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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
 
                                   FORM 10-K
 
                               ----------------
 
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
                                    OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
 
                          COMMISSION FILE NO. 1-13481
 
                           METRO-GOLDWYN-MAYER INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                               ----------------
 
<TABLE>
<S>                                              <C>
                    DELAWARE                                       95-4605850
          (STATE OR OTHER JURISDICTION                          (I.R.S. EMPLOYER
       OF INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
     2500 BROADWAY STREET, SANTA MONICA, CA                          90404
    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                       (ZIP CODE)
</TABLE>
 
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 449-3000
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
                         COMMON STOCK, PAR VALUE $0.01
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                                     NONE
 
                               ----------------
 
  Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the Registrant's best knowledge, in definitive proxy or information statements
incorporated by reference in Part II of this Form 10-K or any amendment to
this Form 10-K. [_]
 
  The aggregate market value of the voting stock (based on the last sale price
of such stock as reported by the Dow Jones News Retrieval) held by non-
affiliates of the Registrant as of March 11, 1998 was $151,593,460.
 
  The number of shares of the Registrant's common stock outstanding as of
March 11, 1998 was 65,779,852.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Certain portions of Registrant's proxy statement for the annual meeting to
be held on May 12, 1998 (the "Proxy Statement"), to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the close of the Registrant's fiscal year, are incorporated by
reference under Part III of this Form 10-K.
 
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                                    PART I
 
ITEM 1. BUSINESS
 
GENERAL
 
  Metro-Goldwyn-Mayer Inc., a Delaware corporation (together, unless the
context indicates otherwise, with its direct and indirect subsidiaries, "MGM"
or the "Company"), is an entertainment company engaged primarily in the
development, production and worldwide distribution of theatrical motion
pictures and television programs. The Company, including Metro-Goldwyn-Mayer
Studios Inc. ("MGM Studios"), United Artists Corporation ("UA"), Orion
Pictures Corporation ("Orion"), Goldwyn Films Inc. ("Goldwyn") and its other
subsidiaries, is one of only seven major film and television studios
worldwide. With approximately 4,000 film titles and over 8,200 episodes of
television programming, the Company's library (the "Library") constitutes the
largest collection of post-1948 feature films in the world. Motion pictures in
the Library have won over 185 Academy Awards, including Best Picture Awards
for Annie Hall, The Apartment, The Best Years of Our Lives, Dances With
Wolves, The Deer Hunter, Hamlet, In the Heat of the Night, Marty, Midnight
Cowboy, Platoon, Rain Man, Rocky, Silence of the Lambs, Tom Jones and West
Side Story. The Library also includes 18 titles in the James Bond film
franchise, five titles in the Rocky film franchise and nine titles in the Pink
Panther film franchise.
 
  MGM's executive offices are located at 2500 Broadway Street, Santa Monica,
California 90404. The Company's telephone number is (310) 449-3000.
 
BACKGROUND OF THE COMPANY
 
  Metro-Goldwyn-Mayer ("Old MGM") was established in 1924 through the merger
of Metro Pictures, Goldwyn Pictures and Louis B. Mayer Productions. A
corporation wholly owned by Kirk Kerkorian became Old MGM's controlling
shareholder in 1969. In 1981 Old MGM acquired UA, which had been formed in
1919 when Mary Pickford, Douglas Fairbanks, D.W. Griffith and Charlie Chaplin
joined forces to release their own motion pictures, as well as motion pictures
made by independent producers. In 1986 Turner Broadcasting System, Inc.
("Turner") acquired the businesses of Old MGM, and as part of that
transaction, Tracinda Corporation ("Tracinda") and certain of the former
stockholders of Old MGM concurrently acquired UA, including the UA library,
from Old MGM. Shortly thereafter, UA reacquired the Metro-Goldwyn-Mayer name
and logo and certain other assets from Turner. UA was then renamed MGM/UA
Communications Co. ("MGM/UA"). Turner retained the film library created
through the pre-1986 operations of Old MGM (the "Old MGM Library").
 
  In November 1990 MGM/UA was acquired by Pathe Communications Corporation
("Pathe") and was renamed MGM-Pathe Communications Co. ("MGM-Pathe"), the
predecessor to MGM Studios. In May 1992 Credit Lyonnais Bank Nederland N.V.
("CLBN"), Pathe's principal lender, foreclosed on substantially all of the
stock of MGM-Pathe, following default by Pathe, and such stock was ultimately
transferred to Consortium de Realisation ("CDR"), a wholly owned subsidiary of
Credit Lyonnais S. A. ("CL").
 
  In July 1993 Frank G. Mancuso was appointed as Chairman and Chief Executive
Officer of MGM Studios. In January 1996 CDR announced its intention to sell
MGM Studios.
 
  Tracinda, Seven Network Limited ("Seven") and senior management of MGM
Studios formed the Company (then known as P&F Acquisition Corp.) to acquire
all of the outstanding capital stock of MGM Studios and its subsidiaries,
including UA, in October 1996 for an aggregate consideration of $1.3 billion
(the "MGM Acquisition"). Tracinda is wholly-owned by Mr. Kerkorian. Seven is
one of the largest television broadcast networks in Australia with stations in
five major Australian metropolitan areas and one regional television station.
 
  In July 1997 the Company acquired all of the outstanding capital stock of
Orion and its subsidiaries, including Goldwyn (the "Orion Companies"), from
Metromedia International Group, Inc. (the "Orion
 
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<PAGE>
 
Acquisition"). In connection with the Orion Acquisition, the Company obtained
the film and television libraries of the Orion Companies consisting of
approximately 1,900 film titles and 3,000 television episodes, nearly doubling
the size of the Library to its current size of approximately 4,000 film titles
and over 8,200 episodes of television programming. The Landmark Theatres owned
by Goldwyn were excluded from the Orion Acquisition.
 
  On November 18, 1997, the Company completed an initial public offering,
whereby it issued and sold 9,000,000 new shares of common stock, $.01 par
value per share (the "Common Stock") at a price per share of $20, less an
underwriting discount, for net proceeds (after expenses of the initial public
offering) to the Company of $165 million (the "Offering"). Concurrent with the
consummation of the Offering, Tracinda purchased directly from the Company, at
a purchase price of $18.85 per share (equal to the per share price to the
public in the Offering, less the underwriting discount), 3,978,780 shares of
the Common Stock for an aggregate purchase price of $75 million (the "Tracinda
Purchase"). In addition, Tracinda acquired an aggregate of 2,429,263 shares of
the Common Stock through open market purchases following commencement of the
Offering through December 31, 1997.
 
THE MOTION PICTURE AND TELEVISION INDUSTRY
 
  Motion Pictures--General. The motion picture industry consists of two
principal activities: production and distribution. Production involves the
development, financing and production of feature-length motion pictures.
Distribution involves the promotion and exploitation of motion pictures
throughout the world in a variety of media, including theatrical exhibition,
home video, television and other ancillary markets. The U.S. motion picture
industry can be divided into major studios and independent companies, with the
major studios dominating the industry in the number of theatrical releases. In
addition to the Company (including Metro-Goldwyn-Mayer Pictures Inc. ("MGM
Pictures"), United Artists Pictures Inc. ("UA Pictures"), Orion and Goldwyn),
the major studios as defined by the Motion Picture Association of America are
The Walt Disney Company (including Buena Vista, Touchstone and Miramax)
("Disney"), Paramount Pictures Corporation ("Paramount"), Sony Pictures
Entertainment Inc. (including Columbia and TriStar) ("Sony"), Twentieth
Century Fox Film Corporation ("Fox"), Universal Studios, Inc. ("Universal")
and Warner Bros. (including Turner, New Line Cinema and Castle Rock
Entertainment) ("Warner"). The major studios are typically large diversified
corporations that have strong relationships with creative talent, exhibitors
and others involved in the entertainment industry and have global film
production and distribution capabilities.
 
  Historically, the major studios have produced and distributed the majority
of high grossing theatrical motion pictures released annually in the United
States. Over the past decade, the number of feature-length motion pictures
released by the major studios has increased dramatically. In addition, most of
the studios have created or accumulated substantial and valuable motion
picture libraries that generate significant revenues. These revenues can
provide the major studios with a stable source of earnings that offsets the
variations in the financial performance of their motion picture releases and
other aspects of their motion picture operations.
 
  The independent companies have more limited production and distribution
capabilities than do the major studios. While certain independent companies
may produce as many films as a major studio in any year, independent motion
pictures typically have lower negative costs and are not as widely released as
motion pictures produced and distributed by the major studios. Additionally,
the independent companies may have limited or no internal distribution
organizations and may rely on the major studios for distribution and
financing.
 
  Motion Picture Production. The production of a motion picture begins with
the screenplay adaptation of a popular novel or other literary work acquired
by the producer of the motion picture or the development of an original
screenplay based upon a story line or scenario conceived or acquired by the
producer. In the development phase, the producer may seek production financing
and tentative commitments from a director, the principal cast members and
other creative personnel. A proposed production schedule and budget are
prepared. At the end of this phase, the decision is made whether or not to
"greenlight," or approve for production, the motion picture.
 
                                       3
<PAGE>
 
  After greenlighting, pre-production of the motion picture begins. In this
phase, the producer engages creative personnel to the extent not previously
committed, finalizes the filming schedule and production budget, obtains
insurance and secures completion guaranties, if necessary. Moreover, the
producer establishes filming locations, secures any necessary studio
facilities and stages and prepares for the start of actual filming.
 
  Principal photography, or the actual filming of the screenplay, generally
extends from seven to 16 weeks, depending upon such factors as budget,
location, weather and complications inherent in the screenplay. Following
completion of principal photography, the motion picture enters what is
typically referred to as post-production. In this phase, the motion picture is
edited, opticals, dialogue, music and any special effects are added, and
voice, effects and music soundtracks and pictures are synchronized. This
results in the production of the negative from which release prints of the
motion picture are made. Major studios and independent film companies hire
editors, composers and special effects technicians on the basis of their
suitability for a particular picture.
 
  The production and marketing of theatrical motion pictures requires
substantial capital. The costs of producing and marketing motion pictures have
generally increased in recent years. These costs may continue to increase in
the future, thereby increasing the costs to the Company of its motion
pictures. Production costs and releasing costs are rising at a faster rate
than increases in either domestic admissions to movie theaters or admission
ticket prices, leaving the Company more dependent on other media, such as home
video and television, and foreign markets.
 
  Motion Picture Distribution. The distribution of a motion picture involves
the licensing of the picture for distribution or exploitation in various
markets, both domestically and internationally, pursuant to a release pattern.
These markets include theatrical exhibition, non-theatrical exhibition (which
includes airlines, hotels and armed forces facilities), home video (including
rental and sell-through), presentation on television (including pay-per-view,
pay, network, syndication or basic cable) and marketing of the other rights in
the picture and underlying literary property, which may include books,
merchandising and soundtracks. The domestic and international markets
generally follow the same release pattern, with the starting date of the
release in the international market varying from being concurrent with the
domestic theatrical release to being as long as nine months afterwards. A
motion picture typically is distributed by a major studio or one or more
distributors that acquire rights from a studio or other producer in one or
more markets or media or a combination of the foregoing.
 
  Both major studios and independent film companies often acquire pictures for
distribution through a customary industry arrangement known as a "negative
pickup," under which the studio or independent film company agrees to acquire
from a production company all rights to a film upon completion of production,
and also acquire completed films.
 
  Television Production. The production of television series programming
involves the development of a format based on a creative concept or literary
property into a television script, the hiring of talent, the filming or taping
of the program and the technical and post-production work necessary to produce
a finished program. Television producers may originate projects internally or
acquire them from others. If a concept is deemed suitable for development, the
studio or other producer or network typically commissions and pays for a
script. Once a script is ordered, one or more license agreements are
negotiated with the potential broadcasters of such program. A pilot episode
usually is ordered or commissioned prior to the determination of whether a
series will be produced.
 
  Television production can generally be divided into two distinct businesses:
network production (i.e., television shows for ABC, CBS, NBC, Fox, UPN and WB)
and non-network production (i.e., made-for-cable and first-run syndication).
The economics of the two types of television production are different. In
network production, a network generally orders approximately six to 13 initial
episodes of each new series for a license fee equal to a percentage of the
program's cost. The balance of the production cost can only be recouped
through international sales and syndication if a series is successful and
generally remains unrecouped for at least four years. In the non-network
production or first-run syndication business, a producer seeking to launch a
new series
 
                                       4
<PAGE>
 
commits to produce a minimum number of episodes if the producer can "clear"
the series by selling to individual television stations in sufficient markets
throughout the country (generally comprising 70 percent of television
households). Once produced, the episodes are immediately available for
licensing to international broadcasters as well. This approach generally
involves a lower production cost risk and earlier return on investment ("ROI")
than the network production business; however, non-network programming also
generally provides a lower ROI than successful network production. See "--
Production--Television Production."
 
  Television Distribution. The U.S. television market is served by network
affiliated stations, independent stations and cable systems, although the
number of independent stations has decreased as many formerly independent
stations have become affiliated with new networks in recent years. During
"prime time" hours, network affiliates primarily broadcast programming
produced for the network. In non-prime time, network affiliates telecast
network programming, off-network programming, first-run programming
(programming produced for distribution on a syndicated basis) and programming
produced by the local stations themselves. Independent television stations and
cable networks, during both prime and non-prime time, produce their own
programs and telecast off-network programs or first-run programs acquired from
independent producers or syndicators. Syndicators generally are companies that
sell to independent television stations and network affiliates programming
produced or acquired by the syndicator for distribution.
 
BUSINESS STRATEGY
 
  The Company's goal is to enhance its position as a premier global
entertainment content company by maximizing the value of its assets, including
the Library and its film and television production units, under the direction
of its experienced management team. To achieve this goal, the Company seeks
to:
 
  Build and Leverage the Library. The Company believes that the Library is its
most powerful asset and that the Library will continue to generate relatively
stable cash flows through the worldwide distribution of its titles. Management
seeks to maximize the value of the Library by (i) producing new motion
pictures and television programs that will not only be successful on their
own, but will also increase the depth and breadth of the Library, (ii)
aggressively marketing and repackaging the Library's titles, (iii) developing
new distribution channels for delivering MGM branded programming, (iv)
capitalizing on developments in technology and (v) further penetrating
international markets as they grow. As opportunities arise, the Company may
pursue strategic acquisitions, including acquisitions of additional titles or
of new distribution channels for the Library. Additionally, the Company
expects to benefit as certain rights to the Library that have been previously
licensed to others revert to the Company over time. See "--Distribution."
 
  Develop, Produce and Distribute Theatrical Motion Pictures. Through MGM
Pictures and UA Pictures, the Company plans to produce or co-produce and
distribute approximately ten to 12 motion pictures annually across a variety
of genres. The Company intends to (i) actively manage its production and
release schedules to maximize overall performance of those motion pictures,
(ii) tightly control development and production expenditures while maintaining
the artistic integrity required to develop and produce successful feature
films and (iii) utilize the Library as an inexpensive source for sequels and
remakes and the expansion of certain well-tested, familiar film franchises.
Additionally, the Company plans to produce or acquire and release
approximately four to six specialty motion pictures annually through Goldwyn.
The Company also plans to distribute annually approximately four to six motion
pictures produced by others.
 
  Develop, Produce and Distribute Television Programming. The Company intends
to focus primarily on the development and production of series for pay
television and the first-run syndication business by using its extensive
Library as a source of ideas. Under its television programming strategy, the
Company has generally been able to recover substantially all production costs
for a series shortly following completion of production by obtaining up-front
financial commitments from domestic pay television broadcasters for production
of multiple episodes of the series and concurrently licensing the series in
international markets. The Company also develops programs such as two-hour
television movies and mini-series. In addition, the Company has recently begun
allocating a portion of its television production budget to producing series
for network television. See "-- Production--Television Production."
 
                                       5
<PAGE>
 
  Leverage the MGM Brand Name. The Company believes that the MGM name and its
lion logo are among the most recognized in the world. The Company intends to
capitalize on the inherent value of its name and logo through the distribution
of branded programming and the selective development of high-quality consumer
products.
 
  When Mr. Mancuso was appointed Chairman and Chief Executive Officer in 1993,
he began implementing the above business strategy. Under Mr. Mancuso's
direction, the Company completed the Orion Acquisition to build the Library,
has reestablished a television series production business and has taken steps
to leverage the MGM brand name. In addition, under Mr. Mancuso's direction the
Company has produced and/or released such successful motion pictures as The
Birdcage, Get Shorty, GoldenEye, Leaving Las Vegas, Species, Stargate and
Tomorrow Never Dies. Although the Company did not approve any motion pictures
for production during the ten month period from CDR's announcement in January
1996 of its intention to sell MGM Studios to the consummation of such sale in
October 1996 (the "Sale Period"), since completion of the MGM Acquisition,
management has taken steps to return operations to a more expanded production
and release schedule. Since October 1996 the Company has approved 16 motion
pictures for production. There can be no assurance that the Company will not
experience problems or delays in its return to more normal operations.
 
FILM AND TELEVISION LIBRARY
 
  The Library is one of the most critically acclaimed libraries in the motion
picture industry, representing one of the largest collections of Academy
Award-winning films. As of December 31, 1997 the Company owned, or held
certain distribution rights with respect to, approximately 4,000 theatrical
motion pictures, excluding the approximately 2,950 titles that the Company has
the right to distribute in home video markets under an agreement with Turner.
See discussion below and "--Distribution--Home Video Distribution." The motion
pictures in the Company's Library have won over 185 Academy Awards. Fifteen
motion pictures have won the Academy Award for Best Picture, including Annie
Hall, The Apartment, The Best Years of Our Lives, Dances With Wolves, The Deer
Hunter, Hamlet, In the Heat of the Night, Marty, Midnight Cowboy, Platoon,
Rain Man, Rocky, Silence of the Lambs, Tom Jones and West Side Story.
 
  The Library also constitutes the largest collection of post-1948 feature
films in the world. In 1948 certain major studios negotiated consent decrees
requiring that the studios separate their exhibition businesses from their
production and distribution businesses and mandating the divestiture of
certain theater holdings. This is generally believed to have triggered greater
competition among the studios and an increased emphasis on the potential for
commercial success in the development and production stages, resulting in a
greater focus on the content and quality of the motion pictures produced and
distributed by the studios. The Company believes that films produced and
developed after 1948 generally are more valuable than films that were produced
and developed previously.
 
  Additionally, the Library includes motion pictures from a wide range of
genres, including dramas, comedies, action-adventure movies, westerns and
suspense thrillers. Management believes that the Library's diversity, quality
and extensive size provides the Company with substantial competitive
advantages. The Company seeks to continue to build upon these advantages by
producing and acquiring new motion pictures across a variety of genres and
budget ranges to update and enhance the Library. See "--Production--Motion
Picture Production."
 
  The Library also includes over 8,200 episodes from television series
previously broadcast on prime-time network television or in first-run
syndication, including episodes of The Addams Family, American Gladiators, Bat
Masterson, Cagney & Lacey, Fame, Green Acres, Highway Patrol, In the Heat of
the Night, Mr. Ed, The Patty Duke Show, Pink Panther, Sea Hunt and
thirtysomething. The television series in the Library have won 41 Emmy awards
and seven Golden Globe awards.
 
  The Company will continue to implement its strategy of developing new
projects from existing Library assets. The Library represents a readily-
available, "market tested" source of development ideas. For example, the
Company recently had success with the film The Birdcage, a remake of La Cage
aux Folles, and is expected
 
                                       6
<PAGE>
 
to release Species II, the sequel to Species, in 1998. Furthermore, the
Company has successfully expanded the valuable film franchises within its
Library, most notably the James Bond franchise, with the 1995 commercial
success of GoldenEye and the release of the latest James Bond film, Tomorrow
Never Dies, on December 19, 1997. As of February 28, 1998, Tomorrow Never Dies
had earned greater domestic box office receipts than any other film in the
James Bond franchise. Additionally, the Company has successfully developed
four television series based on Library motion pictures: Poltergeist: The
Legacy based on Poltergeist; Stargate SG-1 based on Stargate; All Dogs Go to
Heaven, based on the movie of the same name; Fame L.A. based on Fame; and The
Magnificent Seven, based on the movie of the same name. The Company also
produced a remake of Twelve Angry Men as a made-for-television movie, which
first aired on Showtime Networks Inc. ("Showtime") in August 1997.
 
  Eighteen James Bond motion pictures in the Library are produced and
distributed pursuant to a series of agreements with Danjaq, LLC ("Danjaq").
The motion pictures are produced by Danjaq, and the Company has the right to
approve all key elements of the pictures, such as the selection of the
director and the leading actors. The copyright in each of the motion pictures
is owned jointly by the Company and Danjaq. Generally, the Company has the
right to distribute each of the pictures in all media worldwide in perpetuity
or for a term of 15 years. Where the Company's distribution rights are not
perpetual, the rights revert to joint control by the Company and Danjaq after
expiration of the distribution term. Danjaq owns any television series created
that is based on the James Bond motion pictures, and the Company has the
distribution rights to such series. Danjaq controls the merchandising rights
with respect to the pictures, with the Company being entitled to receive a
portion of the revenues from all merchandising licenses. Additionally, the
Company controls all marketing rights, and controls the music from The Living
Daylights (1987) and all subsequent pictures. All other rights relating to the
pictures are controlled jointly by the Company and Danjaq. The agreements
contain certain restrictions on the sale or licensing by the Company of any of
its rights in the pictures. Although the Company does not believe that this
joint nature of ownership and control of the James Bond franchise will have
any material adverse effect on the Company in the future, no assurance to that
effect can be given.
 
