Activities
In February and March 2004, we issued $525 million of 5.875% Senior Notes, due 2014. Through June 30, 2004, we repaid a net $475 million 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 7.9 million shares of our common stock during the first six months of 2004 at a total cost of $344 million. Our share repurchases are conducted under repurchase programs approved by our Board of Directors and publicly announced. At June 30, 2004, we had 0.1 million shares available for repurchase under the November 2003 authorization. In July 2004, our Board of Directors approved a new 10 million share repurchase program. We received $86 million of proceeds from the exercise of employee stock options in the first six months of 2004. As of June 30, 2004, we had approximately $1.4 billion of available liquidity under our bank credit facilities.
Other Factors Affecting Liquidity
The proposed acquisition of Mandalay, the proposed joint venture in Macau and the proposed investments in the United Kingdom 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 in which we operate. 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.
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.
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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.
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 June 30, 2004 but effective after June 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 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 June 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.
The following table provides information about our interest rate swaps as of June 30, 2004:
* Interest rates are determined in arrears. These rates have been estimated based on implied forward rates in the yield curve.
As of June 30, 2004, after giving effect to the interest rate swaps discussed above, long-term fixed rate borrowings represented approximately 74% of our total borrowings. Assuming a 100 basis-point change in LIBOR, our annual interest cost would change by approximately $14 million.
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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 June 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 June 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.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Detroit Slot Machine Litigation
In July 2001, an individual, Mary Kraft, filed a complaint in the Wayne County Circuit Court in Detroit, Michigan, against International Game Technology, Anchor Gaming, Inc. and the three operators of casinos in Detroit, Michigan, including a subsidiary of the Company. The plaintiff claimed the bonus wheel feature of the Wheel of Fortune® and I Dream of Jeannie™ slot machines, which are manufactured, designed and programmed by International Game Technology and/or Anchor Gaming, Inc., are deceptive and misleading. The complaint alleged violations of the Michigan Consumer Protection Act, common law fraud. The plaintiff sought to certify a class of any individual in Michigan who had played either of these games since June of 1999. The machines and their programs were approved for use by the Michigan Gaming Control Board, the administrative agency responsible for policing the Detroit casinos.
We, along with the other casino operators, filed a motion for summary disposition arguing that the plaintiff’s complaint fails to state a claim as a matter of law. In April 2002, the Wayne County Circuit Court granted the motion for summary disposition. The plaintiff appealed and, after a full briefing of the case, oral argument was held in November 2003.
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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.
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 6th Circuit 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.
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Other
For information on other material legal proceedings to which the Company and its subsidiaries are a party, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
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 June 30, 2004:
In July 2004, our Board of Directors approved a new 10 million share repurchase program.
Item 4. Submission of Matters to a Vote of Security Holders
Additionally, a proposal ratifying the selection of Deloitte & Touche to serve as the Company’s independent auditors for the year ending December 31, 2004 was ratified, by a vote of 133,740,645 shares in favor, 1,318,574 shares opposed and 49,239 shares abstaining.
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Item 6. Exhibits and Reports on Form 8-K
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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.
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