MGM

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, for MGM Mirage (formerly MGM Grand, Inc.). The company operates a portfolio of hotel, casino, and entertainment resorts primarily in Las Vegas, Nevada, including the Bellagio, The Mirage, Treasure Island, Boardwalk, MGM Grand, and New York-New York. It also holds interests in properties in Detroit, Michigan; Biloxi, Mississippi; Atlantic City, New Jersey; and Darwin, Australia. As of June 30, 2002, Tracinda Corporation, wholly owned by Kirk Kerkorian, owned approximately 50.8% of the outstanding common stock.

Key Financial Metrics

Note: Operating margins improved sequentially due to expense reductions implemented in late 2001. Interest expense decreased significantly year-over-year due to lower rates and reduced debt levels.

Material Changes vs. Prior Period

• Revenue: Net revenues decreased slightly to $1.04 billion in Q2 2002 from $1.05 billion in Q2 2001. Casino revenues fell 3% due to a 10% decline in table game volume on the Las Vegas Strip, partially offset by a 19% increase in slot revenue at MGM Grand Detroit. Room revenues declined 2% as occupancy on the Strip fell from 98.3% to 95.2%, though rates remained stable.
• Profitability: Operating income increased to $233.5 million from $216.0 million in the prior-year quarter. This improvement was driven by a $10.4 million restructuring credit resulting from the reversal of previously accrued severance costs as business levels improved and rehiring occurred.
• Interest Expense: Net interest expense dropped to $69.1 million in Q2 2002 from $92.5 million in Q2 2001, a 22% reduction attributed to lower interest rates on credit facilities and reduced debt principal.
• Debt Structure: The company repaid $304 million in bank debt during the first six months of 2002. Moody's had lowered the company's senior notes rating to Ba1 (below investment grade) in January 2002, resulting in the pledging of substantially all assets as collateral.

Outlook, Risks, and Unusual Items

• Unusual Items: The company received $11.4 million in proceeds for terminating management agreements for four casinos in South Africa, recorded as revenue. Additionally, a $10.4 million restructuring credit was recognized in Q2 2002.
• Legal Proceedings: A class-action lawsuit regarding the randomness of slot machines remains pending; the court denied class certification in June 2002. In Detroit, litigation regarding the casino selection process is ongoing, though the District Court ruled the company did not receive an unconstitutional preference.
• Development Projects:
  • Detroit: A revised development agreement allows operation of the interim facility until a permanent one opens. The company agreed to pay the City of Detroit $44 million through 2004 and remains obligated to repay $50 million in bonds despite forfeiting land rights.
  • Atlantic City: The company is committed to developing a wholly-owned resort adjacent to the Borgata joint venture, with ground breaking anticipated in late 2003.
• Cost Pressures: A new five-year labor contract with the Culinary Union (effective June 1, 2002) is expected to increase labor costs by approximately $16 million in the first year. Insurance premiums are estimated to rise to $18 million annually from $8 million in 2001 due to market conditions and exclusions for terrorist acts.
• Accounting Changes: The company adopted SFAS 142 (Goodwill) in 2002, ceasing goodwill amortization. No impairment charges were recorded. The company plans to adopt SFAS 145 and SFAS 146 in 2003, which may reclassify debt extinguishment gains/losses and change the timing of exit cost recognition.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with the 4.88:1 leverage ratio and 3.15:1 interest coverage ratio required by credit facilities, given the below-investment-grade rating.
• Detroit Obligations: Confirm the status of the $50 million bond liability and the timeline for the permanent facility development, as these represent significant contingent liabilities and capital requirements.
• Insurance Coverage: Assess the adequacy of property and business interruption coverage given the exclusion of terrorist acts and the significant increase in premiums and deductibles.
• Restructuring Reversal: Monitor the sustainability of the $10.4 million restructuring credit and whether further adjustments to severance accruals are necessary.
• Legal Exposure: Track the status of the slot machine class-action litigation and the Detroit casino selection appeal, as outcomes could impact operations or result in damages.