  Prior to 1959, Ian Fleming authored a number of novels depicting the
adventures of James Bond, and commencing in 1959, Mr. Fleming and Kevin
McClory collaborated on the development of certain plot lines and treatments
and a script entitled Thunderball, featuring the James Bond character. In that
connection, Mr. McClory ultimately acquired from Mr. Fleming certain rights to
make a feature film using the James Bond character in these plot lines. Mr.
Fleming thereafter wrote a novel of the same name. In 1961, Mr. McClory
commenced litigation against Mr. Fleming with regard to the script, the novel
and certain related rights.
 
  In 1962, prior to the settlement of the Fleming-McClory litigation, Mr.
Fleming effectively granted to a predecessor-in-interest of Danjaq the
exclusive worldwide rights to, among other things, make films based on Mr.
Fleming's existing or future James Bond novels (other than Thunderball or
Casino Royale) and to create original screenplays about the adventures of
James Bond not based on Mr. Flemings's James Bond novels. This agreement
further provides that the film rights to the Thunderball novel that were the
subject of the Fleming-McClory litigation would also be transferred to
Danjaq's predecessor to the extent Mr. Fleming was permitted to transfer such
rights following completion of the litigation.
 
  The Fleming-McClory litigation was resolved in 1963 by a settlement among
Mr. Fleming, Mr. McClory and the other parties to the litigation in which Mr.
McClory acknowledged that Mr. Fleming was the creator and proprietor of the
James Bond character. Pursuant to that settlement, Mr. McClory was, in effect,
given the film rights in the Thunderball documents and scripts attached to the
settlement agreement, the rights to reproduce any part of Mr. Fleming's
Thunderball novel in a film and to exhibit any such film in any manner
whatsoever and the rights to use the James Bond character in the film
Thunderball. The Company believes these rights, at most, gave Mr. McClory the
right to make a film of the story in the novel Thunderball (i.e. a "remake" of
Thunderball). Mr. McClory produced the film Thunderball (with UA and Danjaq)
in 1965. Mr. McClory has at various times since 1963 taken the position that
he has broader rights to use the James Bond character than simply remake
Thunderball, but since 1965 he has only made the 1983 film Never Say Never
Again, which Mr. McClory claimed was a remake of the film Thunderball.
 
                                       7
<PAGE>
 
  On October 13, 1997, Sony issued a press release announcing plans by its
Columbia Pictures division to produce a series of new James Bond feature films
based on works created by Mr. Fleming, Mr. McClory and John Whittingham. On
November 17, 1997, the Company and Danjaq filed an action in federal court in
Los Angeles against Sony Corporation, Sony Pictures Entertainment Inc.,
Columbia Pictures Industries, Inc., John Calley, Kevin McClory and Spectre
Associates, Inc. seeking declaratory and injunctive relief and/or damages for
copyright infringement, trademark dilution, slander of title, unfair
competition, inducing breach of contract and breach of fiduciary duties, and
misappropriation of trade secrets. On January 23, 1998, the Company and Danjaq
filed an amended complaint adding claims for trademark infringement, federal
unfair competition and California trademark dilution. Among other things, the
Company and Danjaq contend not only that Mr. McClory's rights were limited to
remaking Thunderball but that even those rights have expired under U.S. law
pursuant to the doctrine of Stewart v. Abend, 495 U.S. 207 (1990) and that Mr.
McClory's rights have been recently acquired by Danjaq. See "Item 3. Legal
Proceedings."
 
  The Company seeks to aggressively market and distribute titles in the
Library in existing pay and free television, home video and other markets
worldwide, as well as through developing technologies. Rather than selling its
titles on a single or multi-picture basis, the Company strives to pool
strategically its motion picture and television titles into cohesive
programming packages directed at specific markets, including purchasers of
large quantity programming and services in emerging markets which may not have
their own programming capabilities. The Company believes that the development
and growth of direct broadcast satellite ("DBS") and other new distribution
systems may generate significant incremental profits for the industry as the
number of channels requiring content grows. The Company believes that, with
its extensive Library and its branded programming strategy, the Company is
well positioned to benefit from such growth and development. As opportunities
arise, the Company expects to consider acquisitions, including acquisitions to
expand the Library or to obtain new distribution channels.
 
  The Company has differing types of rights to the various titles in the
Library. In some cases, the Company owns the title outright, with the right to
exploit the title in all media and territories for an unlimited time. In other
cases, the title may be owned by a third party and the Company may have
obtained the right to distribute the title in certain media and territories
for a limited term. Even if a title is owned by the Company, the Company may
have granted rights to exploit the title in certain media and territories to
others. The Company owns outright, or has been granted rights in perpetuity
to, approximately 50 percent of the titles in the Library. The Company's
rights in the other titles are limited in time and, pursuant to the terms of
the existing arrangements, the rights granted to the Company expire with
respect to approximately 15 percent of the Library over the next five years
(i.e. through the year 2002), with respect to another approximately 17 percent
over the five years thereafter (from 2002 to 2007), and with respect to
another approximately 15 percent over the ten years thereafter (from 2007 to
2017). The Company has generally been able to renew such rights on acceptable
terms, however no assurances can be made that it will continue to be able to
do so in the future. In accordance with industry practice, for purposes of
calculating the size of the Library, the Company includes any title that the
Company has the right to distribute in any territory in any media for any
term. The only material exception to the foregoing practice is that, even
though the Company has home video distribution rights through 2001 with
respect to approximately 2,950 titles owned by Turner, the Company does not
include such titles in calculating the number of titles in the Library.
 
  Due to certain long-term pre-paid licenses entered into by prior management,
the Company does not expect to receive significant revenue with respect to
substantial portions of its Library from domestic free and certain major
international television markets for the next several years. This includes
many of the most valuable titles in the Library, including approximately 50
percent of the pre-1990 MGM and UA titles, which have been licensed in one or
more of the U.S., France, Spain and Germany, and less than 50 percent of the
Orion titles, which have been licensed in one or more of France, Spain,
Germany and the United Kingdom. See "--Distribution--Pay and Free Television
Distribution." The Company expects to benefit as certain rights to the Library
that have been previously licensed to others revert to the Company over time.
See "--Distribution--Home Video Distribution" and the discussion above.
 
                                       8
<PAGE>
 
PRODUCTION
 
 MOTION PICTURE PRODUCTION
 
  The Company currently develops and produces theatrical motion picture
projects through two separate production entities, MGM Pictures and UA
Pictures. The Company operates these production units independently with
separate management teams and allows them to compete directly for the best new
projects on the creative side of the business. At the same time, the Company
supports the units with the benefits of centralized marketing, sales, legal,
physical production and distribution functions. Direct access to senior
management also expedites major decision-making. By utilizing its two separate
production units, management believes that the Company benefits from the
distinct creative talents and perspective of each of its chief production
executives, resulting in greater diversity within its overall release slate.
 
  Through these production units, the Company plans to produce or co-produce
and distribute between approximately ten and 12 motion pictures annually
across a variety of genres and budget ranges and release approximately four to
six additional pictures each year that are produced by other producers. Both
production units employ a development staff of creative executives who work to
refine concepts and scripts so that projects are developed to the point that
production decisions can be made. The creative staffs of both MGM Pictures and
UA Pictures currently have approximately 100 ongoing projects in the
aggregate, which are in various phases of development and pre-production. The
Company's current strategy is to have fewer projects in development at any one
time than the other major studios in order to concentrate its efforts and
assets on the projects that management believes could be the most commercially
successful. The Company believes that this strategy will result in lower
development related write-offs and abandonment costs. Historically, the
Company's development related write-offs and abandonment costs were $21.2
million, $11.6 million and $19.5 million in the years ended December 31, 1997,
1996 and 1995, respectively.
 
  Additionally, the Company plans to release approximately four to six
specialty motion pictures each year through Goldwyn. These motion pictures
will be produced or co-produced by Goldwyn or acquired through negative
pickups or other distribution arrangements and will include motion pictures in
a variety of genres generally involving producers and directors, writers or
other talent who typically work outside of the major studio system. The
Company's investment in such pictures is expected to be significantly less
than the Company's investment for pictures produced through MGM Pictures or UA
Pictures. The Company believes that this strategy of releasing independent
motion pictures will add greater diversity to the Company's release slate and
enhance the Library both through the addition of new film product and the
building of relationships with up-and-coming producers and directors, writers
and other talent.
 
  In order to manage the financial risks inherent in motion picture
production, management has developed a rigorous budgeting and approval process
and strictly controls the cost of each motion picture through active
management involvement in all phases of the production process. When a project
is considered to have commercial potential, budgets are developed
independently by the physical production department to determine the below-
the-line cost of a motion picture. At a point early in this process, a
preliminary below-the-line estimate is combined with potential above-the-line
costs, such as talent costs and participations, to form a model of the total
cost of the motion picture. The Company then performs sensitivity analyses to
determine the motion picture's potential ROI. The ROI range is developed using
a preliminary cost model together with a revenue model based on the picture's
budget, genre, cast, international appeal and other factors. The Company
believes that, as a result of its focus on budgeting and controlling
production expenditures, it will be able to avoid unnecessary cost-overruns
and excess expenditures. The Company (like most major motion picture studios)
generally does not obtain "completion bonds" from outside insurers to protect
itself against budget overruns and completion delays.
 
  The Company believes that it pursues fewer producer or talent "overhead"
arrangements, in which a studio pays a portion of the overhead of creative
talent (i.e., producer, director or actor) for the right to receive a "first
look" at that party's projects, than other major studios. In general, the
Company believes that its capital resources are better allocated to acquire
literary property or the services of talent for a specific project than to
fund overhead.
 
                                       9
<PAGE>
 
  The Company does not own any studio facilities or stages but rather leases
facilities and sound stages on an "as needed" basis in connection with the
production of specific motion picture and television projects. The Company has
not experienced any difficulties in leasing appropriate facilities and sound
stages when needed.
 
  Motion picture production and distribution is highly speculative and
inherently risky. There can be no assurance of the economic success of any
motion picture since the revenues derived from the production and distribution
of a motion picture (which do not necessarily bear a direct correlation to the
production or distribution costs incurred) depend primarily upon its
acceptance by the public, which cannot be predicted. The commercial success of
a motion picture also depends upon the quality and acceptance of other
competing films released into the marketplace at or near the same time, the
availability of alternative forms of entertainment and leisure time
activities, general economic conditions and other tangible and intangible
factors, all of which can change and cannot be predicted with certainty.
Further, the theatrical success of a motion picture is generally a key factor
in generating revenues from other distribution channels. There is a
substantial risk that some or all of the Company's motion pictures will not be
commercially successful, resulting in costs not being recouped or anticipated
profits not being realized. Based on the Company's current business plan for
next five years, its annual release slates may be comprised of proportionately
fewer large budget "event" motion pictures than the current release slates of
the other major studios.
 
                                      10
<PAGE>
 
  The following table details the Company's current 1998 release schedule.
 
                               RELEASE SCHEDULE
 
<TABLE>
<CAPTION>
                           APPROXIMATE
         TITLE            RELEASE DATE           SUMMARY                PRINCIPAL ACTORS
------------------------  ------------- -------------------------- --------------------------
<S>                       <C>           <C>                        <C>
Live Flesh..............  Released      Pedro Almadovar's latest   Javier Bardem, Liberto
                                        look at love and sex        Rabal, Francesca Neri,
                                                                    Angela Molina, Jose
                                                                    Sancho

Deceiver................  Released      Suspenseful thriller about Tim Roth, Chris Penn,
                                        a murder investigation and  Michael Rooker, Renee
                                        the web of lies that        Zellweger, Ellen Burstyn,
                                        surrounds it                Rosanna Arquette

Hurricane Streets.......  Released      Disturbing look at modern- Brendan Sexton III, Isidra
                                        day youth                   Vega, Shawn Elliott

I Love You Don't Touch                                             
 Me.....................  Released      A bold romantic comedy     Marla Schaffel, Mitchell
                                                                    Whitfield, Meredith Scott
                                                                    Lynn, Michael Harris

The Man in the Iron              
 Mask(2)................  Released      Period piece based on the   Leonardo DiCaprio, John
                                        Alexandre Dumas novel       Malkovich, Jeremy Irons,
                                                                    Gerard Depardieu, Gabriel
                                                                    Byrne

Welcome to Woop Woop....  April 1998    Twisted road comedy from   Johnathon Schaech, Rod
                                        the director of "The        Taylor, Susie Porter, Dee
                                        Adventures of Priscilla,    Smart
                                        Queen of the Desert"

Species II(1)...........  April 1998    Sequel to the successful   Michael Madsen, Marg
                                        1995 film                   Helgenberger, Natasha
                                                                    Henstridge

Music From Another Room.  April 1998    Romantic comedy about a    Brenda Blethyn, Jude Law,
                                        man's search for his one    Jennifer Tilly, Martha
                                        true love                   Plimpton

Hanging Garden..........  May 1998      A 25-year old gay man      Chris Leavins, Kerry Fox,
                                        returns to his              Seana McKenna, Peter
                                        dysfunctional family in     McNeill, Troy Veinotte
                                        Nova Scotia after a 10-
                                        year absence

Dirty Work(1)...........  May 1998      Comedy about the revenge   Norm Macdonald, Chevy
                                        business                    Chase, Jack Warden, Don
                                                                    Rickles

Be the Man(1)...........  July 1998     Comic Super Dave Osborne   Dave Osborne, Don Lake,
                                        attempts to leave his       Fuji, Mike Walden
                                        bumpy career as a hapless
                                        stuntman and open up a
                                        school for would-be fall
                                        guys

Disturbing Behavior(1)..  August 1998   A teen thriller about a    James Marsden, Nick Stahl,
                                        new kid in town who         Katie Holmes
                                        discovers the town's evil
                                        method of turning
                                        rebellious teens into
                                        wholesome overachievers

At First Sight(1).......  October 1998  Based on the true story by Val Kilmer, Mira Sorvino,
                                        Oliver Sacks (Awakenings)   Kelly McGillis, Nathan
                                        of a blind man whose sight  Lane, Steven Weber, Ken
                                        is restored and the         Howard, Bruce Davison
                                        effects it has on him, his
                                        sister and the woman he
                                        loves

Ronin(2)................  November 1998 John Frankenheimer directs Robert DeNiro, Jean Reno,
                                        an action-adventure about   Sean Bean, Jonathan
                                        a team of international     Pryce, Stellan Skarsgard,
                                        agents hired to carry out   Natasha McElhone
                                        a dangerous mission

Supernova(2)............  December 1998 Science-fiction thriller   James Spader
                                        about a medical spaceship
                                        that responds to a
                                        distress signal and takes
                                        on a mysterious passenger
</TABLE>
--------
(1) Developed and produced by MGM Pictures.
(2) Developed and produced by UA Pictures.
 
                                      11
<PAGE>
 
  The Company may revise the release date of a motion picture as the
production schedule changes or in such a manner as the Company believes is
likely to maximize revenues. Additionally, there can be no assurance that any
of the motion pictures scheduled for release will be completed, that
completion will occur in accordance with the anticipated schedule or budget,
or that the motion pictures will necessarily involve all of the creative
talent listed above, as the production, completion and distribution of motion
pictures are subject to numerous uncertainties including financing
requirements, personnel availability (see "--Employees") and the release
schedule of competitive motion pictures.
 
 TELEVISION PRODUCTION
 
  Through MGM Worldwide Television Group, the television production and
distribution unit of MGM Studios, the Company is engaged in the development
and production of episodic television series, mini-series and movies for
distribution on domestic and international television networks, local
independent and network-affiliated television stations, pay television
networks, basic cable networks and home video. Since the re-establishment of
its television series production operations in 1994, the Company has obtained
commitments for approximately 820 hours of television programming, of which
approximately 50 percent remained to be aired as of December 31, 1997.
Historically, the Company's television activities were focused on the
traditional network production business and made-for-television movies, and
many of the television programs in the Library were produced as network
series. Since the networks have substantially lowered the license fees as a
percentage of the budget for network television programming in recent years,
resulting in significantly larger production investment risks for the
producers of such programming, the Company altered its television strategy in
1994 when the Company's management re-established the Company's television
series production operations. See "--The Motion Picture and Television
Industry."
 
  Since 1994 the Company has focused primarily on the development and
production of series for the first-run syndication business, which involves a
lower production investment risk for the Company, and movies and mini-series
for both network and off-network broadcasters. The Company's strategy is
designed to (i) minimize up-front capital investment through the production of
series for the first-run syndication business and through co-production
arrangements, (ii) minimize risks associated with large deficit financing by
developing product such as two-hour movies or mini-series that generally offer
stable, predictable cash flows, (iii) use valuable Library assets such as The
Outer Limits, Poltergeist, Stargate, All Dogs Go to Heaven, Fame and The
Magnificent Seven to develop recognizable products with enhanced marketability
at a reduced cost and (iv) develop alternative types of programming, such as
animated cartoon strips, talk shows, variety shows and reality-based
programming such as LAPD--Life on the Beat.
 
  As part of its strategy, the Company has entered into a programming
arrangement with Showtime whereby the Company provides television series and
movies for premiere on Showtime. Showtime has agreed to license exclusive U.S.
pay television rights to the following television series: (i) 122 hours (one-
hour and two-hour episodes) (six seasons) of The Outer Limits (winner of the
Cable Ace award for Best Dramatic Series in 1995 and 1996) of which 56 hours
remained to be aired as of December 31, 1997; (ii) 66 episodes (three seasons)
of Poltergeist: The Legacy of which 22 episodes remained to be aired as of
December 31, 1997; (iii) 88 episodes (four seasons) of Stargate-SG1 of which
76 episodes remained to be aired as of December 31, 1997; and (iv) three new
series (one of which series will be for a minimum commitment of 44 episodes
and two of which series will be for a minimum commitment of 22 episodes) to be
produced by the Company for Showtime, with one new series to commence
broadcast in each of 1999, 2000, and 2001. Showtime has also committed to a
two-hour pilot for Species, a possible television series based on the
theatrical motion picture of the same name. The Company has also acquired
worldwide (excluding Canada) distribution rights to the Showtime series Dead
Man's Gun (a Cable Ace nominee for Best Dramatic Series in 1997). Twenty-two
new episodes of such series will be produced, giving the Company a minimum of
44 episodes that have not previously been distributed outside North America.
 
  Additionally, the Company has obtained a commitment from Fox Family Channel
to license 40 episodes of All Dogs Go to Heaven, a half-hour animated series,
which commitment includes a production order for 14 new
 
                                      12
<PAGE>
 
episodes. The series is scheduled to air beginning in fall 1998. The Company
has also entered into agreements to produce for U.S. broadcast syndication
(i.e. licenses to individual television stations) 40 half-hour episodes of
Robocop: Alpha Commando, an animated series based on the feature motion
picture Robocop, and 13 half-hour episodes of The Lionhearts, an animated
series based on Leo, the familiar MGM lion, and his cartoon "family."
Furthermore, the Company has produced 22 episodes of Fame L.A. for U.S.
broadcast syndication in markets throughout the U.S. comprising approximately
90 percent of television households.
 
  The Company recently expanded its focus to produce series for network
television on a selective basis, which typically require deficit financing but
generally offer the potential for greater financial return. In its first sale
of a series to network television since 1994, the Company has produced a two-
hour pilot and eight episodes of The Magnificent Seven for CBS as a midseason
1997/98 series, with all of the episodes to air before the end of April 1998.
 
  Also, the Company has obtained a commitment from Paxson Communications
("Paxson") to license 88 episodes of Flipper, a one-hour series, which
commitment includes a production order for 44 episodes. The series is
scheduled to air beginning in fall 1998 on Paxson's PAX NET network, comprised
principally of owned and operated stations which cover approximately 65
percent of television households.
 
  Since the Company's ability to recover production costs and realize profits
on its television programs depends on various factors, including but not
limited to the programs' acceptance by the public, prevailing advertising
rates, and the ability to distribute the programs into licenses subsequent to
their first run license, there can be no assurance that the Company can
recover the production costs or realize profits on any television series.
 
DISTRIBUTION
 
  THEATRICAL DISTRIBUTION
 
  General. The initial step in the release of a motion picture is the booking
of engagements with theatrical exhibitors. The exhibitors retain a portion of
the admissions paid at the box office, which generally includes a fixed amount
per week, as well as a percentage of the admissions that escalates over time.
A studio's or other producer's (or third party distributor's) share is
approximately 50 percent of gross box office admissions, although such
percentage, which has generally decreased in recent years, varies depending
upon factors such as the number and box office performance of such studio's or
other producer's recent releases. Although the lack of production during the
Sale Period may have adversely affected the Company's relationship with major
domestic exhibitors, the Company believes that its exhibitor relationships and
negotiated share of box office receipts will improve to the extent that it
achieves box office success with the films in its 1998 release slate.
 
  The Company intends to release a slate of films appealing to a wide variety
of audiences. By strategically timing the release of its motion pictures
throughout the year, the Company intends to avoid some of the risks posed when
a motion picture is inappropriately released during the most crowded and
competitive box office seasons. The Company believes that this strategy is
unlikely to have a negative impact on its ability to generate home video
rentals.
 
  All motion pictures that are released theatrically by the Company in the
U.S. and Canada, whether produced by MGM Pictures or UA Pictures or third
parties, are marketed and distributed by Metro-Goldwyn-Mayer Distribution Co.
Additionally, the Company generally distributes its motion pictures in
theatrical markets outside of the U.S. and Canada through United International
Pictures ("UIP"), a partnership owned equally by the Company, Paramount and
Universal. UIP is the world's largest theatrical motion picture distribution
company outside the U.S., with distribution activities in over 50 countries.
UIP has a cost sharing arrangement that requires each partner to be
responsible for one-third of UIP's annual operating overhead. UIP charges each
partner a distribution fee of 35 percent of gross theatrical receipts until
the fee equals one-third of the annual operating costs of the partnership, and
thereafter a negotiated percentage of any additional gross receipts as a fee
for incremental use of the organization. Each partner bears all of its own
releasing costs and retains all cash flow from its pictures after payment of
fees.
 
                                      13
<PAGE>
 
  The Company can elect to withdraw from UIP on November 1 of any year with at
least one year's prior notice (although the Company has no current intention
to withdraw). If the Company, or either other partner, withdraws, that partner
is entitled to one-third of the book value of UIP less one-third of the
estimated winding down costs of the partnership. Both Universal and Paramount
have agreed not to withdraw from the partnership until after 2001; however,
the Company believes that either party's exit from UIP would not have a
material adverse effect on the Company's financial condition or results of
operations, as the Company would expect to distribute its motion pictures in
these territories by either modifying and downsizing the UIP structure or
finding or developing satisfactory alternative methods for international
distribution. There can be no assurance, however, that such alternatives would
not result in decreased revenues or profitability. The partners are prohibited
from transferring their respective partnership interests. UIP has recently
received a "Statement of Objections" from the Competition Directorate of the
Commission of European Communities. See "--Regulation."
 
  Co-Production and Distribution Agreements. In addition to producing feature
motion pictures independently, the Company occasionally enters into co-
production agreements under which the Company retains certain distribution
rights with respect to a picture and shares the cost of production with a
partner that obtains other rights (generally outside of the U.S. and Canada).
While such agreements limit the Company's risk relating to a motion picture's
performance as they reduce the Company's production costs, such agreements
also limit profitability. The Company also acquires rights to distribute films
through negative pickup arrangements under which the Company acquires a
completed motion picture, or certain rights therein, from a third party. Under
co-production or negative pickup arrangements, the Company may be committed to
spend specified amounts for prints and advertising. Additionally, the Company
occasionally enters into "rent-a-system" arrangements under which the Company
provides distribution services to an independent film company for a percentage
distribution fee. Under rent-a-system arrangements the independent film
company generally is responsible for all print and advertising costs. These
types of arrangements may be entered into before, during or after production
of a particular motion picture.
 
  Theatrical Marketing. The Company's theatrical marketing department consists
of five functional groups: research, media planning, advertising, promotion
and publicity. The objective of the marketing department is to maximize the
Company's ROI on each motion picture by designing and implementing a marketing
campaign tailored to appeal to the picture's most receptive audience. The
marketing process begins with research before a motion picture is completed.
The research department determines, through audience screenings and focus
groups, a motion picture's appeal to its most likely target audience. The
marketing group begins to develop media plans and marketing materials well in
advance of a motion picture's scheduled theatrical release. The media campaign
generally begins six months before release with the circulation of teaser
trailers, posters and exhibitor advertising materials. The campaign becomes
more aggressive two to three months before release as full-length trailers are
released in theaters and more significant materials are sent to exhibitors.
Finally, a national campaign is launched four to five weeks before opening
day. This media campaign generally involves advertising a picture's release on
national television, including network prime time and syndication markets,
national cable and radio and in magazines, newspapers and specific target
markets, such as colleges. In addition, public appearances, such as television
talk shows, are arranged for a picture's stars in order to promote the film.
The entire process is managed by the Company's in-house staff, although
outside agencies are frequently retained to provide creative input.
 
  HOME VIDEO DISTRIBUTION
 
  The Company's marketing and distribution strategy in the home video market
domestically and internationally is to (i) market its motion picture and
television titles in cohesive packages, (ii) create branded product lines,
(iii) adapt to a maturing home video market and (iv) release new motion
pictures into the home entertainment market at the time of the year that it
believes will generate the most sales without diminishing revenues from other
markets. Under current management, the Company has repackaged and repriced a
number of Library titles through the creation of various branded lines.
Examples of these branded lines include MGM Movie Time, Contemporary Classics,
Screen Epics, Vintage Classics and Musicals. The Company believes this
strategy has resulted in increased shelf space in video retail stores and has
led to increased sales. Such strategy
 
                                      14
<PAGE>
 
will be carried over to the Orion library as Orion titles will be integrated
into two current MGM collections, Movie Time and Contemporary Classics. In
addition, new branded lines such as Soul Cinema and World Films will exploit
the strengths of the Orion library. Additionally, the Company will release the
Library films, or groups of the Library films, in connection with new films
which it releases into the market, in order to increase sales of both the
Library films and new releases. An example is the recent European James Bond
video campaign, whereby the Bond catalog has been repromoted in conjunction
with the theatrical release of Tomorrow Never Dies. The Company intends to
continue this strategy of packaging groups of films or film franchises and
releasing them in connection with the releases of its most highly visible new
films. The Company also intends to utilize new formats for home video sales,
such as the successful "infomercials" for James Bond and Elvis Presley videos,
the first in the motion picture business.
 
  MGM Home Entertainment Inc. ("Home Entertainment") manages the marketing and
distribution of both current feature motion pictures and Library product of
MGM Studios and its subsidiaries in the home video and other home
entertainment markets. In addition, the Company has an agreement with Turner
pursuant to which the Company distributes the Turner library, the Old MGM
Library and all pre-1949 Warner titles in worldwide home video markets, for a
total of approximately 2,950 titles. The Company's rights under this agreement
with Turner expire in June 2001. As more fully described below, these titles
as well as the current pictures and Library product of MGM Studios and its
subsidiaries, and any theatrical motion picture in which MGM Studios or, with
certain exceptions, one of its affiliates acquires home video rights, are
serviced pursuant to the WHV Agreement (as defined below).
 
  In 1990, as part of the acquisition of MGM/UA by Pathe, MGM-Pathe (the
predecessor in interest to MGM Studios), MGM/UA and UA Pictures, Inc.
(collectively, the "Parties") entered into an agreement (as amended, the "WHV
Agreement") with Warner Home Video, Inc. ("WHV"). Under the WHV Agreement, the
Parties have granted to WHV certain home video distribution rights with
respect to new motion pictures and the motion picture library of MGM/UA, UA
and their respective affiliates, subject to certain limited exceptions,
throughout the world for a distribution fee expressed as a percentage of
worldwide home video revenues (as determined under the WHV Agreement) and
reimbursement of certain distribution expenses. In general, the percentage
varies from 10 percent to 15 percent based upon the amount of worldwide home
video revenues in any calendar year and other factors. MGM Studios and its
affiliates maintain direct control of all significant elements of distribution
such as the determination of release dates, marketing, return policies and
pricing for these home video releases. Laser disc and digital video disc
("DVD") distribution rights are also covered by the WHV Agreement.
 
  The WHV Agreement expires in May 2003, with the home video rights of each of
the films still covered by the WHV Agreement at that time reverting to MGM
Studios or its affiliates five years after the film's initial availability in
the U.S. home video market. Management believes that the Company will be able
to manage home video distribution in a more cost-effective manner and increase
sales and profitability upon the expiration of the WHV Agreement. Even with
the agreement in effect, the Company's home video sales have increased since
1993. From 1993 to 1997, the Company increased its annual worldwide home video
gross revenue from feature films by 44 percent, from $243.0 million to $350.5
million. The Company believes that this increase is a result of more effective
and efficient marketing by the Company, the renegotiation by the Company of
key vendor relationships and a reorganization of the Company's distribution
infrastructure. The Company continues to seek beneficial renegotiation of
vendor relationships. For example, the Company believes it will achieve cost
savings as a result of its renegotiated deal in December 1997 with the
Company's domestic video duplicator, MediaCopy. The Company believes that 1997
was a transitional period for the home video division as revenues were reduced
by the lack of first-run rental product resulting from the slowdown in
production that accompanied the sale of MGM Studios in 1996.
 
  The WHV Agreement provides that it applies (with certain exceptions
discussed below) to (i) all motion pictures owned or controlled by the Parties
or their affiliates prior to the date of the WHV Agreement, (ii) new motion
pictures financed, developed, produced, owned and/or acquired by the Parties
or any of their present or future affiliates during the term of the agreement
and (iii) all other motion pictures as to which the Parties or any
 
                                      15
<PAGE>
 
of their present or future affiliates own, control or acquire any home video
rights during the term of the agreement. In general, the WHV Agreement
requires that the Parties and their present and future affiliates acquire home
video rights for any motion picture in which they acquire theatrical and/or
television rights in any given territory, unless WHV otherwise agrees. With
respect to licenses existing on such product prior to the date of acquisition,
the Parties have agreed to allow such rights to expire or terminate such
rights when and to the extent permitted. The Parties have limited termination
rights for WHV's failure to make certain payments or to provide certain
accountings.
 
  Orion manages the marketing and distribution of both current feature motion
pictures and library product of the Orion Companies in the home video markets,
except for the library product of Goldwyn. Goldwyn has licensed to Hallmark
Entertainment Distribution Company, Inc. ("Hallmark") the right to distribute
in the U.S. home video market substantially all of the Goldwyn library. The
term of Hallmark's license of each of its library pictures expires on the
later of five and a half years after the date of the picture's initial
availability in the U.S. home video market or Hallmark's recoupment of its
advance under the license, but no later than June 30, 2005. In November 1997
the Company and Hallmark terminated an output agreement with Hallmark which
covered feature motion pictures produced or acquired by Goldwyn between May
1995 and April 2000.
 
  The WHV Agreement expressly provides that WHV's rights do not extend to,
among other things, motion pictures owned, produced or released by any of a
defined list of other major studios in the event that any of the Parties or
any of their affiliates acquires control of any such major studio (so long as
substantially the same quality and quantity of motion pictures are produced
that are covered by the WHV Agreement following the acquisition as prior to
the acquisition) and specifically names Orion as well as others as major
studios. Despite this provision, MGM Studios has received correspondence from
WHV alleging that the Orion Companies' future production and library is
subject to the WHV Agreement. The Company has responded by referring to the
express Orion exclusion and is currently in discussions with WHV about this
matter. No assurance can be made as to the outcome of this matter. To the
extent that the future production and library films of the Orion Companies, or
any future affiliate of MGM Studios, were determined to be subject to the WHV
Agreement, there would likely be a reduction in the revenue and profits from
the distribution of that product.
 
  As of February 1998, Home Entertainment has completed the release of the
first slate of Orion rental product, including the titles 8 Heads in a Duffel
Bag, City of Industry and Gang Related. Additionally, Home Entertainment has
also acquired and distributed the sell-through release of Garth Brooks Live in
Central Park under the Orion label.
 
  The Company intends to capitalize on developing technologies such as DVD, a
high-quality mass-produced delivery system for video and audio data. The
Company believes that DVD is a promising technology that could generate
significant incremental profits for the industry because the cost of
manufacturing DVDs is substantially less than the cost of manufacturing
videocassettes and the format may be more attractive to retail purchasers than
videocassettes. The Company was among the first major studios to make titles
available on DVD. The Company's GoldenEye was the second highest selling DVD
title in consumer sales across all distributors through December 1997. The
Company believes that it is well positioned to benefit if DVD is successful,
since the high quality of DVD is expected to create additional demand for the
many classic or familiar "collectible" titles in the Library. As DVD is a
developing technology, it is uncertain when and if DVD will become viable and,
therefore, the Company has only projected modest incremental revenue in its
1998 business plan from the technology.
 
  PAY AND FREE TELEVISION DISTRIBUTION
 
  General. The Company generally licenses its current theatrical motion
pictures for pay and free television through output agreements pursuant to
which films not yet produced are pre-licensed for a specified fee paid on
delivery. The Company believes that output agreements with international
distributors with recognized expertise are beneficial as they assure that a
significant advance will be received for a given territory and that a
prominent distributor with recognized distribution and marketing capabilities
will distribute the picture in such territory.
 
                                      16
<PAGE>
 
The Company currently has a long-term output agreement with a subsidiary of
Seven. See "Item 13. Certain Relationships and Related Transactions."
 
  The Company expects to enter into relatively short-term licenses of its
Library motion pictures for pay and free television in packages that are
strategically designed for the relevant marketplace. The Company has created a
proprietary database for use by its salesforce which contains detailed
information on each of the Company's films, including dates of availability,
media controlled by the Company, sales history, genre, format, length, stars,
soundtrack, etc. This information can be utilized by the sales force in order
to create strategically designed packages of motion pictures based on one or
more various criteria. The Company believes that this system is the most
advanced in the entertainment business and provides its sales force with an
advantage in a competitive marketplace that requires large amounts of diverse
content and is becoming more receptive to packaged programming.
 
  Previously, the Company had distributed its motion pictures in pay
television markets outside of the U.S. and Canada through UIP. However, as
part of an agreement reached between UIP and the competition authorities of
the European Union in 1997, UIP agreed that it will no longer engage in the
licensing or marketing of motion picture product for pay television, and the
Company now licenses its motion pictures to such markets directly. See "--
Regulation."
 
  Domestic Pay Television. The Company and Showtime have entered into a
theatrical motion picture output agreement requiring the Company's future
theatrical motion pictures to air on Showtime's pay television network. The
first output period expires upon the first to occur of August 31, 2001 or the
delivery of 150 pictures (other than specialty pictures) under the agreement.
As of December 31, 1997, the Company had delivered 27 pictures to Showtime.
The second output period commences on September 1, 2001 and expires upon the
first to occur of December 31, 2003 or the delivery of 65 additional pictures
(other than specialty pictures). Additionally, the agreement requires the
Company's future specialty pictures (i.e., pictures released under the Goldwyn
logo) to air on Showtime's pay television network. The output period for
specialty motion pictures expires upon the first to occur of December 31, 2003
or the delivery of 50 specialty motion pictures. The license fees for each
picture are determined according to a formula based on U.S. theatrical rentals
of such picture, with special provisions applicable to the specialty motion
pictures.
 
  Orion and Home Box Office ("HBO") have entered into a theatrical motion
picture output agreement requiring future theatrical motion pictures produced
and distributed by the Orion Companies (excluding pictures produced by Goldwyn
and distributed under both the prior and current Goldwyn logo) to air on HBO's
pay television network. The license fees for each picture are determined
according to a formula based on U.S. theatrical rentals of such picture. The
agreement expires on December 31, 2001, but HBO has the right to extend the
agreement through December 31, 2006.
 
  Domestic Free Television. The Company distributes its feature motion
pictures to U.S. and Canadian networks, local television stations in the U.S.
and Canada and basic cable networks. The Company also generates rrevenue by
granting syndication licenses on a barter basis. Barter syndication allows the
television stations to license the Company's product in exchange for a portion
of the local commercial air time. The Company, in turn, sells the inventory of
commercial air time to advertisers on a national basis, while the television
stations retain a portion of the commercial air time for local advertisers.
The Company has used outside barter companies to sell television spots to
advertisers in the past, but the Company commenced its own barter sales
business in 1996.
 
  In connection with the acquisition of MGM/UA by Pathe in November 1990, MGM-
Pathe licensed the domestic free television rights to a substantial portion of
its library (the UA library and the post-1986 MGM/UA titles in theatrical
release at the time) and selected television programs to Turner for a period
of ten years beginning from the availability of each such product in that
market. The license excludes motion pictures released theatrically after 1987.
With respect to most of the motion pictures and television programming covered
by the license, the domestic free television rights revert to the Company
between 2000 and 2003. The Company
 
                                      17
<PAGE>
 
expects to receive relatively little revenue from the licensing of the product
covered by the agreement with Turner in the domestic free television market
until 2000. The Company believes that, due to the significant increases in
licensing fees for domestic television since 1990, the expiration of the
Turner license and the subsequent ability of the Company to freely license the
Library in this market will generate incremental revenue for the Company,
however there can be no assurance that sales or profitability will increase
after these agreements expire.
 
  International Pay and Free Television. The Company currently distributes its
motion pictures through pay television licenses in over 90 territories. The
Company has output agreements with licensees in major territories, including
the United Kingdom, Spain, Italy, Germany, Japan and Brazil. In 1997 the
Company received $58.8 million in revenue from international pay television
distribution, accounting for seven percent of the Company's total revenue for
the year.
 
  The Company currently distributes its motion pictures and television product
through free television licenses in over 100 territories. In 1997 the Company
received $120.1 million in revenues under these agreements, accounting for 14
percent of the Company's total revenues for the year. These license
arrangements typically provide licensees with the right to exhibit the
licensed motion pictures on television for a specific number of airings over a
period of three to seven years.
 
  However, in connection with the acquisition of MGM/UA by Pathe in November
1990, MGM-Pathe entered into long-term licenses of pay and free television
rights for theatrical and television movies and, in some cases, television
series in its Library at that time with United Communications (France) and
F.O.R.T.A. (Spain). A similar agreement had been entered into in 1984 with
Degeto Film (Germany). Substantially all of the license fees under these long-
term licenses have already been paid to the Company, and, therefore, the
Company does not expect to receive significant revenue from these licenses in
future periods. With respect to most of the motion pictures licensed to United
Communications, the rights granted revert to the Company between 2000 and
2003. The James Bond features were excluded from such license. With respect to
most of the motion pictures licensed to F.O.R.T.A., the free television rights
revert to the Company between 1997 and 2000. With respect to most of the
motion pictures and television series licensed to Degeto Film, the
distribution rights granted revert to the Company between 1999 and 2010.
 
  Additionally, Orion has entered into certain long-term licenses covering a
significant number of its library motion pictures in the international free
and pay television markets. Orion has already received substantially all of
the license fees under these licenses, and therefore, the Company does not
expect significant revenue from these licenses in future periods. Orion has
licensed titles to Capitol Film and TV International (Germany), Compagnie
Luxembourgeoise de Telediffusion (France), British Sky Broadcasting (the
United Kingdom), Film Finance Group, Inc. and Principal Network Limited
(Italy) and Televisio de Catalunya, S.A. (Spain). The distribution rights
granted to Capitol Film and TV International revert to Orion in 2025. The
distribution rights granted to Compagnie Luxembourgeoise de Telediffusion
revert to Orion between 2003 and 2013. The distribution rights granted to
British Sky Broadcasting are currently reverting to Orion, with such reversion
being complete in 2002. The distribution rights granted to Film Finance Group,
Inc. and Principal Network Limited revert to Orion between 1999 and 2012. The
distribution rights granted to Televisio de Catalunya, S.A. are currently
reverting to Orion, with such reversion being complete in 2010. The Company
believes that, due to the importance of France, Spain, Germany, the United
Kingdom and Italy and the significant increases in licensing fees for
television in these markets since 1990, the expiration of these licenses and
subsequent ability of the Company to freely license its Library in these
markets could create substantial incremental revenue for the Company. However,
there can be no assurance that sales or profitability will increase after
these agreements expire.
 
  The MGM/UA and Orion licenses discussed above (in "--Domestic Free
Television" and "--International Pay and Free Television") cover many of the
most valuable motion pictures in the Library. Although the Company exploits
the remaining titles in the Library in these markets, they do not generate
significant revenues.
 
                                      18
<PAGE>
 
  In addition to licensing packages of films, the Company holds equity
positions ranging from 12.5 percent to 25 percent in joint ventures such as
CineCanal, Telecine, Star Channel (through UIP) and MovieVision, which are
emerging international cable television networks broadcasting in different
territories around the world. The Company has entered into license agreements
with respect to each of CineCanal, Telecine, Star Channel and MovieVision,
licensing theatrical and television motion pictures and, in some cases,
television series to each of the ventures.
 
  The Company believes its strategy of providing strategically pooled, branded
MGM programming through the licensing of programming packages to cable
networks and television broadcasters, as well as through the development of
new channels of distribution that deliver the Company's programming, will
provide opportunities in the international marketplace as foreign countries
continue to develop cable television infrastructures and satellite television
becomes more available.
 
  In June 1996 the Company announced the creation of MGM Gold (Asia), a 24-
hour satellite and cable delivered Hollywood entertainment television channel
serving certain Southeast Asian territories as well as Hong Kong, Taiwan,
China and India. MGM Gold (Asia) features primarily movie product from the
Library. MGM Gold (Asia) is a joint venture between the Company and Encore
International, an indirect subsidiary of Tele-Communications, Inc., in which
each of the joint venturers shares equally in the profits of the venture and
each is obligated to fund 50 percent of the joint venture's expenses up to a
maximum of $23.3 million each, of which the Company had funded $11.3 million
as of December 31, 1997. Additionally, the Company's share of start-up losses
for the venture had totaled approximately $11.8 million as of December 31,
1997. As of December 31, 1997, MGM Gold (Asia) was being delivered to
approximately 1.9 million subscribers in Hong Kong, Indonesia, Malaysia, the
Philippines, Singapore, Thailand and Taiwan. The Company has entered into a
license agreement with MGM Gold (Asia) to license certain motion pictures and
trademarks to the venture. The recent deterioration in general economic
conditions in much of Asia poses a business risk to the venture. The future
direction of the venture is therefore subject to management's ongoing
evaluation of such risk and of the venture's performance to date.
 
  The Company launched MGM Gold (Brazil), a 24-hour satellite and cable
delivered channel which features MGM film and television programming, on
December 14, 1997. MGM Gold (Brazil) is wholly owned by the Company. The
Company has entered into a distribution agreement with Net Brasil, the largest
cable owner and operator in Brazil presently serving approximately 70 percent
of current cable television households. The Company has recently entered into
an agreement with TVA Sistema de Televisao, the second largest cable owner and
operator in Brazil. In addition, the Company has agreements with Sky Latin
American and Galaxy Latin America, Brazil's two leading direct-to home
satellite services. With these four agreements in place, MGM Gold (Brazil)
will have access to distribution systems serving more than 90 percent of
Brazil's multi-channel television households.
 
TRADEMARKS AND CONSUMER PRODUCTS
 
  The Company owns the registered trademarks Metro-Goldwyn-Mayer, MGM, United
Artists, UA, Orion and variations thereof, as well as trademarks, logos and
other representations of characters, such as The Pink Panther, from motion
pictures and television series produced or distributed by the Company. In
1997, the Company received $9.5 million in revenue from the licensing of these
trademarks, logos and other representations.
 
  The Company believes that the MGM name and its lion logo are among the most
recognized in the world, evoking images of classic Hollywood. The Company
believes that the name and logo represent assets the value of which has been
substantially unrealized in the past. The Company plans to pursue a focused
branded strategy that will capitalize upon the Company's name and logo and
seek licensing opportunities for such name and logo, as well as other
trademarks of the Company, in a range of high quality product categories
(including gifts and apparel), distribution channels and venues.
 
  In February 1980 Old MGM granted to a predecessor-in-interest to MGM Grand,
Inc., an affiliate of Tracinda, an exclusive open-ended royalty-free license
to use certain trademarks and trade names that include
 
                                      19
<PAGE>
 
the letters "MGM," as well as logos consisting of a stylized depiction of a
lion, in MGM Grand, Inc.'s hotel/gaming business and businesses that are not
entertainment-related. In 1986 MGM/UA granted MGM Grand Air, Inc. ("Grand
Air"), an affiliate of Tracinda, an exclusive open-ended royalty-free license
to use one of its logos consisting of a stylized depiction of a lion in Grand
Air's airline business. See "Item 13. Certain Relationships and Related
Transactions."
 
  In June 1985 Old MGM granted to Walt Disney Productions ("Disney
Productions") an exclusive long-term worldwide license (the "Disney License")
to use all trademarks, trade names and logos of MGM Studios that do not
include "United Artists" or "UA" and materials from certain MGM and UA motion
pictures and television programming in movie theme parks of Disney Productions
that include a working movie production studio, as long as Disney Productions
makes the annual license payments. The Disney License becomes non-exclusive
with respect to the licensed trademarks, trade names and logos on May 1, 2004
and is subject to early termination under certain circumstances. Additionally,
if Disney Productions did not develop a movie theme park in any given
territory by June 27, 1994, the Disney License requires that Disney
Productions reconvey all the licensed rights in that territory to MGM Studios.
MGM Studios has requested the reconveyance of the licensed rights in all
territories except the U.S., and Disney Productions reconveyed those rights in
1995 for all territories except the U.S. and Western European territories in
1995. The Company filed a lawsuit against Disney Enterprises, Inc. ("Disney")
to compel the reconveyance of the licensed rights in Western Europe and for
termination of the Disney License, and, on November 5, 1997, received a jury
verdict in its favor with respect to the rights in Western Europe. The court
granted summary adjudication in favor of Disney denying the Company the right
to terminate Disney's U.S. rights under the Disney License. The Company has
appealed this aspect of the decision. See "Item 3. Legal Proceedings."
 
COMPETITION
 
  Motion picture production and distribution are highly competitive
businesses. The Company faces competition from companies within the
entertainment business, as well as alternative forms of leisure entertainment.
The Company competes with the other major studios, numerous independent motion
picture and television production companies, television networks and pay
television systems for the acquisition of literary properties, the services of
performing artists, directors, producers and other creative and technical
personnel and production financing. Numerous organizations with which the
Company competes in the motion picture industry have significantly greater
financial and other resources than does the Company, while the independent
production companies may have less overhead than the Company. Most of the
other major studios are part of large diversified corporate groups with a
variety of other operations, including television networks and cable channels,
which can provide both means of distributing their products and stable sources
of earnings that offset the fluctuations in the financial performance of their
motion picture and television operations. See "--Distribution--Pay and Free
Television Distribution."
 
  In addition, the Company's motion pictures compete for audience acceptance
and exhibition outlets with motion pictures produced and distributed by other
companies. As a result, the success of any of the Company's motion pictures is
dependent not only on the quality and acceptance of a particular picture, but
also on the quality and acceptance of other competing motion pictures released
into the marketplace at or near the same time. The number of films released by
the Company's competitors, particularly the other major film studios, in any
given period may create an oversupply of product in the market, thereby
potentially reducing the Company's share of gross box office admissions and
may make it more difficult for the Company's films to succeed.
 
  Competition is also intense within the television industry. There are
numerous suppliers of television programming, including the networks, the
television production divisions of the major studios and independent
producers, all of which compete actively for the limited number of available
broadcast hours. The Company's programming competes with first-run
programming, network reruns and programs produced by local television
stations. Competition is also intense in supplying motion pictures and other
programming for the pay television and home video markets. Numerous
organizations with which the Company competes in the television industry have
significantly greater financial and other resources than does the Company.
 
                                      20
<PAGE>
 
  The entertainment industry continues to undergo significant changes,
primarily due to technological developments. Due to this rapid growth in
technology, shifting consumer tastes and the popularity and availability of
other forms of entertainment, it is impossible to predict the overall effect
these factors will have on the potential revenue from and profitability of
feature-length motion pictures and television programming.
 
EMPLOYEES
 
  As of December 31, 1997, the Company had approximately 1020 full-time and
part-time regular employees in its worldwide operations. Of that total,
approximately 135 were primarily engaged in production and development,
approximately 315 were primarily engaged in sales, marketing and distribution
and approximately 565 were primarily engaged in management and administration.
Approximately 165 of the Company's employees are currently covered by
employment contracts. The Company also hires additional employees on a
picture-by-picture basis in connection with the production of the Company's
motion pictures and television programming. The salaries of these additional
employees, as well as portions of the salaries of certain full-time employees
of the Company who provide direct production services, are typically allocated
to the capitalized cost of the related motion pictures or television
programming. The Company believes that its employee and labor relations are
good.
 
  Approximately 45 of the Company's current employees (and many of the
employees that the Company hires on a project-by-project basis) are
represented under industry-wide collective bargaining agreements with various
unions, including the Writers Guild of America ("WGA"), the Directors Guild of
America ("DGA"), the Screen Actors Guild ("SAG") and the International
Alliance of Theatrical Stage Employees. A strike, job action or labor
disturbance by the members of any of these organizations may have a material
adverse effect on the production of a motion picture or television program
within the U.S.
 
  The collective bargaining agreement between SAG and the major studios
(including the Company) and other producers of motion pictures and television
product that are signatories to that agreement expires June 30, 1998. It is
possible that a new agreement may not be concluded between SAG and such
studios and other producers prior to such expiration, and, in such event, a
strike by the members of SAG may result. The Company may seek to adjust its
production schedule so as to reduce the impact of any strike. However, any
such strike, particularly if protracted, could have a material adverse effect
on the Company's business, financial condition and results of operations.
 
REGULATION
 
  In 1994 the U.S. was unable to reach agreement with its major international
trading partners to include audiovisual works, such as television programs and
motion pictures, under the terms of the General Agreement on Trade and Tariffs
Treaty ("GATT"). The failure to include audiovisual works under GATT allows
many countries (including members of the European Union, which consists of
Belgium, Denmark, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg,
The Netherlands, Portugal and the United Kingdom) to continue enforcing quotas
that restrict the amount of U.S. produced television programming which may be
aired on television in such countries. The European Union Council of Ministers
has adopted a directive requiring all member states of the European Union to
enact laws specifying that broadcasters must reserve a majority of their
transmission time (exclusive of news, sports, game shows and advertising) for
European works. The directive does not itself constitute law, but must be
implemented by appropriate legislation in each member country. In addition,
France requires that original French programming constitute a certain portion
of all programming aired on French television. These quotas generally apply
only to television programming and not to theatrical exhibition of motion
pictures, but quotas on the theatrical exhibition of motion pictures could
also be enacted in the future. There can be no assurance that additional or
more restrictive theatrical or television quotas will not be enacted or that
countries with existing quotas will not more strictly enforce such quotas.
Additional or more restrictive quotas or more stringent enforcement of
existing quotas could materially and adversely affect the business of the
Company by limiting the ability of the Company to exploit fully its motion
pictures internationally and, consequently, to finance such motion pictures.
 
                                      21
<PAGE>
 
  Distribution rights to motion pictures are granted legal protection under
the copyright laws of the U.S. and most foreign countries, which laws provide
substantial civil and criminal sanctions for unauthorized duplication and
exhibition of motion pictures. The Company seeks to take appropriate and
reasonable measures to secure, protect and maintain or obtain agreements to
secure, protect and maintain copyright protection for all of its motion
pictures or television programming under the laws of applicable jurisdictions.
Motion picture piracy is an international as well as a domestic problem.
Motion picture piracy is extensive in many parts of the world, including South
America, Asia (including Korea, China and Taiwan), the countries of the former
Soviet Union and other former Eastern bloc countries. In addition to the
Motion Picture Association of America (the "MPAA"), the Motion Picture
Association, the American Film Marketing Association and the American Film
Export Association monitor the progress and efforts made by various countries
to limit or prevent piracy. In the past, these various trade associations have
enacted voluntary embargoes of motion picture exports to certain countries in
order to pressure the governments of those countries to become more aggressive
in preventing motion picture piracy. In addition, the U.S. government has
publicly considered trade sanctions against specific countries which do not
take steps to prevent copyright infringement of U.S. produced motion pictures.
There can be no assurance that voluntary industry embargoes or U.S. government
trade sanctions will be enacted. If enacted, such actions could impact the
amount of revenue that the Company realizes from the international
exploitation of its motion pictures depending upon the countries subject to
such action and the duration of such action. If not enacted or if other
measures are not taken, the motion picture industry (including the Company)
may continue to lose an indeterminate amount of revenues as a result of motion
picture piracy.
 
  Article 85(1) of the Treaty of Rome prohibits certain agreements and
concerted practices which prevent, restrict or distort trade within the
European Union. In 1989 after several years of proceedings before the European
Commission, UIP received an exemption from Article 85(1) with respect to its
theatrical distribution activities in the European Union. In connection with
this exemption, UIP gave certain undertakings to the European Commission. The
1989 exemption expired in 1993 and, although UIP has filed an application
seeking renewal of such exemption, such renewal has not yet been granted. In
July 1996 the European Commission conducted unannounced visits of four of
UIP's offices in Europe, interviewing officers and copying documents. These
visits were based on complaints submitted to the European Commission by third
parties, to the effect that UIP was acting in an anti-competitive manner and
was not complying with certain of the undertakings given by it in connection
with receiving the 1989 exemption. In addition, on January 16, 1998, in
response to UIP's renewal application, the Competition Directorate of the
Commission of the European Communities issued a Statement of Objections. The
Statement of Objections indicates that, although a final decision has not been
taken, the Commission is of the opinion that the exemption granted to UIP in
1989 should not be extended and that UIP should be required to cease
operations in the European Union. There can be no assurances that the 1989
exemption will be renewed or renewed on terms acceptable to UIP. If the 1989
exemption is not renewed at all or not renewed on terms satisfactory to UIP
and UIP ceased operations, the Company believes that it would be able to find
or develop satisfactory alternative methods for international distribution,
although such alternatives may result in decreased revenues and profitability
from such distribution. See "--Distribution--Theatrical Distribution."
 
  The Code and Ratings Administration of the MPAA assigns ratings indicating
age-group suitability for theatrical distribution of motion pictures. The
Company has followed and will continue to follow the practice of submitting
its pictures for such ratings. As a substantial number of the Company's films
are rated "R," under rules enforced by theatrical exhibitors, children under
certain ages may attend the applicable motion picture only if accompanied by
an adult.
 
  United States television stations and networks as well as foreign
governments impose content restrictions on motion pictures which may restrict
in whole or in part exhibition on television or in a particular territory.
There can be no assurance that such restrictions will not limit or alter the
Company's ability to exhibit certain motion pictures in such media or markets.
 
                                      22
<PAGE>
 
ITEM 2. PROPERTIES
 
  The Company leases approximately 300,000 square feet of office space, as
well as related parking facilities, for its corporate headquarters in Santa
Monica, California under several leases which generally expire in May 2003.
The Company also leases approximately 27,000 square feet in New York City for
its East Coast publicity, marketing and theatrical and television distribution
offices under a lease that expires in June 2004. Additionally, the Company
leases approximately 96,000 square feet of office space in Los Angeles,
California, which has been used by Orion, under a lease that expires in
January 2004. The monthly rent for the above properties is approximately $1.2
million in the aggregate (in addition to taxes, insurance and certain expenses
paid by the Company). The Company is in the process of subleasing the office
space used by Orion. In addition, the Company maintains relatively small
domestic theatrical and television distribution branches in Boca Raton,
Chicago, Montreal, San Juan and Toronto and has small international theatrical
and television distribution offices in London and Sydney. The Company recently
closed its Paris office and moved its European distribution operations to
London. The Company also leases studio facilities and stages from unaffiliated
parties on an "as-needed" basis in connection with the production of specific
motion picture and television projects.
 
  The Company believes that its current facilities are adequate to conduct its
business operations for the foreseeable future.
 
ITEM 3. LEGAL PROCEEDINGS
 
  MGM Pictures and UA Pictures are named defendants in a matter entitled
Estate of Jim Garrison, et al v. Warner Bros., Inc., et al, which was filed as
a putative class action in the Los Angeles County Superior Court in November
1995. Warner, Paramount, Fox, Universal, Sony, Columbia Pictures Inc., Disney,
Disney Productions, Touchstone Pictures Inc., Hollywood Pictures Inc., Tri-
Star Pictures Inc. and the MPAA were also named as defendants in the action.
 
  The plaintiffs in the action are the heirs of Jim Garrison, the former New
Orleans District Attorney who wrote the book "On The Trail of the Assassins"
upon which the Warner film JFK was based. The plaintiffs claim that the
defendant studios had conspired to fix the price and terms of contingent
compensation payable by the studios to actors, directors, producers, writers
and other "rights holders" (collectively identified as "talent"), through the
use of "standard net profits" provisions in contracts entered into with
respect to motion pictures produced by the defendant studios between January
1, 1988 and the date of the complaint.
 
  In December 1995 the defendants removed the Garrison action to the U.S.
District Court for the Central District of California. MGM Pictures and UA
Pictures have denied all of the material allegations of the complaint and have
asserted 33 separate and additional defenses. The other studio defendants have
responded similarly. The court denied class certification with respect to the
plaintiffs' claims for breach of contract, breach of implied covenant, unjust
enrichment, imposition of constructive trust and declaratory relief, but
granted class certification with respect to the plaintiffs' claims for price
fixing under the Sherman Antitrust Act, price fixing under state law,
boycott/concerted refusal to deal under the Sherman Antitrust Act and
boycott/concerted refusal to deal under state law. The court subsequently has
announced that its grant of the plaintiffs' class certification motion may
have been "inadvertent," and has issued an order on its own motion requesting
briefing on the issue whether the class should be decertified. The briefing is
to be completed by March 9, 1998, and the court is expected to decide the
decertification issue by March 30, 1998.
 
  The plaintiffs have not yet quantified their claim for damages, nor has the
size and membership of the class been determined. Based upon the information
available to date, the Company's management does not believe that any adverse
determination in the Garrison matter is likely to have a material adverse
effect on the financial condition or results of operations of the Company.
 
  MGM Studios is a defendant in an action filed in the Los Angeles County
Superior Court in March 1994, entitled Parretti v. CLBN, MGM et al. The
complaint seeks damages totaling $3.9 billion dollars for breach of Mr.
Parretti's employment contract and other relief. MGM Studios' motions for
final judgment have been granted
 
                                      23
<PAGE>
 
on all grounds. A notice of appeal was filed in August 1997 by Mr. Parretti.
Mr. Parretti's counsel withdrew from the case in February 1997 and there is,
at the moment, no schedule for briefs to be submitted by the parties. MGM
Studios believes that the appeal is without merit. MGM Studios has
indemnification from liability in the Parretti proceeding from CDR.
Accordingly, the Company's management does not believe that any adverse
determination in the Parretti litigation will have any material adverse effect
on the Company's financial condition or results of operations.
 
  In May 1996 MGM Studios initiated an action in Los Angeles County Superior
Court against Disney to compel the reconveyance of rights granted with respect
to Western European territories to Disney Productions under the Disney
License. See "Item 1. Business--Trademarks and Consumer Products." MGM Studios
also claims that Disney Productions' breach of the reconveyance obligation
entitles MGM Studios under the terms of the Disney License to terminate the
Disney License altogether. On November 5, 1997 the Company received a jury
verdict in its favor with respect to the Western European rights. The court
granted summary adjudication in favor of Disney denying the Company the right
to terminate Disney's U.S. rights under the Disney License. The Company has
appealed this aspect of the decision.
 
  MGM Studios, as successor in interest to UA, is a defendant in an action
originally filed in Georgia state court entitled Turner Broadcasting System
Inc., et al. v. Metro-Goldwyn-Mayer Inc., et al. Turner alleges that, as a
result of the 1986 acquisition of Old MGM by Turner, UA was unjustly enriched
by reason of a tax benefit in excess of $260 million to which Turner was
entitled but was actually utilized by Tracinda. MGM removed the action to
federal court, and the court granted MGM's motion to transfer the case to the
United States District Court for the District of Nevada. The action has since
been consolidated with a virtually identical action by Turner against
Tracinda. Management believes that UA did not receive any benefit from these
transactions and accordingly that it is unlikely that the Turner matter would
have a material adverse effect on the Company's financial condition or results
of operations.
 
  Certain subsidiaries of the Company are defendants in an action pending in
the Commercial Court of Brussels, Belgium entitled Credit General Foncier et
Mobilier S.A. ("Cregefon") et al. v. Canon International V.O.F., Canon
International N.V., Canon Film Distribution Nederland B.V. and Pathe
Entertainment N.V. The action involves a suit by the bankruptcy trustee of
Cregefon to recover a 1990 loan made to Canon International V.O.F., as a
depository for Comfinance S.A. (a company associated with Mr. Parretti). The
suit seeks damages of up to approximately $60 million. The Company has
indemnification from CDR with respect to this matter. As a result, management
believes that the Cregefon litigation will not have any material adverse
effect on the Company's financial condition or results of operations. The
terms for a settlement regarding this action were reached between the parties
in January 1998 for approximately $9 million and are pending court approval.
The full amount of this settlement will be funded by CDR.
 
  Orion is a defendant in a matter entitled Sidney Sapsowitz et al. v. John W.
Kluge, Metromedia International Inc., and Orion Pictures Corp., et al., which
was filed in June 1997. The plaintiffs claim a "finder's fee" of $28.5 million
in connection with the Orion Acquisition. There have been no material
developments in the Sapsowitz case to date. Pursuant to the terms of
agreements executed in connection with the Orion Acquisition, the Company has
indemnification from Metromedia International Group, Inc. with respect to the
payment of any finder's fee. As a result, management believes that the
Sapsowitz litigation will not have any material adverse effect on the
Company's financial condition or results of operations.
 
  The Company is a defendant in an action entitled Samuel Goldwyn, Jr., et al.
v. Metro-Goldwyn-Mayer Inc., et al., pending in the Los Angeles County
Superior Court, which alleges claims for, among other things, fraud and
deceit, breach of various agreements, breach of fiduciary duty, trademark
infringement, and unfair competition. The complaint was served on the Company
on October 30, 1997, and no responsive pleading is due until March 1998. The
complaint seeks, among other relief, damages in excess of $5 million, an
injunction against the defendants' use of certain trademarks, injunctive
relief preventing the Company from using the "Goldwyn" name in connection with
the licensing or exhibition of any new film that has not been acquired by the
Company's Goldwyn subsidiary, termination of a distribution agreement and
unspecified punitive damages.
 
                                      24
<PAGE>
 
The Company intends to contest the litigation vigorously and believes that
this action will not have a material adverse effect on the Company's financial
condition or results of operations.
 
  On November 17, 1997, the Company and Danjaq filed an action in federal
court in Los Angeles against Sony Corporation, Sony Pictures Entertainment
Inc., Columbia Pictures Industries, Inc. ("Columbia"), John Calley, Kevin
McClory and Spectre Associates, Inc. seeking declaratory and injunctive relief
and/or damages for copyright infringement, trademark dilution, slander of
title, unfair competition, inducing breach of contract and breach of fiduciary
duties, and misappropriation of trade secrets, based on Sony's publicized
assertion on October 13, 1997 that it had the right (together with Mr.
McClory) to create its own James Bond film franchise. The complaint seeks
various forms of legal relief based on the Company's position that the
defendants do not have any legal right to produce or distribute a franchise of
James Bond films, or any James Bond films, in the United States. On January
23, 1998, the Company and Danjaq filed an amended complaint adding claims for
trademark infringement, federal unfair competition and California trademark
dilution. The Company and Danjaq contend not only that Mr. McClory's rights
were limited to remaking Thunderball but that even those rights have expired
under U.S. law pursuant to the doctrine of Stewart v. Abend, 495 U.S. 207
(1990) and that Mr. McClory's rights have been recently acquired by Danjaq.
They also contend that Mr. Calley misappropriated trade secret information
about the James Bond franchise when he left UA Pictures for Sony. On
February 12, 1998, Sony Pictures Entertainment Inc. and Columbia filed an
answer and counterclaim asserting, among other things, that Mr. McClory owns
the rights to materials he claims were the genesis of the cinematic James
Bond, and that Sony is the assignee of those rights and that they are
therefore owed an accounting of profits on all James Bond films Danjaq and the
Company have produced and marketed in the United States. See "Item 1.
Business--The Motion Picture and Television Industry." The Company intends
vigorously to assert both substantive and procedural defenses to all of Sony's
claims and to pursue its own remedies fully. The Company believes that a
remake of Thunderball by Mr. McClory, Sony or others would not have a material
adverse effect on the Company's business or results of operations. However, a
determination that Mr. McClory, Sony or others have broader rights to produce
or exploit other films, television programs or other similar programs that are
based, in whole or in part, on the James Bond character or that such persons
have a right to any of the profits from the James Bond films that Danjaq and
the Company have produced could have a material adverse effect on the
Company's business and results of operations.
 
  On December 10, 1997, plaintiffs Nova Entertainment, GmbH and HAT
International, GmbH filed suit in the United States District Court for the
Central District of California, against the Company, for claims arising out of
the Company's decision in 1997 not to enter into a financing, production and
distribution arrangement with the plaintiffs. The complaint seeks damages in
excess of $90 million in fees the plaintiffs claim they would have received
from an alleged production of nine motion pictures over three years, along
with punitive damages in an unstated amount. While no assurance can be given
regarding the outcome of this matter, the Company believes it had no agreement
or binding arrangement with the plaintiffs, whether legal or equitable, and no
obligation to enter into one, and that it has strong and meritorious defenses
to all of the claims asserted in the complaint. The Company plans to
vigorously defend itself against such claims.
 
  In addition, from time to time the Company becomes involved in other
litigation arising in the normal course of business, and the Company believes
that none of such other litigation as is currently pending will have a
material adverse effect on the Company's financial condition or results of
operations.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
 
  None.
 
                                      25
<PAGE>
 
ITEM 4(A). EXECUTIVE OFFICERS OF THE COMPANY
 
  Frank G. Mancuso (age 64). Mr. Mancuso has been the Chairman of the Board
and Chief Executive Officer of the Company since October 1996 and has been the
Chairman of the Board and Chief Executive Officer of MGM Studios since July
1993. Prior to joining MGM Studios, Mr. Mancuso was the Chairman and Chief
Executive Officer of Paramount from September 1984 to March 1991, having
served Paramount in numerous other capacities beginning in 1963, and was an
entertainment industry consultant and private investor from March 1991 to July
1993. Mr. Mancuso has served on the board of directors of MGM Grand, Inc.
since December 1997.
 
  A. Robert Pisano (age 55). Mr. Pisano was appointed as a director and Vice
Chairman of the Board of Directors of the Company in December 1997. Mr. Pisano
has served as Vice Chairman of the Company and MGM Studios since March 1997
and, prior thereto, served as Executive Vice President of MGM Studios from
August 1993 to March 1997. Prior to joining MGM Studios, Mr. Pisano was
Executive Vice President of Paramount from June 1985 to May 1991, where he
served as General Counsel and a member of the Office of the Chairman. Prior to
1985 and from February 1992 to August 1993, Mr. Pisano was a partner with the
law firm of O'Melveny & Myers LLP.
 
  Michael G. Corrigan (age 40). Mr. Corrigan has been Senior Executive Vice
President and Chief Financial Officer of the Company and MGM Studios since
July 1997. From 1978 until July 1997, Mr. Corrigan was with Price Waterhouse
LLP, an independent accounting firm, most recently as a senior partner with
the entertainment, media and communications practice group.
 
  David G. Johnson (age 41). Mr. Johnson has been Senior Executive Vice
President and General Counsel of the Company and MGM Studios since June 1997
and, prior thereto, was Executive Vice President and General Counsel of MGM
Studios since January 1995. From September 1990 until January 1995 Mr. Johnson
was with the law firm of White & Case, most recently as a partner in its Los
Angeles office.
 
  William A. Jones (age 56). Mr. Jones has been Senior Executive Vice
President and Secretary of the Company and MGM Studios since June 1997 and,
prior thereto, served as Executive Vice President--Corporate Affairs and
Secretary of MGM Studios since January 1995. Mr. Jones served as Executive
Vice President, General Counsel and Secretary of MGM-Pathe and MGM Studios
from May 1991 to January 1995 and as General Counsel and Secretary of
predecessors to the Company since 1983. Mr. Jones was a director of MGM-Pathe
from June 1991 to January 1992.
 
                                      26
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
COMMON STOCK
 
  The Company's Common Stock is listed with, and trades on, the New York Stock
Exchange ("NYSE") under the symbol "MGM." On March 11, 1998 the closing sale
price per share of the Common Stock on the NYSE, as reported by the Dow Jones
News Retrieval, was $23.00. The following table sets forth the high and low
closing sale prices of the Common Stock on the NYSE, as reported by the Dow
Jones News Retrieval, for the period from the date of commencement of trading
of the Company's Common Stock on the NYSE, November 13, 1997 through
December 31, 1997.
 
<TABLE>
<CAPTION>
            PERIOD                                               HIGH     LOW
            ------                                              ------- -------
     <S>                                                        <C>     <C>
     November 13, 1997--December 31, 1997...................... $21 7/8 $19 3/8
</TABLE>
 
  As of March 11, 1998, there were 65,779,852 shares issued and outstanding
and in excess of 2,000 beneficial holders of the Company's Common Stock,
including individual participants in security position listings.
 
  The Company has not paid any dividends to date on the Common Stock and
currently intends to retain any earnings to provide funds for the operation
and expansion of its business and for the servicing and repayment of
indebtedness. Therefore, the Company does not intend to pay cash dividends on
its Common Stock for the foreseeable future. Furthermore, as a holding company
with no independent operations, the ability of the Company to pay cash
dividends will be dependent upon the receipt of dividends or other payments
from its subsidiaries. In addition, the Company's principal credit facilities
contain certain covenants which, among other things, restrict the payment of
dividends by the Company. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations." Any determination to pay cash
dividends on the Common Stock in the future will be at the sole discretion of
the Company's Board of Directors.
 
  Unless otherwise indicated, all information in this Form 10-K gives effect
to a recapitalization of the Company which occurred immediately prior to the
closing of the Offering on November 18, 1997 and consisted of (i) the
conversion of each share of the Company's then outstanding Series A Cumulative
Convertible Preferred Stock into one share of the Common Stock and (ii) a
subsequent 41.667 for 1 stock split of the Common Stock.
 
RECENT SALES OF UNREGISTERED SECURITIES
 
  Concurrent with the consummation of the Offering, Tracinda and the Company
consummated the Tracinda Purchase, pursuant to which Tracinda purchased
directly from the Company, at a purchase price of $18.85 per share (equal to
the purchase price to the public in the Offering, less underwriting
discounts), 3,978,780 shares of the Common Stock, for an aggregate purchase
price of $75 million.
 
  Pursuant to an investment agreement dated May 2, 1997 among Seven, Tracinda
and the Company, and in connection with the Orion Acquisition, Tracinda
purchased 13,375,107 shares of the Common Stock and Seven purchased 1,625,013
shares of the Common Stock, for a purchase price of $24.00 per share and an
aggregate purchase price of $360 million.
 
  Pursuant to his employment agreement, and in addition to other amounts he is
entitled to thereunder, Mr. Mancuso receives an annual stock purchase payment
of $3,000,000 per year, out of the after-tax proceeds of which he is required
to purchase shares of the Common Stock. Prior to November 17, 1997, Mr.
Mancuso received such annual stock purchase payment in 26 even payments over
the course of the year. On November 17, 1997, Mr. Mancuso received, and will
receive on November 17 of each year during the remaining term of his contract,
the entire annual stock purchase payment in advance for the year. With respect
to annual stock purchase payments received on or before November 17, 1997, the
purchase price for the shares of the Common Stock
 
                                      27
<PAGE>
 
required to be purchased by Mr. Mancuso was $24.00 per share. After November
17, 1997, the purchase price will equal the fair market value of the Common
Stock. For the year ended December 31, 1997, Mr. Mancuso purchased 124,746
shares of the Common Stock for aggregate consideration of $2,993,904, which
amount represents the after-tax proceeds of (i) the portion of the annual
stock purchase payment for the period of January 1, 1997 to November 17, 1997
and (ii) the annual stock purchase payment paid in advance for the period
November 18, 1997 to November 17, 1998. See "Item 11. Executive Compensation--
Employment Agreements--Frank G. Mancuso."
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
  The selected consolidated financial data of the Company (including its
predecessor) presented below as of December 31 of each of the years 1993
through 1995, the period from January 1 to October 10, 1996, the period from
October 11 to December 31, 1996 and the year ended December 31, 1997 and each
of the years or periods then ending have been derived from the audited
Consolidated Financial Statements of the Company. The audited Consolidated
Financial Statements of the Company for the year ended December 31, 1997 and
the period from October 11 to December 31, 1996 and the audited Consolidated
Financial Statements of MGM Studios for the period from January 1 to October
10, 1996 were audited by Arthur Andersen LLP, independent public accountants.
The audited Consolidated Financial Statements of MGM Studios for the years
ended December 31, 1995 and 1994 were audited by Price Waterhouse LLP,
independent public accountants. The audited Consolidated Financial Statements
of MGM Studios for the year ended December 31, 1993 were audited by KPMG Peat
Marwick LLP, independent public accountants.
 
  The selected consolidated financial data should be read in conjunction with
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the Consolidated Financial Statements and the
related notes thereto for the Company included elsewhere in this Form 10-K.
 
                                      28
<PAGE>
 
<TABLE>
<CAPTION>
                                          (PREDECESSOR)                              (SUCCESSOR)
                          ------------------------------------------------    --------------------------
                              YEAR ENDED DECEMBER 31,         JANUARY 1 TO    OCTOBER 11 TO  YEAR ENDED
                          ----------------------------------  OCTOBER 10,     DECEMBER 31,  DECEMBER 31,
                             1993        1994        1995         1996           1996(2)     1997(2)(4)
                          ----------  ----------  ----------  ------------    ------------- ------------
                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                       <C>         <C>         <C>         <C>             <C>           <C>          <C>
STATEMENT OF OPERATIONS
 DATA
Revenues................  $  538,887  $  597,121  $  860,971   $  912,706      $  228,686    $  831,302
Expenses:
 Film and television
  production and
  distribution..........     700,134     668,516     894,280      953,820         195,076       799,539
 General and
  administration
  expenses..............      75,745      49,314      64,175       60,056          18,319        87,644
 Goodwill amortization..      14,876      14,876      14,876       11,570           1,717        11,230
 Provision for
  impairment............         --          --          --       563,829 (3)         --            --
                          ----------  ----------  ----------   ----------      ----------    ----------
                             790,755     732,706     973,331    1,589,275         215,112       898,413
                          ----------  ----------  ----------   ----------      ----------    ----------
Operating income (loss).    (251,868)   (135,585)   (112,360)    (676,569)         13,574       (67,111)
Interest expense, net of
 amounts capitalized....     (87,472)    (33,860)    (66,386)     (71,375)         (9,875)      (53,105)
Interest and other
 income, net............       1,020       2,070      10,372        3,179             813         2,447
                          ----------  ----------  ----------   ----------      ----------    ----------
Income (loss) from
 continuing operations
 before provision for
 income taxes...........    (338,320)   (167,375)   (168,374)    (744,765)          4,512      (117,769)
Income tax provision....      (6,725)     (3,877)       (935)        (273)         (4,346)      (10,345)
                          ----------  ----------  ----------   ----------      ----------    ----------
Income (loss) from
 continuing operations..  $ (345,045) $ (171,252) $ (169,309)  $ (745,038)     $      166    $ (128,114)
                          ==========  ==========  ==========   ==========      ==========    ==========
Basic and diluted
 earnings (loss) per
 share..................                                                       $     0.01    $    (4.47)
                                                                               ==========    ==========
OTHER OPERATING DATA
 (UNAUDITED)
Cash flow from operating
 activities.............  $   80,455  $  216,289  $  371,657   $  343,137      $   61,328    $  245,318
Cash flow from investing
 activities.............    (253,371)   (464,031)   (710,812)    (380,142)     (1,390,861)   (1,290,022)
Cash flow from financing
 activities.............     182,704     239,965     328,029       44,852       1,345,394     1,028,784
EBITDA(1)...............    (222,118)   (103,499)    (81,588)     (87,289)         16,709       (49,098)
Capital expenditures....      15,578       9,099       9,376        6,901           2,079         9,555
Depreciation expense....       2,999       5,335       4,021        4,645           1,418         6,783
<CAPTION>
                                          (PREDECESSOR)                              (SUCCESSOR)
                          ------------------------------------------------    --------------------------
                                 AS OF DECEMBER 31,              AS OF            AS OF        AS OF
                          ----------------------------------  OCTOBER 10,     DECEMBER 31,  DECEMBER 31,
                             1993        1994        1995         1996           1996(2)     1997(2)(4)
                          ----------  ----------  ----------  ------------    ------------- ------------
                                   (IN THOUSANDS)                                   (IN THOUSANDS)
<S>                       <C>         <C>         <C>         <C>             <C>           <C>          <C>
BALANCE SHEET DATA
Cash and cash
 equivalents............  $   36,773  $   28,797  $   17,128   $   24,717      $   16,381    $    3,978
Film and television
 costs, net.............   1,343,931   1,412,607   1,565,438    1,006,402       1,099,201     1,867,126
Total assets............   2,142,562   2,235,622   2,440,254    1,744,234       1,774,668     2,822,654
Bank and other debt.....     555,915     876,866   1,217,316    1,229,499         444,427       890,508
Stockholders' equity....     984,607     829,059     659,499          --          903,122     1,378,555
Cash dividends..........         --          --       15,448        3,995             --            --
</TABLE>
-------
(1) "EBITDA" is defined as earnings before interest, taxes, depreciation and
    non-film amortization. While many in the financial community consider
    EBITDA to be an important measure of comparative operating performance, it
    should not be construed as an alternative to operating income or cash
    flows from operating activities (as determined in accordance with
    generally accepted accounting principles ("GAAP")). EBITDA does not
    reflect cash necessary or available to fund cash requirements, and the
    items excluded from EBITDA, such as depreciation and non-film
    amortization, are significant components in assessing the Company's
    financial performance. Other significant uses of cash flows are required
    before cash will be available to the Company, including debt service,
    taxes and cash expenditures for various long-term assets. The Company's
    calculation of EBITDA may be different from the calculation used by other
    companies and, therefore, comparability may be limited. See "Item 7.
    Management's Discussion and Analysis of Financial Condition and Results of
    Operations--Liquidity and Capital Resources."
 
(2) Financial data presented for periods subsequent to October 10, 1996
    reflect the consolidated balance sheet and results of operations of the
    combined entity resulting from the MGM Acquisition.
 
(3) The proceeds from the sale of MGM Studios were insufficient to recover the
    net asset value of MGM Studios on the date of the disposition by CDR.
    Accordingly, the Company recorded a provision for impairment of intangible
    assets of $563.8 million.
 
(4) Financial data presented for periods subsequent to July 10, 1997 reflect
    the consolidated balance sheet and results of operations of the combined
    entity resulting from the Orion Acquisition.
 
                                      29
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
  This report includes forward-looking statements. Generally, the words
"believes," "anticipates," "may," "will," "should," "expect," "intend,"
"estimate," "continue" and similar expressions or the negative thereof or
comparable terminology are intended to identify forward-looking statements.
Such statements are subject to certain risks and uncertainties, including the
matters set forth in this report or other reports or documents the Company
files with the Securities and Exchange Commission from time to time, which
could cause actual results or outcomes to differ materially from those
projected. Undue reliance should not be placed on these forward-looking
statements which speak only as of the date hereof. The Company undertakes no
obligation to update publicly any revisions to these forward-looking
statements.
 
  The following discussion and analysis should be read in conjunction with
"Item 6. Selected Consolidated Financial Data" and the Consolidated Financial
Statements and the related notes thereto and other financial information
contained elsewhere in this Form 10-K.
 
GENERAL
 
  The Company is engaged primarily in the development, production and
worldwide distribution of theatrical motion pictures and television
programming. See "Item 1. Business."
 
SOURCES OF REVENUE
 
  The principal sources of motion picture industry revenue are the domestic
and international distribution of motion pictures, including theatrical
exhibition, home video and television (network, syndication, basic cable, pay
and pay-per-view). Over the last decade, the relative contributions of these
components of revenues have changed dramatically. Although revenues from
domestic theatrical distribution have increased, growth in total motion
picture industry revenues has resulted predominantly from increased revenues
derived from the distribution of motion pictures internationally as well as
from other media and distribution channels.
 
  The Company's feature films are exploited through a series of sequential
domestic and international distribution channels, typically beginning with
theatrical exhibition. Thereafter, feature films are first made available for
home video generally six months after theatrical release; for pay television,
one year after theatrical release; and for syndication, approximately three to
five years after theatrical release. The Company's television programming is
produced for initial broadcast on either pay, syndicated or network television
in the United States, followed by international territories and, in some
cases, worldwide video markets.
 
  The Company distributes its motion picture and television productions in
foreign countries and, in recent years, has derived approximately 40 percent
of its revenues from foreign sources. As a result, the Company's business is
subject to certain risks inherent in international commerce, many of which are
beyond its control, such as changes in laws and policies affecting trade,
investment and taxes and the instability of foreign economies and governments.
Approximately 25 percent of the Company's revenues are denominated in foreign
currencies. In addition, the Company incurs certain operating and production
costs in foreign currencies. As a result, fluctuations in foreign currency
exchange rates can adversely affect the Company's business. The Company, in
certain instances, enters into foreign currency exchange contracts in order to
reduce exposure to changes in foreign currency exchange rates that affect the
value of its firm commitments and certain anticipated foreign currency cash
flows. These contracts generally mature within one year. The Company does not
enter into foreign currency contracts for speculative purposes. Realized gains
and losses on contracts that hedge anticipated future cash flows were not
material in each of the periods presented herein. Deferred gains and losses on
foreign exchange contracts as of December 31, 1997 were not material.
 
COST STRUCTURE
 
  General. In the motion picture industry, the largest component of the cost
of producing a motion picture generally is the negative cost, which includes
the "above-the-line" and "below-the-line" costs of producing the film. Above-
the-line costs are costs related to the acquisition of picture rights and the
costs associated with the producer, the director, the writer and the principal
cast. Below-the-line costs are the remaining costs involved in producing the
picture, such as film studio rental, principal photography, sound and editing.
 
                                      30
<PAGE>
 
  Distribution expenses consist primarily of the costs of advertising and
preparing release prints. The costs of advertising associated with a major
domestic theatrical motion picture release are significant and typically
involve national and target market media campaigns, as well as public
appearances of a film's stars. These advertising costs are separate from the
advertising costs associated with other domestic distribution channels and the
international market.
 
  The major studios generally fund production costs from cash flow generated
by motion picture and related distribution activities or bank and other
financing methods. Over the past decade, expenses in the motion picture
industry have increased rapidly as a result of increased production costs and
distribution expenses.
 
  Additionally, each of the major studios must fund substantial overhead
costs, consisting primarily of salaries and related costs of the production,
distribution and administrative staffs, as well as facilities costs and other
recurring overhead.
 
  Participations and Residuals. In connection with the production and
distribution of a motion picture, major studios generally grant contractual
rights to actors, directors, screenwriters, producers and other creative and
financial contributors to share in the gross receipts or contractually defined
net profits from a particular motion picture. Except for the most sought-after
talent, these third-party participations are generally payable after all
distribution fees, marketing expenses, direct production costs and financing
costs are recouped in full.
 
  Major studios also typically incur obligations to pay residuals to various
guilds and unions including SAG, DGA and WGA. The residual payments are made
on a picture-by-picture basis with respect to the exploitation of a motion
picture in markets other than the primary intended markets for such picture
and are calculated as a percentage of the gross revenues derived from the
exploitation of the picture in these ancillary markets.
 
  The Company's cost structure for motion pictures generally follows the
industry structure described above. For a discussion of television programming
cost structure, see "Item 1. Business--The Motion Picture and Television
Industry."
 
  In recent years the Company has experienced significant fluctuations in the
level of its production activities. In July 1993 a new management team was
brought into MGM Studios with a mandate to increase its production and
distribution activities in anticipation of the eventual sale of MGM Studios.
As a result, production and distribution expenditures increased substantially
in 1994 and 1995. Starting in January 1996 and continuing throughout the Sale
Period, no new production was approved, and accordingly, production
expenditures on new films decreased significantly during 1996. Following the
MGM Acquisition in October 1996, the Company's production activity has
increased to a more active level. These fluctuations in production and
distribution expenditures had a material impact on operating results and cash
flows during the related periods and will continue to do so for at least the
next two years.
 
INDUSTRY ACCOUNTING PRACTICES
 
  Revenue Recognition. Revenues from theatrical distribution of feature motion
pictures are recognized on the dates of exhibition. Revenues from home video
distribution, together with related costs, are recognized in the period in
which the product is available for sale at the retail level. Revenues from
television distribution are recognized when the motion picture or television
program is available to the licensee for broadcast.
 
  Accounting for Motion Picture and Television Costs. In accordance with
generally accepted accounting principles ("GAAP") and industry practice, the
Company amortizes film and television programming costs using the individual-
film-forecast method under which such costs are amortized for each film or
television program in the ratio that revenue earned in the current period for
such title bears to management's estimate of the total revenues to be realized
from all media and markets for such title. Management regularly reviews, and
revises when necessary, its total revenue estimates on a title-by-title basis,
which may result in a change in the rate of amortization and/or a write-down
of the film or television asset to net realizable value. A typical motion
picture generates 80 to 85 percent of its ultimate revenues within the first
two years of release. By then, the
 
                                      31
<PAGE>
 
picture has been exploited in the domestic and international pay television
and pay-per-view markets. A similar percentage of the picture's capitalized
costs should be expected to be amortized accordingly, assuming the picture is
profitable.
 
  The commercial potential of individual motion pictures and television
programming varies dramatically, and is not directly correlated with
production or acquisition costs. Therefore, it is difficult to predict or
project a trend of the Company's income or loss. However, the likelihood of
the Company reporting losses, particularly in the year of a motion picture's
release, is increased by the industry's method of accounting which requires
the immediate recognition of the entire loss (through increased amortization)
in instances where it is estimated the ultimate revenues of a motion picture
or television program will not recover the Company's costs. On the other hand,
the profit of a profitable motion picture or television program must be
deferred and recognized over the entire revenue stream generated by that
motion picture or television program. This method of accounting may also
result in significant fluctuations in reported income or loss, particularly on
a quarterly basis, depending on the Company's release schedule and the
relative performance of individual motion pictures or television programs. For
films released by the Company since January 1994 which resulted in feature
film write-downs in the period of initial release, subsequent performance as
it relates to this group of films has not resulted in additional material
write-downs. As a result of the lack of movie production and distribution
during the Sale Period, the Company expects to experience lower revenues for
at least the next two years, and thus the fluctuations caused by this
accounting method may have a greater impact, than otherwise might be the case.
 
RESULTS OF OPERATIONS
 
 Years Ended December 31, 1997 and 1996
 
  In connection with the MGM Acquisition, all of the assets and liabilities of
MGM Studios, including the Library, were revalued as of October 10, 1996 under
purchase accounting. The revaluation of the Library was based upon projected
future discounted net cash flows from the underlying assets, in accordance
with GAAP. In addition, the ultimate revenue projections for the Library were
revised accordingly, resulting in an amortization period not to exceed 20
years. The combined effect of the Library revaluation and the revision of the
ultimate revenue projections resulted in a reduction in the amortization rate
in the periods following the MGM Acquisition. Furthermore, the Company
completed the Orion Acquisition and has consolidated its results of operations
from the July 10, 1997 acquisition date. Consequently, operating results for
the year ended December 31, 1997 are not comparable to the corresponding 1996
period. For purposes of presentation and management's discussion and analysis
of the changes in financial condition and results of operations for the above
periods, the following table combines the January 1, 1996 to October 10, 1996
pre-MGM Acquisition period with the October 11, 1996 to December 31, 1996
post-MGM Acquisition period for comparison to the year-ended December 31,
1997.
 
                                      32
<PAGE>
 
  The following table sets forth EBITDA (defined as operating income (loss)
before depreciation and non-film amortization principally of goodwill related
to business combinations) for the year ended December 31, 1997 and the periods
from January 1, 1996 to October 10, 1996 and from October 11, 1996 to December
31, 1996. While many in the financial community consider EBITDA to be an
important measure of comparative operating performance, it should be
considered in addition to, but not as a substitute for or superior to,
operating income, net earnings, cash flow and other measures of financial
performance prepared in accordance with GAAP.
 
<TABLE>
<CAPTION>
                          (SUCCESSOR)  (PREDECESSOR)  (SUCCESSOR)    (COMBINED)
                          ------------ ------------- -------------- ------------
                                        PERIOD FROM   PERIOD FROM
                           YEAR ENDED  JANUARY 1, TO OCTOBER 11, TO  YEAR ENDED
                          DECEMBER 31,  OCTOBER 10,   DECEMBER 31,  DECEMBER 31,
                              1997         1996           1996          1996
                          ------------ ------------- -------------- ------------
                                          (AMOUNTS IN THOUSANDS)
<S>                       <C>          <C>           <C>            <C>
Revenues:
  Feature films.........   $ 699,219     $ 815,460      $209,354     $1,024,814
  Television programs...     114,200        82,315        14,413         96,728
  Other.................      17,883        14,931         4,919         19,850
                           ---------     ---------      --------     ----------
    Total revenues......   $ 831,302     $ 912,706      $228,686     $1,141,392
                           =========     =========      ========     ==========
EBITDA:
  Feature films.........   $  65,509     $ (45,032)     $ 37,140     $   (7,892)
  Television programs...      (7,201)       11,412        (4,062)         7,350
  Other.................     (26,545)        1,742           532          2,274
                           ---------     ---------      --------     ----------
  EBITDA before general
   and administration
   expenses.............      31,763       (31,878)       33,610          1,732
  General and
   administration
   expenses.............     (80,861)      (55,411)      (16,901)       (72,312)
                           ---------     ---------      --------     ----------
    EBITDA..............     (49,098)      (87,289)       16,709        (70,580)
Depreciation and other
 amortization...........     (18,013)      (25,451)       (3,135)       (28,586)
Provision for
 impairment.............         --       (563,829)          --        (563,829)
                           ---------     ---------      --------     ----------
Operating income (loss).     (67,111)     (676,569)       13,574       (662,995)
Interest expense, net of
 amounts capitalized....     (53,105)      (71,375)       (9,875)       (81,250)
Interest and other
 income, net............       2,447         3,179           813          3,992
                           ---------     ---------      --------     ----------
Income (loss) before
 provision for income
 taxes..................    (117,769)     (744,765)        4,512       (740,253)
Income tax provision....     (10,345)         (273)       (4,346)        (4,619)
                           ---------     ---------      --------     ----------
Net income (loss).......   $(128,114)    $(745,038)     $    166     $ (744,872)
                           =========     =========      ========     ==========
</TABLE>
 
  Feature Films. Feature film revenues decreased by $325.6 million, or 32
percent, to $699.2 million in the year ended December 31, 1997 compared to the
year ended December 31, 1996. Explanations for the decrease in revenues are
discussed in the following paragraphs.
 
  Worldwide theatrical revenues decreased by $149.5 million, or 59 percent, to
$102.9 million in 1997 due to relatively limited worldwide theatrical
distribution activity following the sale of the Company on October 10, 1996.
In 1997, the Company released 15 new feature films domestically and two films
internationally, as compared to 13 films released domestically and eight films
internationally in 1996. In 1997, the Company released Hoodlum, Red Corner and
Tomorrow Never Dies, which was initially released in December 1997 and will
earn a significant portion of its theatrical revenues in 1998. Of the
remaining 1997 releases, seven films were produced by Orion and six of these
were released in limited distribution only. In 1996, the Company earned
significantly higher worldwide theatrical revenues from GoldenEye, The
Birdcage, Leaving Las Vegas and Get Shorty.
 
  Worldwide home video revenues decreased by $244.6 million, or 41 percent, to
$350.4 million in 1997, which included the domestic releases of Kingpin and
Fled in the rental market, as well as the releases of Larger Than Life, The
Birdcage and Warriers of Virtue in the sell-through markets. In 1996,
significant home video
 
                                      33
<PAGE>
 
revenues were realized from the releases of GoldenEye, The Birdcage, Get
Shorty, Leaving Las Vegas and Showgirls in the rental market, as well as the
release of All Dogs Go To Heaven 2 and promotions of the James Bond and Rocky
film series in the sell-through market.
 
  Worldwide pay television revenues increased by $13.5 million, or 14 percent,
to $107.6 million in 1997, primarily due to the availability of The Birdcage,
Kingpin and Fled, among other films, in the domestic pay television market as
well as significant international pay television license fees recognized for
GoldenEye, The Birdcage and Species. In 1996, the Company realized domestic
pay television revenues for GoldenEye, Get Shorty and Species, among others,
but earned significantly less in international pay television markets than in
1997. Network television revenues increased $13.2 million to $14.7 million in
1997, which included license fees recognized on the films Stargate, Blown
Away, Getting Even With Dad and Speechless, among others. Worldwide syndicated
television revenues increased $41.8 million, or 51 percent, to $123.6 million
in 1997 principally due to the acquisition of the Orion film library on July
10, 1997, which contributed syndication revenues of $22.7 million in the
period, as well as international syndication license fees recognized for Blown
Away, Getting Even With Dad and Rob Roy, among others.
 
  EBITDA from feature films was a profit of $65.5 million in 1997 as compared
to a loss of $7.9 million in 1996. The 1997 results reflect a higher operating
margin on the Library, which was revalued pursuant to purchase accounting in
connection with the MGM Acquisition and yielded lower amortization rates than
in 1996. Additionally, there were feature film write-downs of $38.1 million in
1997 with respect to certain theatrical releases in that period as compared to
$82.5 million in write-downs on certain theatrical releases in 1996.
 
  Television Programming. Television programming revenues increased by $17.5
million, or 18 percent, to $114.2 million in 1997 as compared to 1996.
Worldwide pay television revenues increased by $6.4 million, or 25 percent, to
$32.3 million in 1997 due to the delivery of the new series Stargate SG-1 and
the television movie Twelve Angry Men. Worldwide syndicated television
revenues increased by $4.0 million, or 7 percent, to $60.9 million in 1997 due
to additional episodes of The Outer Limits and Poltergeist in domestic
syndication, and the release of the new series Fame LA. Worldwide home video
revenues with respect to television programming increased in 1997 by $4.9
million, or 40 percent, to $16.9 million due to the release of Babes in
Toyland in the domestic home video marketplace, partially offset by generally
reduced video revenues from other television movies in the period. The
remaining revenue increase in 1997 of $2.2 million principally related to
higher network and licensing income.
 
  EBITDA from television programming was a loss of $7.2 million in 1997 as
compared to a profit of $7.4 million in 1996. Amortization expense on current
series increased in 1997 due to loss reserves recognized on The Bradshaw
Difference, which has been cancelled, and on the new series Fame LA.
 
  Other. Other revenues include distribution of consumer products, interactive
media and branded programming services, all of which constitute emerging
businesses for MGM Studios with relatively limited current operations. EBITDA
from other businesses was a loss of $26.5 million in 1997 as compared to a
profit of $2.3 million in 1996. The 1997 results included interactive product
and development costs of $16.8 million, as compared to interactive costs of
only $9.1 million in 1996. In addition, the 1997 results include start-up
losses of $11.8 million on the Company's investment in MGM Gold (Asia), a
satellite and cable delivered channel based in Asia in which the Company holds
a 50 percent equity interest, and $2.4 million of start-up costs associated
with the Company's newly launched service MGM Gold (Brazil). There were no
such start-up losses or costs in the 1996 period.
 
  General and Administration Expenses. General and administration expenses
increased by $8.5 million, or 12 percent, to $80.9 million in 1997 as compared
to 1996, primarily as a result of the acquisition of Orion Pictures
Corporation, which added overhead charges of $6.7 million (including non-
recurring overhead of approximately $4.0 million) from the July 10, 1997
acquisition date, and the accrual of long-term management incentive and other
bonuses of $15.5 million. In 1996, the Company accrued long-term management
incentive bonuses of $12.6 million.
 
                                      34
<PAGE>
 
  Depreciation and Other Amortization. Depreciation and other amortization
decreased by $10.6 million, or 37 percent, to $18.0 million in 1997 compared
to 1996 due to the revaluation of the Company's assets and liabilities
pursuant to purchase accounting in connection with the MGM Acquisition on
October 10, 1996, which resulted in lower goodwill than previously carried in
the balance sheet.
 
  Provision for Impairment. In accordance with Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of", the predecessor company
(i.e. MGM Studios) recorded a charge of $563.8 million during 1996 to write-
off certain intangible assets in connection with CDR's disposition of its
ownership interest, including $404.4 million to write-off its remaining
investment in the film distribution organization and a charge of $159.4
million to reduce its investment in goodwill to net realizable value.
 
  Interest Expense, Net of Amounts Capitalized. Net interest expense was $53.1
million in 1997 as compared to $81.3 million in 1996. Net interest expense
decreased in 1997 due to the substantial equity investments received by the
Company in connection with the MGM Acquisition, the Offering and the Tracinda
Purchase (see "--Liquidity and Capital Resources"), and correspondingly lower
debt levels, as well as increased capitalization associated with increased
film production in the period.
 
  Income Tax Provision. The income tax provision of $10.3 million in 1997
reflects primarily foreign remittance taxes attributable to international
distribution revenues. The income tax provision of $4.6 million in 1996
reflects foreign remittance taxes attributable to international distribution
revenues, net of the reversal of certain tax reserves of approximately $14.0
million no longer required, and tax expense on net profits in the post-MGM
Acquisition period. The Company does not anticipate any further substantial
reversals of tax reserves.
 
                                      35
<PAGE>
 
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
 
  In connection with the MGM Acquisition, all of the assets and liabilities of
MGM Studios, including the Library, were revalued as of October 10, 1996 under
purchase accounting, resulting in lower amortization rates in periods after
the MGM Acquisition than in the prior periods. For purposes of presentation
and for management's discussion and analysis of the changes in financial
condition and results of operations for the above periods, the following table
combines the January 1, 1996 to October 10, 1996 pre-MGM Acquisition period
with the October 11, 1996 to December 31, 1996 post-MGM Acquisition period for
comparison to the year ended December 31, 1995:
 
<TABLE>
<CAPTION>
                           PREDECESSOR    SUCCESSOR      COMBINED   PREDECESSOR
                          ------------- -------------- ------------ ------------
                          JANUARY 1, TO OCTOBER 11, TO  YEAR ENDED   YEAR ENDED
                           OCTOBER 10,   DECEMBER 31,  DECEMBER 31, DECEMBER 31,
                              1996           1996          1996         1995
                          ------------- -------------- ------------ ------------
                                          (AMOUNTS IN THOUSANDS)
<S>                       <C>           <C>            <C>          <C>
Revenues:
  Feature films.........    $ 815,460      $209,354     $1,024,814   $ 736,152
  Television programs...       82,315        14,413         96,728      90,231
  Other.................       14,931         4,919         19,850      34,588
                            ---------      --------     ----------   ---------
    Total revenues......    $ 912,706      $228,686     $1,141,392   $ 860,971
                            =========      ========     ==========   =========
EBITDA:
  Feature films.........    $ (45,032)     $ 37,140     $   (7,892)  $ (70,184)
  Television programs...       11,412        (4,062)         7,350      22,928
  Other.................        1,742           532          2,274      25,822
                            ---------      --------     ----------   ---------
EBITDA before general
 and administration
 expense................      (31,878)       33,610          1,732     (21,434)
General and administra-
 tion expense...........      (55,411)      (16,901)       (72,312)    (60,154)
                            ---------      --------     ----------   ---------
    EBITDA..............      (87,289)       16,709        (70,580)    (81,588)
Depreciation and other
 amortization...........      (25,451)       (3,135)       (28,586)    (30,772)
Provision for
 impairment.............     (563,829)          --        (563,829)        --
                            ---------      --------     ----------   ---------
  Operating income
   (loss)...............     (676,569)       13,574       (662,995)   (112,360)
Interest expense, net of
 amounts capitalized....      (71,375)       (9,875)       (81,250)    (66,386)
Interest and other
 income, net............        3,179           813          3,992      10,372
                            ---------      --------     ----------   ---------
Income (loss) before
 provision for income
 taxes..................     (744,765)        4,512       (740,253)   (168,374)
Income tax provision....         (273)       (4,346)        (4,619)       (935)
                            ---------      --------     ----------   ---------
Net income (loss).......    $(745,038)     $    166     $ (744,872)  $(169,309)
                            =========      ========     ==========   =========
</TABLE>
 
  Feature Films. Feature film revenues increased by $288.7 million, or 39
percent, to $1.0 billion in the year ended December 31, 1996 compared to the
year ended December 31, 1995. Explanations for the increase in revenues are
discussed in the following paragraphs.
 
  Worldwide theatrical revenues increased by $21.9 million, or 10 percent, to
$252.4 million in 1996. Theatrical revenues increased in 1996 principally due
to significant international theatrical revenues earned by GoldenEye, a
substantial portion of which were earned in 1996 although the film was
initially released in December 1995. The Company released 13 new feature films
in each year in the domestic marketplace, and eight new feature films in each
year in the international marketplace. In 1996 the Company earned significant
revenues from the domestic theatrical releases of The Birdcage and Leaving Las
Vegas as compared to GoldenEye, Get Shorty and Species in 1995.
Internationally, the Company earned significant revenues from GoldenEye, Get
Shorty and The Birdcage as compared to GoldenEye, Species and Rob Roy in 1995.
 
  Worldwide home video revenues increased by $262.3 million, or 79 percent, to
$595.1 million in 1996. In 1996, home video revenues included the domestic
rental releases of GoldenEye, The Birdcage, Get Shorty and Leaving Las Vegas
as well as the sell-through release of All Dogs Go To Heaven 2. In 1995 the
Company
 
                                      36
<PAGE>
 
released Species, Rob Roy and Speechless in the domestic rental marketplace,
as well as Pebble and the Penguin in the domestic sell-through market. The
increase in home video revenue in 1996 reflected the strong performance of
titles released in the period, as well as the substantial increase in the
number of titles released as compared to 1995. The Company released 15 new
feature films in the home video market in 1996 as compared to nine new feature
films in 1995. Additionally, revenues earned under the Company's distribution
agreement with Turner increased substantially in 1996, primarily as a result
of a sell-through promotion of The Wizard of Oz. The Company also earned
significant revenues in 1996 from sell-through promotions of the James Bond
and Rocky film series. In 1996 significant international home video revenues
were contributed by GoldenEye, Species and Get Shorty as compared to Blown
Away and Getting Even With Dad in 1995.
 
  Worldwide pay television revenues increased by $30.4 million, or 48 percent,
to $94.1 million in 1996, which included significant license fees earned on
the availability of GoldenEye, Get Shorty and Species, among others, as
compared to Stargate, Blown Away and Getting Even With Dad in 1995. Network
revenues decreased by $2.2 million, or 59 percent, to $1.5 million in 1996 due
to the availability of only one feature film, Undercover Blues, in 1996 as
compared to Benny & Joon and Untamed Heart in 1995. Worldwide syndication
revenues decreased by $23.7 million, or 22 percent, to $81.8 million in 1996,
primarily as a result of domestic license fees earned for Rain Man, License to
Kill, A Fish Called Wanda, Rocky IV and Rocky V in 1995. The Company
recognized relatively lower license fees for Rocky III and The Russia House,
among others, in 1996. Additionally, international syndication revenues were
higher in 1995 due to license fees recognized under a new agreement covering
free television in Germany.
 
  EBITDA from feature films was a loss of $7.9 million in 1996 as compared to
a loss of $70.2 million in 1995. The improvement in the operating loss in 1996
reflects the aforementioned substantial increase in revenues and a higher
operating margin in the 1996 post-MGM Acquisition period, which benefited from
the lower amortization rates due to the revaluation of the Library under
purchase accounting. Additionally, feature film write-downs were $82.5 million
in 1996, as compared to feature film write-downs of $134.0 million in 1995.
 
  Television Programming. Television programming revenues increased by $6.5
million, or 7 percent, to $96.7 million in 1996 as compared to 1995. Worldwide
pay television revenues increased by $11.6 million, or 81 percent, to $25.9
million in 1996, primarily due to the licensing of a new series, Poltergeist:
The Legacy. Network revenues decreased $2.7 million, or 95 percent, to $0.1
million in 1996 as a result of the broadcast in 1995 of one new television
movie. There was no comparable network programming broadcast in 1996.
Worldwide home video revenues increased by $9.4 million, or 348 percent, to
$12.1 million in 1996, primarily as a result of international sales of made-
for-television movies and The Outer Limits series. Worldwide television
syndication revenues decreased by $13.0 million, or 19 percent, to $56.9
million due to substantial domestic license fees earned in 1995 on the In The
Heat Of The Night series. Other operating revenues increased $1.2 million in
1996 primarily due to merchandising income earned on current series.
 
  EBITDA from television programming decreased by $15.6 million, or 68
percent, to $7.4 million in 1996 due to higher amortization rates on the
Company's new series, which generated a higher proportion of 1996 revenues, as
compared to lower amortization on revenues from the television library of
older series in 1995.
 
  Other. Other revenues include distribution of consumer products, interactive
media and branded programming services, all of which constitute emerging
businesses with relatively limited current operations. EBITDA from other
businesses was $2.3 million in 1996 as compared to $25.8 million in 1995. The
1996 results included interactive product and development costs of $9.1
million. The 1995 results did not include comparable activity in this new
business. EBITDA from other businesses in 1995 included payments received in
connection with an Australian pay television joint venture and an audit
settlement with a major distributor.
 
  General and Administration Expenses. General and administration expenses
increased by $12.2 million, or 20 percent, to $72.3 million in 1996 compared
to 1995 primarily due to increased executive
compensation of $5.4 million, increased accrual of long-term management
incentive bonuses of $2.6 million, higher legal and professional fees of $2.0
million, and a net increase in various other items of $2.2 million.
 
                                      37
<PAGE>
 
  Depreciation and Other Amortization. Depreciation and other amortization
decreased by $2.2 million, or 7 percent, to $28.9 million in 1996 compared to
1995 due to the revaluation of the Company's assets and liabilities pursuant
to purchase accounting in connection with the MGM Acquisition on October 10,
1996, which resulted in lower goodwill than previously carried in the balance
sheet.
 
  Provision For Impairment. In accordance with Statement of Financial
Accounting Standards No 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," the Company recorded a
charge of $563.8 million during 1996 in connection with CDR's sale of MGM
Studios to the Company to write-off certain intangible assets, including
$404.4 million to write-off its remaining investment in the film distribution
organization and a charge of $159.4 million to reduce its investment in
goodwill to net realizable value.
 
  Interest Expense, Net of Amounts Capitalized. Net interest expense increased
by $14.9 million, or 22 percent, to $81.3 million in 1996 as compared to 1995.
Net interest expense increased in 1996 due to higher average borrowing levels
in the 1996 pre-MGM Acquisition period, partially offset by lower interest in
the 1996 post-MGM Acquisition period due to reduced debt levels associated
with the equity infusions received in connection with the MGM Acquisition.
 
  Interest and Other Income, Net. Net interest and other income decreased by
$6.4 million, or 62 percent, to $4.0 million in 1996 as compared to 1995. In
1995 the Company recovered proceeds under a directors' and officers' insurance
policy relating to litigation originating prior to 1991 and also reduced
certain prior period litigation reserves, resulting in additional income in
the period. There was no such comparable activity in 1996.
 
  Provisions For Income Taxes. The income tax provision of $4.6 million in
1996 reflects foreign remittance taxes attributable to foreign distribution
revenues, net of the reversal of certain tax reserves of approximately $14.0
million, and tax expense on net profits in the post-MGM Acquisition period.
The income tax provision of $0.9 million in 1995 resulted from foreign
remittance taxes incurred on international distribution revenues, net of the
reversal of certain tax reserves of approximately $10.0 million.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  In recent years the Company has funded its operations primarily from
internally generated funds and bank borrowings. The Company is currently
operating under a business plan which calls for substantial continued
borrowing, primarily to fund film and television production.
 
  On July 10, 1997, the Company completed the Orion Acquisition for a total
purchase price of approximately $573 million. In connection with the Orion
Acquisition, the Company issued 15,000,120 shares of Common Stock to Tracinda
and Seven for $360 million. In addition, Orion obtained a credit facility (the
"Original Orion Credit Facility") consisting of a $200 million term loan and a
$50 million revolving credit facility. On October 15, 1997, proceeds from the
Amended Credit Facility (as defined below) were used to retire all amounts
outstanding under the Original Orion Credit Facility.
 
  On October 15, 1997, MGM Studios and its principal lenders entered into an
amended and restated credit facility (the "Amended Credit Facility")
aggregating $1.3 billion consisting of a six year $600 million revolving
credit facility (the "Revolving Facility"), a $400 million seven and one-half
year term loan ("Tranche A Loan") and a $300 million eight and one-half year
term loan ("Tranche B Loan" and, collectively with the Tranche A Loan, the
"Terms Loans"). The facility also contains provisions allowing, with the
consent of the requisite lenders and subject to syndication thereof, for an
additional $200 million tranche, raising the amount of the Amended Credit
facility to $1.5 billion. As of December 31, 1997, MGM Studios had $425
million available under the Amended Credit Facility to fund the ongoing
operating activities of the Company. The Revolving Facility and Tranche A Loan
bear interest at 2.25 percent over the Adjusted LIBOR rate, as defined, and
the Tranche B Loan bears interest at 2.50 percent over the Adjusted LIBOR
rate. The Company has entered into three year fixed interest rate swap
contracts in relation to a portion of the Term Loans for a notional value of
$500 million at an average rate of 8.6 percent, which expire in November 2000.
Scheduled amortization of the
 
                                      38
<PAGE>
 
Term Loans under the Amended Credit Facility commences with $33 million in
2001, $73 million in 2002, $103 million in 2003, $103 million in 2004, and
$103 million in 2005, with the remaining balance at maturity. The revolving
facility portion of the Amended Credit Facility matures in October 2003,
subject to extension under certain conditions. The Amended Credit Facility
contains various covenants, including limitations on indebtedness, dividends
and capital expenditures and maintenance of certain financial ratios.
 
  On November 18, 1997, the Company issued and sold 9,000,000 new shares of
the Common Stock at a price per share of $20, less an underwriting discount,
for net proceeds (after Offering expenses) to the Company of $165 million.
Concurrent with the consummation of the Offering, Tracinda purchased directly
from the Company 3,978,780 shares of Common Stock, at a price per share of $20
less an amount equal to the underwriting discount per share for shares issued
in the Offering, for an aggregate purchase price of $75 million. Subsequently,
$190 million of the net proceeds of the Offering and the Tracinda purchase
were used to repay existing bank debt with the remaining net proceeds retained
and used for working capital purposes. Concurrent with the Offering and the
Tracinda Purchase, (i) all of the Company's then outstanding Series A
Cumulative Convertible Preferred Stock was converted into Common Stock, (ii)
the Company effected a 41.667 for 1 stock split of the Common Stock and (iii)
the Company increased the number of authorized shares of the Common Stock to
125,000,000.
 
  The Company's strategy and business plans contemplate substantial on-going
investments in production of new feature films and television programs. In
addition, the Company plans to continue to make investments or enter into
joint ventures to develop new distribution channels to further exploit the
Library. The Company may also make strategic acquisitions, including
acquisitions to obtain such distribution channels or to further expand the
Library, and may enter into other joint ventures, including ventures to
produce motion pictures. The nature and extent of such additional investments
(including potential acquisitions and joint ventures) are dependent upon the
future evaluation of the specific strategic and economic factors underlying
such opportunities.
 
  The Company believes that the available credit under the Amended Credit
Facility should be sufficient to meet the Company's current obligations and
commitments and will enable the Company to continue to conduct its operations
in accordance with its current business plans, although no assurance can be
given in that regard. The Company may need to seek other sources of financing
in order to complete any future acquisitions. Even if the Company does not
consummate any acquisitions, in order to take advantage of opportunities in
the capital markets, the Company may from time to time seek additional
financing. No assurance can be given that such other sources will be available
or on terms acceptable to the Company.
 
YEAR 2000 DATE CONVERSION
 
  The Company has begun to identify, evaluate and implement the changes that
need to be made to computer systems and applications necessary to achieve a
year 2000 date conversion with no disruption of business operations. These
actions are necessary to ensure that the systems and applications will
recognize and process the year 2000 and beyond. The Company also is
communicating with suppliers, distributors, financial institutions and others
with which it does business to coordinate year 2000 conversion. Due to
recently completed and ongoing systems implementations, the Company does not
anticipate that the additional costs of completing the year 2000 date
conversion will be material to the Company's results of operations, liquidity
or its capital resources.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
  The Report of Independent Public Accountants, Consolidated Financial
Statements and Notes to the Company's Consolidated Financial Statements appear
in a separate section of this Form 10-K (beginning on page 44) following Part
IV. The index to Consolidated Financial Statements of the Company is included
in Item 14.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
  None.
 
                                      39
<PAGE>
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
 
  The information required by Item 10 is set forth in the Proxy Statement
under the caption "Election of Directors" and incorporated herein by reference
except that the information regarding the Company's executive officers is
included in Part I under the heading "Executive Officers of the Company".
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The information required by Item 11 is set forth in the Proxy Statement
under the caption "Executive Compensation" and is incorporated herein by this
reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The information required by Item 12 is set forth in the Proxy Statement
under the caption "Security Ownership of Certain Beneficial Owners and
Management" and is incorporated herein by this reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  The information required by Item 13 is set forth in the Proxy Statement
under the caption "Certain Relationships and Related Transactions" and is
incorporated herein by this reference.
 
                                      40
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
 
  (a) The following documents are filed as part of this report:
 
    1. Consolidated Financial Statements
 
      The financial statements listed in the accompanying Index to
       Financial Statements are filed as part of this Form 10-K at pages 44
       to 79.
 
    2. Financial Statement Schedules
 
      The financial statement schedules listed in the accompanying Index to
       Financial Statements are filed as part of this Form 10-K at pages 80
       to 85.
 
    3. Exhibits.
 
      The exhibits listed in the accompanying Exhibit Index on pages 86 to
       87 are filed as part of this Form 10-K.
 
  (b) Reports on Form 8-K
 
  There were no reports on Form 8-K filed during the quarter ended December
31, 1997.
 
                                      41
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
 
                                          METRO-GOLDWYN-MAYER INC.
 
                                                  /s/ Frank G. Mancuso
                                          By: _________________________________
                                                      Frank G. Mancuso
                                                  Chairman of the Board of
                                                       Directors and
                                                  Chief Executive Officer
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
             SIGNATURE                            TITLE                   DATE
             ---------                            -----                   ----
<S>                                  <C>                             <C>
      /s/ Frank G. Mancuso           Chairman of the Board of        March 12, 1998
____________________________________  Directors, Chief Executive
          Frank G. Mancuso            Officer and Director
      /s/ A. Robert Pisano           Vice Chairman and Director      March 12, 1998
____________________________________
          A. Robert Pisano
        /s/ James Aljian             Director                        March 12, 1998
____________________________________
            James Aljian
    /s/ Francis Ford Coppola         Director                        March 12, 1998
____________________________________
        Francis Ford Coppola
      /s/ Michael R. Gleason         Director                        March 12, 1998
____________________________________
         Michael R. Gleason
                                     Director                        March   , 1998
____________________________________
           Kirk Kerkorian
        /s/ Kerry Stokes             Director                        March 12, 1998
____________________________________
            Kerry Stokes
      /s/ Alex Yemenidjian           Director                        March 12, 1998
____________________________________
          Alex Yemenidjian
       /s/ Jerome B. York            Director                        March 12, 1998
____________________________________
           Jerome B. York
     /s/ Michael G. Corrigan         Senior Executive Vice President March 12, 1998
____________________________________  and Chief Financial Officer
        Michael G. Corrigan
</TABLE>
 
                                      42
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
METRO-GOLDWYN-MAYER INC.
Successor Consolidated Financial Statements:
  Report of Independent Public Accountants................................  44
  Consolidated Balance Sheets as of December 31, 1997 and 1996............  45
  Consolidated Statements of Operations for the Year Ended December 31,
   1997 and the Period from October 11, 1996 to December 31, 1996.........  46
  Consolidated Statements of Stockholders' Equity for the Year Ended
   December 31, 1997 and the Period from October 11, 1996 to December 31,
   1996...................................................................  47
  Consolidated Statements of Cash Flows for the Year Ended December 31,
   1997 and the Period from October 11, 1996 to December 31, 1996.........  48
  Notes to Consolidated Financial Statements..............................  49
METRO-GOLDWYN-MAYER STUDIOS INC.
Predecessor Consolidated Financial Statements:
  Report of Independent Public Accountants................................  63
  Report of Independent Public Accountants................................  64
  Consolidated Balance Sheets as of October 10, 1996 and December 31,
   1995...................................................................  65
  Consolidated Statements of Operations for the Period from January 1,
   1996 to October 10, 1996 and for the Years Ended December 31, 1995 and
   1994...................................................................  66
  Consolidated Statements of Stockholder's Equity for the Period from
   January 1, 1996 to October 10, 1996 and for the Years Ended December
   31, 1995 and 1994......................................................  67
  Consolidated Statements of Cash Flows for the Period from January 1,
   1996 to October 10, 1996 and for the Years Ended December 31, 1995 and
   1994...................................................................  68
  Notes to Consolidated Financial Statements..............................  69
FINANCIAL STATEMENT SCHEDULES
  Report of Independent Public Accountants................................  80
  Schedule I: Condensed Financial Information of the Registrant...........  81
  Schedule II: Valuation and Qualifying Accounts and Reserves.............  85
</TABLE>
 
                                       43
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Metro-Goldwyn-Mayer Inc.:
 
  We have audited the accompanying consolidated balance sheets of Metro-
Goldwyn-Mayer Inc. (formerly known as P&F Acquisition Corp.) (a Delaware
corporation) and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for the year ended December 31, 1997 and the period from October 11,
1996 (date of commencement of principal operations) to December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements
based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Metro-Goldwyn-Mayer Inc.
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for the year ended December 31, 1997 and the
period from October 11, 1996 (date of commencement of principal operations) to
December 31, 1996 in conformity with generally accepted accounting principles.
 
                                          Arthur Andersen LLP
 
Los Angeles, California
February 26, 1998
 
                                      44
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31, DECEMBER 31,
                                                               1997         1996
                                                           ------------ ------------
<S>                                                        <C>          <C>
                         ASSETS
                         ------
Cash and cash equivalents................................   $    3,978   $   16,381
Accounts and contracts receivable (net of allowance for
 doubtful accounts of $27,603 and $11,730, respectively).      285,283      271,106
Film and television costs, net...........................    1,867,126    1,099,201
Investments and advances to affiliates...................        9,917       16,107
Property and equipment, net..............................       32,785       27,347
Excess of cost over net assets of acquired businesses,
 net.....................................................      574,795      302,741
Other assets.............................................       48,770       41,785
                                                            ----------   ----------
                                                            $2,822,654   $1,774,668
                                                            ==========   ==========
          LIABILITIES AND STOCKHOLDERS' EQUITY
          ------------------------------------
Liabilities:
  Bank and other debt....................................   $  890,508   $  444,427
  Accounts payable and accrued liabilities...............      147,476       90,933
  Accrued participants' share............................      216,530      173,094
  Income taxes payable...................................       31,579       29,269
  Advances and deferred revenues.........................      130,329      104,516
  Other liabilities......................................       27,677       29,307
                                                            ----------   ----------
    Total liabilities....................................    1,444,099      871,546
                                                            ----------   ----------
Commitments and contingencies
Stockholders' equity:
  Preferred Stock, $.01 par value, 25,000,000 shares
   authorized,
   501,006 shares issued and outstanding at December 31,
   1996..................................................          --             5
  Common Stock, $.01 par value, 125,000,000 shares
   authorized, 65,765,655 and 16,700,342 shares issued
   and outstanding.......................................          658          167
  Additional paid-in capital.............................    1,504,850      901,639
  Retained earnings (deficit)............................     (127,948)         166
  Cumulative translation adjustment......................          995        1,145
                                                            ----------   ----------
    Stockholders' equity.................................    1,378,555      903,122
                                                            ----------   ----------
                                                            $2,822,654   $1,774,668
                                                            ==========   ==========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       45
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED  OCTOBER 11 TO
                                                     DECEMBER 31, DECEMBER 31,
                                                         1997         1996
                                                     ------------ -------------
<S>                                                  <C>          <C>
Revenues............................................  $  831,302   $  228,686
Expenses:
  Film and television production and distribution...     799,539      195,076
  General and administration expenses...............      87,644       18,319
  Goodwill amortization.............................      11,230        1,717
                                                      ----------   ----------
    Total expenses..................................     898,413      215,112
                                                      ----------   ----------
Operating income (loss).............................     (67,111)      13,574
Other income (expense):
  Interest expense, net of amounts capitalized......     (53,105)      (9,875)
  Interest and other income, net....................       2,447          813
                                                      ----------   ----------
    Total other expense.............................     (50,658)      (9,062)
                                                      ----------   ----------
Income (loss) from operations before provision for
 income taxes.......................................    (117,769)       4,512
Income tax provision................................     (10,345)      (4,346)
                                                      ----------   ----------
Net income (loss)...................................  $ (128,114)  $      166
                                                      ==========   ==========
Basic and diluted earnings (loss) per share.........  $    (4.47)  $     0.01
                                                      ==========   ==========
Weighted average number of common shares
 outstanding........................................  28,634,362   16,692,217
                                                      ==========   ==========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       46
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                            PREFERRED
                              STOCK          COMMON STOCK
                          ---------------  ----------------   ADD'L     RETAINED   CUMULATIVE      TOTAL
                           NO. OF    PAR     NO. OF    PAR   PAID-IN    EARNINGS   TRANSLATION STOCKHOLDERS'
                           SHARES   VALUE    SHARES   VALUE  CAPITAL    (DEFICIT)  ADJUSTMENT     EQUITY
                          --------  -----  ---------- ----- ----------  ---------  ----------- -------------
<S>                       <C>       <C>    <C>        <C>   <C>         <C>        <C>         <C>
BEGINNING BALANCE.......       --   $ --          --  $ --  $      --   $     --     $  --      $      --
Issuance of preferred
 and common stock.......   501,006     5   16,700,342  167     901,639        --        --         901,811
Foreign currency
 translation adjustment.       --     --          --    --         --         --      1,145          1,145
Net income..............       --     --          --    --         --         166       --             166
                          --------  ----   ---------- ----  ----------  ---------    ------     ----------
BALANCE DECEMBER 31,
 1996...................   501,006     5   16,700,342  167     901,639        166     1,145        903,122
Issuance of preferred
 and common stock.......     1,914    --   28,110,145  281     603,416        --        --         603,697
Conversion of preferred
 stock into common
 stock..................  (502,920)   (5)  20,955,168  210        (205)       --        --             --
Foreign currency
 translation adjustment.       --     --          --    --         --         --       (150)          (150)
Net loss................       --     --          --    --         --    (128,114)      --        (128,114)
                          --------  ----   ---------- ----  ----------  ---------    ------     ----------
BALANCE DECEMBER 31,
 1997...................       --   $ --   65,765,655 $658  $1,504,850  $(127,948)   $  995     $1,378,555
                          ========  ====   ========== ====  ==========  =========    ======     ==========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       47
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED   OCTOBER 11 TO
                                                   DECEMBER 31,  DECEMBER 31,
                                                       1997          1996
                                                   ------------  -------------
<S>                                                <C>           <C>
Operating activities:
Net income (loss)................................. $  (128,114)   $       166
Adjustments to reconcile net income from
 operations to net cash provided by operating
 activities:
  Amortization of film and television costs and
   participants' share............................     429,003         83,508
  Depreciation and amortization of property and
   equipment......................................       6,783          1,418
  Amortization of goodwill and deferred financing
   costs..........................................      16,323          2,761
  Reduction in goodwill due to realization of tax
   benefits ......................................         --           1,206
  Increase in bad debt and other reserves.........       6,382            --
  Losses (gains) on equity investments, net.......      17,620         (2,592)
  Decrease in accounts and contracts receivable
   and other assets...............................      35,054         12,895
  Decrease in accounts payable, accrued and other
   liabilities, accrued participants' share and
   domestic and foreign taxes.....................     (99,455)       (31,542)
  Decrease in advances and deferred revenues......     (40,468)        (6,258)
  Foreign currency exchange (gain) loss...........       2,190           (234)
                                                   -----------    -----------
  Net cash provided by operating activities.......     245,318         61,328
                                                   -----------    -----------
Investing activities:
  Acquisition of Metro-Goldwyn-Mayer Studios Inc..         --      (1,331,430)
  Acquisition of Orion Pictures Corporation.......    (565,965)           --
  Additions to film costs, net....................    (703,222)       (55,814)
  Additions to property and equipment.............      (9,555)        (2,079)
  Other investing activities......................     (11,280)        (1,538)
                                                   -----------    -----------
  Net cash used in investing activities...........  (1,290,022)    (1,390,861)
                                                   -----------    -----------
Financing activities:
  Proceeds from issuance of preferred and common
   stock..........................................     603,697        901,811
  Proceeds from debt issuance.....................     200,000        475,000
  Net bank advances (repayments)..................     235,127        (31,417)
  Financing costs and other.......................     (10,040)           --
                                                   -----------    -----------
  Net cash provided by financing activities.......   1,028,784      1,345,394
                                                   -----------    -----------
Net change in cash and cash equivalents from
 operating, investing and financing activities....     (15,920)        15,861
Net increase (decrease) in cash due to foreign
 currency fluctuations............................        (831)           520
                                                   -----------    -----------
Net change in cash and cash equivalents...........     (16,751)        16,381
Cash and cash equivalents at beginning of period..      16,381            --
Cash of acquired subsidiary.......................       4,348            --
                                                   -----------    -----------
Cash and cash equivalents at end of the period.... $     3,978    $    16,381
                                                   ===========    ===========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       48
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               DECEMBER 31, 1997
 
NOTE 1--BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Presentation. The accompanying consolidated financial statements
include the accounts of Metro-Goldwyn-Mayer Inc. (formerly known as P&F
Acquisition Corp.) ("MGM"), Metro-Goldwyn-Mayer Studios Inc. and its majority
owned subsidiaries ("MGM Studios") and Orion Pictures Corporation and its
majority owned subsidiaries ("Orion") (collectively, the "Company"). MGM is a
Delaware corporation formed on July 10, 1996 specifically to acquire MGM
Studios. The acquisition of MGM Studios by MGM was completed on October 10,
1996 (see Notes 2 and 7), at which time MGM commenced principal operations.
The acquisition of Orion was completed on July 10, 1997 (see Notes 2 and 7).
Prior to its acquisition by MGM, MGM Studios was wholly owned by MGM Group
Holdings Corporation, an indirect wholly owned subsidiary of Consortium de
Realisation ("CDR"). CDR is a wholly owned subsidiary of Credit Lyonnais S.A.
and is controlled by the French State.
 
  As permitted by Statement of Financial Accounting Standards ("SFAS") No. 53,
"Financial Reporting by Producers and Distributors of Motion Pictures", the
Company has presented an unclassified consolidated balance sheet.
 
  Business. The Company is engaged primarily in the development, production
and worldwide distribution of theatrical motion pictures and television
programs. The Company also distributes films produced or financed, in whole or
in part, by third parties.
 
  Motion picture and television production and distribution is highly
speculative and inherently risky. There can be no assurance of the economic
success of such motion pictures and television programming since the revenues
derived from the production and distribution (which do not necessarily bear a
direct correlation to the production or distribution costs incurred) depend
primarily upon its acceptance by the public, which cannot be predicted. The
commercial success of a motion picture also depends upon the quality and
acceptance of other competing films released into the marketplace at or near
the same time, the availability of alternative forms of entertainment and
leisure time activities, general economic conditions and other tangible and
intangible factors, all of which can change and cannot be predicted with
certainty. The theatrical success of a motion picture is a very important
factor in generating revenues from such motion picture in other media.
 
  The success of the Company's television programming also may be impacted by
prevailing advertising rates, which are subject to fluctuation. Therefore,
there is a substantial risk that some or all of the Company's motion picture
and television projects will not be commercially successful, resulting in
costs not being recouped or anticipated profits not being realized.
 
  Principles of Consolidation. The consolidated financial statements include
the accounts of MGM, MGM Studios and all of its majority-owned and controlled
subsidiaries. The Company's investments in related companies which represent a
20% to 50% ownership interest over which the Company has significant influence
but not control are accounted for using the equity method (see Note 4). All
significant intercompany balances have been eliminated.
 
  Cash and Cash Equivalents. The Company considers all highly liquid debt
instruments, purchased with an initial maturity of three months or less, to be
cash equivalents. Included in other assets at December 31, 1997 and 1996 is
approximately $4,905,000 and $11,357,000, respectively, of cash restricted by
various escrow agreements. The carrying value of the Company's cash
equivalents approximated cost at each balance sheet date.
 
  Revenue Recognition. Revenues from theatrical distribution of feature films
are recognized on the dates of exhibition. Revenues from direct home video
distribution are recognized, net of an allowance for estimated returns,
together with related costs, in the period in which the product is available
for sale by the Company's customers. Revenues from television licensing,
together with related costs, are recognized when the feature film
 
                                      49
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
or television program is available to the licensee for telecast. Long-term
non-interest-bearing receivables arising from licensing agreements are
discounted to present value.
 
  Accounting for Film and Television Costs. Except for purchase accounting
adjustments, film costs include the costs of production, prints, pre-release
and other advertising expected to benefit future periods and capitalized
overhead and interest. These costs, as well as participations and talent
residuals, are charged against earnings on an individual film basis in the
ratio that the current year's gross film revenues bear to management's
estimate of total remaining ultimate gross film revenues from all sources. The
cost allocated to films revalued in purchase accounting is being amortized
over their estimated economic lives not to exceed 20 years.
 
  Film costs are stated at the lower of cost or estimated net realizable value
on an individual film basis. Revenue and cost forecasts are continually
reviewed by management and revised when warranted by changing conditions. When
estimates of total revenues and costs indicate that a feature film or
television program will result in an ultimate loss, additional amortization is
recognized to the extent required to produce a zero gross margin over the
remaining life of the film or television program.
 
  Property and Equipment. Except for purchase accounting adjustments, property
and equipment are stated at cost. Property and equipment acquired as part of
the acquisitions of MGM Studios and Orion are stated at estimated fair market
value. Depreciation of property and equipment is computed under the straight-
line method over the expected useful lives of applicable assets, ranging from
three to five years. Leasehold improvements are amortized under the straight-
line method over the shorter of the estimated useful lives of the assets or
the terms of the related leases. When property is sold or otherwise disposed
of, the cost and related accumulated depreciation is removed from the
accounts, and any resulting gain or loss is included in income. The costs of
normal maintenance, repairs and minor replacements are charged to expense when
incurred.
 
  Goodwill. The excess cost of acquisition over the fair market values of
identifiable net assets acquired (goodwill) is amortized over an estimated
useful life of 40 years using the straight-line method. For the period from
October 11, 1996 to December 31, 1996, goodwill was reduced by $1,206,000 due
to the utilization of certain tax assets not benefitted at the acquisition
date. During the year ended December 31, 1997, the Company reduced goodwill
and accrued tax reserves by $11,075,000 due to the favorable resolution of
certain pre-acquisition contingencies. Accumulated amortization of goodwill
was $12,947,000 and $1,717,000 as of December 31, 1997 and 1996, respectively.
 
  Income Taxes. In accordance with SFAS No. 109, "Accounting for Income
Taxes," deferred tax assets and liabilities are recognized with respect to the
tax consequences attributable to differences between the financial statement
carrying values and tax bases of existing assets and liabilities. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which these temporary differences are
expected to be recovered or settled. Further, the effect on deferred tax
assets and liabilities of changes in tax rates is recognized in income in the
period that includes the enactment date.
 
  Foreign Currency Translation. Generally, foreign subsidiary assets and
liabilities are translated into United States dollars at the exchange rates in
effect at the balance sheet date. Revenues and expenses of foreign
subsidiaries are translated into United States dollars at the average exchange
rates that prevailed during the period. The gains or losses that result from
this process are included as a component of the cumulative translation
adjustment balance in stockholders' equity. Foreign currency denominated
transactions are recorded at the exchange rate in effect at the time of
occurrence, and the gains or losses resulting from subsequent translation at
current exchange rates are included in the statement of operations.
 
                                      50
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Financial Instruments. The carrying values of short-term trade receivables
and payables approximate their estimated fair values because of the short
maturity of these instruments. The carrying values of receivables with
maturities greater than one year have been discounted at LIBOR plus 2.50
percent (approximately 8.31 percent and 8.38 percent at December 31, 1997 and
1996, respectively), which approximates the Company's current effective
borrowing rates.
 
  The Company has only limited involvement with derivative financial
instruments and does not use them for trading purposes. They are used to
manage well-defined interest rate risks. The Company enters into interest rate
swaps to lower funding costs, to diversify sources of funding, or to alter
interest rate exposures arising from mismatches between assets and
liabilities. Interest rate swaps allow the Company to raise long-term
borrowings at floating rates and effectively swap them into fixed rates that
are lower than those available to the Company if fixed-rate borrowings were
made directly. Under interest rate swaps, the Company agrees with other
parties to exchange, at specified intervals, the difference between fixed-rate
and floating-rate interest amounts calculated by reference to an agreed
notional principal amount.
 
  Accounts and Contracts Receivable. At December 31, 1997, accounts and
contracts receivable aggregated $312,886,000 (before allowance for doubtful
accounts), of which approximately $259,544,000 is due within one
year. Concentration of credit and geographic risk with respect to accounts
receivable is limited due to the large number and general dispersion of
accounts which constitute the Company's customer base. The Company performs
credit evaluations of its customers and in some instances requires collateral.
At December 31, 1997, there were no significant customers accounting for
greater than 10 percent of the Company's accounts and contracts receivable. At
December 31, 1996, approximately 27 percent of the Company's accounts and
contracts receivable arose from an exclusive home video servicing agreement
with Warner Home Video.
 
  Earnings Per Share. The Company has adopted SFAS No. 128, "Earnings Per
Share" ("EPS"), effective for the year ending December 31, 1997 and has
restated its earnings per share disclosure for the period ended December 31,
1996 to comply with SFAS No. 128. Under SFAS No. 128, primary EPS is replaced
by "Basic" EPS, which excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common
shares outstanding for the period. "Diluted" EPS, which is computed similarly
to fully diluted EPS, reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock. When dilutive, stock options are included as
share equivalents in computing diluted earnings per share using the treasury
stock method. The weighted average number of shares used in computing basic
earnings (loss) per share was 28,634,362 in the year ended December 31, 1997,
and 16,692,217 in the period from October 11, 1996 to December 31, 1996,
respectively. The per share computations for all periods presented reflect the
41.667 for stock split (see Note 7). Basic EPS for the period from October 11,
1996 to December 31, 1996 increased by $.01 per share due to the adoption of
SFAS No. 128. Included in the computation of weighted average shares for
diluted EPS for the period from October 11, 1996 to December 31, 1996 are
21,104,455 shares of dilutive securities. Dilutive securities of
18,291,004 shares are not included in the calculation of diluted EPS in the
year ending December 31, 1997 because they are antidilutive.
 
  Use of Estimates in the Preparation of Financial Statements. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities. Management estimates ultimate
revenues and costs for feature films and television programs for each market
based on anticipated release patterns, public acceptance and historical
results for similar products. Actual results could differ from those
estimates.
 
  New Accounting Pronouncements. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income", which is effective for the Company's fiscal
year ending December 31, 1998. This
 
                                      51
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
statement establishes standards for the reporting and display of comprehensive
income and its components in financial statements and thereby report a measure
of all changes in equity of an enterprise that result from transactions and
other economic events other than transactions with owners.
 
  In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information", which is effective for the Company's
fiscal year ending December 31, 1998. This statement changes the requirements
under which publicly held companies report disaggregated information.
 
  The Company will adopt these statements on their respective effective dates.
The effect of these new accounting pronouncements has not yet been determined
by Management.
 
NOTE 2--ACQUISITIONS
 
  On October 10, 1996, MGM completed the acquisition of all the common stock
of MGM Studios (the "Acquisition") for a purchase price of $1,300,000,000 in
cash, plus payment of acquisition related costs of approximately $31,430,000.
In connection with an investment agreement (the "Investment Agreement")
between Mr. Frank Mancuso and an investor group comprised of Tracinda
Corporation ("Tracinda") and Seven Network Limited ("Seven") (collectively,
the "Investors") and MGM, Tracinda acquired $200,000,000 of the common stock
of MGM (the "Common Stock") and $450,000,000 of the Series A Cumulative
Convertible Preferred Stock of MGM (the "Preferred Stock"), and Seven acquired
$200,000,000 of the Common Stock and $50,000,000 of the Preferred Stock,
concurrent with the closing of the Acquisition. Also, in connection with the
Acquisition, Tracinda and Celsus Financial Corp., an entity wholly-owned by
Michael R. Gleason (a director of the Company), were each granted an option by
the Company to purchase 156,251 shares of the Common Stock at an exercise
price of $6.41 per share (the options expire on October 10, 2002) and
reimbursed an agreed-upon amount of $4,750,000 each for costs related to the
Acquisition.
 
  On July 10, 1997, the Company acquired all the outstanding common stock of
Orion, together with certain of its subsidiaries, for an aggregate purchase
price of $573,000,000 (the "Orion Acquisition"). The Company financed the
Orion Acquisition through (i) the issuance of 13,375,107 and 1,625,013 shares
of the Common Stock to Tracinda Corporation ("Tracinda") and Seven Network
Limited ("Seven"), respectively, for aggregate net proceeds of $360,000,000,
(ii) borrowings by Orion under a new $250,000,000 Orion credit facility
("Original Orion Credit Facility"), which was subsequently amended (see Note
6), and (iii) assumption of certain liabilities.
 
  The Orion Acquisition has been accounted for as a purchase. Orion's assets
and liabilities have been recorded in the Company's financial statements at
their estimated fair values at the acquisition date allocated as follows (in
thousands):
 
<TABLE>
     <S>                                                             <C>
     Accounts and contracts receivable.............................. $  51,015
     Film and television costs......................................   396,437
     Other assets...................................................    14,953
     Excess of cost over net assets of acquired businesses..........   294,355
     Liabilities assumed, including reserve for severance of
      $36,000.......................................................  (190,795)
                                                                     ---------
     Cash purchase price............................................ $ 565,965
                                                                     =========
</TABLE>
 
                                      52
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The results of operations of MGM Studios have been included in the
consolidated financial statements from October 11, 1996, the date of
commencement of principal operations. The results of operations of Orion have
been included in the consolidated financial statements from July 10, 1997, the
date of acquisition. The Company has made severance and other payments
associated with the Orion Acquisition aggregating $19,620,000 from the date of
acquisition to December 31, 1997. The pro forma results of operations for the
years ended December 31, 1997 and 1996 as if the Acquisition, the Orion
Acquisition, the 41.667 stock split and the conversion of the Preferred Stock
had occurred at the beginning of each period are as follows (in thousands,
except share data):
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED   YEAR ENDED
                                                      DECEMBER 31, DECEMBER 31,
                                                          1997         1996
                                                      ------------ ------------
   <S>                                                <C>          <C>
   Revenues..........................................  $  902,083   $1,315,128
   Operating loss....................................  $  (81,952)  $ (598,742)
   Net loss..........................................  $ (159,284)  $ (669,251)
   Pro forma loss per share..........................  $    (2.93)  $   (12.73)
   Pro forma weighted average shares.................  54,458,427   52,567,754
</TABLE>
 
NOTE 3--FILM AND TELEVISION COSTS
 
  Film and television costs, net of amortization, are summarized as follows
(in thousands):
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31, DECEMBER 31,
                                                           1997         1996
                                                       ------------ ------------
   <S>                                                 <C>          <C>
   Theatrical productions:
     Released.........................................  $1,418,446   $  912,216
     Completed not released...........................       7,662          --
     In process and development.......................     174,386       59,077
   Television programming.............................     266,632      127,908
                                                        ----------   ----------
                                                        $1,867,126   $1,099,201
                                                        ==========   ==========
</TABLE>
 
  Interest costs capitalized to theatrical productions were $15,242,000 and
$524,000 during the year ended December 31, 1997 and the period from October
11, 1996 to December 31, 1996, respectively.
 
  Based on the Company's estimates of projected gross revenues as of December
31, 1997, approximately 61% of unamortized film costs applicable to released
theatrical films and released television programs will be amortized during the
six years ending December 31, 2003.
 
NOTE 4--INVESTMENTS
 
  Distribution in foreign theatrical and certain pay television markets is
performed by United International Pictures B.V. ("UIP"), in which the Company
has a one-third interest. The Company's investment in UIP, which is included
in investments and advances to affiliates, is stated at cost plus equity in
undistributed earnings. The Company includes in its financial statements the
revenues and related costs associated with its films distributed by UIP. The
distribution fees paid to UIP by the Company are included in film and
television production and distribution expense. Due to timing differences
there are no taxable earnings and, therefore, there is no tax provision on
undistributed earnings. The Company's carrying value of its investment in UIP
at December 31, 1997 and 1996 was $6,623,000 and $12,490,000, respectively.
 
  In May 1996, the Company entered into a joint venture agreement with Encore
International, Inc., an indirect subsidiary of Telecommunications, Inc., to
develop MGM Gold Networks (Asia) ("MGM Gold"), a
 
                                      53
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
satellite and cable delivery channel based in Asia in which each of the joint
venture partners share equally in net earnings and each is obligated to fund
50 percent of MGM Gold's expenses up to a maximum of $23,300,000 each, of
which the Company had funded approximately $11,300,000 as of December 31,
1997. Additionally, the Company's share of MGM Gold's start-up losses in the
year ended December 31, 1997 was $11,754,000.
 
NOTE 5--PROPERTY AND EQUIPMENT
 
  Property and equipment are summarized as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31, DECEMBER 31,
                                                           1997         1996
                                                       ------------ ------------
   <S>                                                 <C>          <C>
   Leasehold improvements.............................   $14,845      $13,691
   Furniture, fixtures and equipment..................    26,141       15,074
                                                         -------      -------
                                                          40,986       28,765
   Less accumulated depreciation and amortization.....    (8,201)      (1,418)
                                                         -------      -------
                                                         $32,785      $27,347
                                                         =======      =======
</TABLE>
 
NOTE 6--BANK AND OTHER DEBT
 
  BANK AND OTHER DEBT IS SUMMARIZED AS FOLLOWS (IN THOUSANDS):
 
<TABLE>
<CAPTION>
                                                      DECEMBER 31, DECEMBER 31,
                                                          1997         1996
                                                      ------------ ------------
   <S>                                                <C>          <C>
   Revolving Facility................................   $175,000     $ 94,000
   Term Loans........................................    700,000      349,750
   Capitalized lease obligations and other
    borrowings.......................................     15,508          677
                                                        --------     --------
                                                        $890,508     $444,427
                                                        ========     ========
</TABLE>
 
  On October 15, 1997, the Company entered into an amended and restated credit
facility with a syndicate of banks aggregating $1.3 billion (the "Amended
Credit Facility") consisting of a six year $600 million revolving credit
facility (the "Revolving Facility"), a $400 million seven and one-half year
term loan ("Tranche A Loan") and a $300 million eight and one-half year term
loan ("Tranche B Loan") (collectively, the "Term Loans"). The Amended Credit
Facility contains provisions allowing, with the consent of the requisite
lenders and subject to syndication thereof, for an additional $200 million
tranche, raising the potential amount of Amended Credit Facility to $1.5
billion. The Revolving Facility and the Tranche A Loan bear interest at 2.25
percent over the Adjusted LIBOR rate, as defined (8.06 percent December 31,
1997). The Tranche B Loan bears interest at 2.50 percent over the Adjusted
LIBOR rate (8.31 percent at December 31, 1997). Scheduled amortization of the
Term Loans under the Amended Credit Facility commences with $33 million in
2001, $73 million in 2002, $103 million in 2003, $103 million in 2004 and $103
million in 2005, with the remaining balance due at maturity. The Revolving
Facility matures in October 2003, subject to extension under certain
conditions.
 
  The Company has entered into three year fixed interest rate swap contracts
in relation to a portion of the Term Loans for a notional value of
$500,000,000 at an average rate of 8.6 percent, which expire in November 2000.
At December 31, 1997, the Company would have to pay approximately $2,151,000
to terminate such swap contracts.
 
  The Company's borrowings under the Amended Credit Facility are secured by
substantially all the assets of the Company. The Amended Credit Facility
contains various covenants including limitations on dividends, capital
expenditures and indebtedness, and the maintenance of certain financial
ratios.
 
                                      54
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Lease and other borrowings. Capitalized lease and other borrowings relate
principally to contractual liabilities and computer equipment financing at
interest rates of approximately 10%.
 
  Maturity schedule. Credit facilities, lease and other borrowings at December
31, 1997 are scheduled to mature as follows (in thousands):
 
<TABLE>
     <S>                                                                <C>
     1998.............................................................. $  9,352
     1999..............................................................    1,618
     2000..............................................................    1,386
     2001..............................................................   32,977
     2002..............................................................   73,739
     Thereafter........................................................  771,436
                                                                        --------
                                                                        $890,508
                                                                        ========
</TABLE>
 
NOTE 7--STOCKHOLDERS' EQUITY
 
  Recapitalization. On November 13, 1997, the Company effected a
recapitalization pursuant to which the Company, immediately prior to the
closing of the Offering and the Tracinda Purchase (as such terms are defined
below) (i) converted each share of its Preferred Stock into one share of
Common Stock, (ii) effected a 41.667 for 1 stock split and (iii) increased the
number of authorized shares of the Common Stock from 50,000,000 to
125,000,000. Share and per share information have been retroactively restated
for all periods presented to reflect this recapitalization.
 
  Orion Acquisition. The Company financed a portion of the Orion Acquisition
through the issuance of 13,375,107 and 1,625,013 shares of the Common Stock to
Tracinda and Seven, respectively, for aggregate net proceeds of $360,000,000
(see Note 2).
 
  Initial Public Offering and Tracinda Purchase. On November 13, 1997, the
Company issued and sold 9,000,000 new shares of the Common Stock at a price
per share of $20, less an underwriting discount and Offering expenses, for net
proceeds of $165,000,000, in an initial public offering (the "Offering").
Concurrent with the consummation of the Offering, Tracinda purchased directly
from the Company 3,978,780 shares of the Common Stock, at a price per share of
$20 less an amount equal to the underwriting discount per share for shares
issued in the Offering, for net proceeds of $75,000,000 (the "Tracinda
Purchase"). Subsequently, $190,000,000 of the net proceeds of the Offering and
the Tracinda Purchase were used to repay existing bank debt and the remaining
net proceeds were retained and used for working capital purposes.
 
  1996 Incentive Plan. The Company has an Amended and Restated 1996 Stock
Incentive Plan (the "1996 Incentive Plan"). Awards under the 1996 Incentive
Plan are generally not restricted to any specific form or structure and may
include, without limitation, qualified or non-qualified stock options,
incentive stock options, restricted stock awards and stock appreciation rights
(collectively, "Awards"). Outstanding stock options under the 1996 Incentive
Plan generally vest over a period of five years and are not exercisable until
vested. Awards may be conditioned on continued employment, have various
vesting schedules and accelerated vesting and exercisability provisions in the
event of, among other things, a change in control of the Company.
 
                                      55
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Stock option transactions as of December 31, 1997 and 1996 under the 1996
Incentive Plan were as follows:
 
<TABLE>
     <S>                                                             <C>
     Balance as of October 11, 1996.................................       --
     Granted at $24.00 per share.................................... 1,745,680
                                                                     ---------
     Balance as of December 31, 1996................................ 1,745,680
     Granted at a weighted average price of $22.33 per share........ 5,948,672
     Forfeited at $20.00 per share..................................   (10,400)
                                                                     ---------
     Balance as of December 31, 1997 at a weighted average price of
      $22.71 per share.............................................. 7,683,952
                                                                     =========
     Number of shares authorized for grant.......................... 8,125,065
                                                                     =========
     Number of options exercisable at $24.00 per share.............. 5,205,702
                                                                     =========
     Number of options exercisable at $20.00 per share.............. 2,478,250
                                                                     =========
     Weighted average remaining contractual life as of December 31,
      1997.......................................................... 9.2 years
                                                                     =========
</TABLE>
 
  Of the outstanding employee options, 608,751 options are vested or will
become vested within 60 days, and none are exercisable or will become
exercisable within 60 days.
 
  Senior Management Bonus Plan. The Company has a Senior Management Bonus Plan
("the Senior Management Bonus Plan") under which 2,420,685 bonus interests
("Bonus Interests") have been granted to key employees. No additional bonus
interests may be issued under the Bonus Plan. The Senior Management Bonus Plan
is subject to approval by the stockholders of the Company no later than
December 31, 1998. Subject to the stockholder approval requirement discussed
above and to certain vesting and other requirements, each Bonus Interest
entitles the holder to receive a cash payment if (a) the sum of the average
closing price of Common Stock during the 20 trading days and, in certain
circumstances, per share distributions on the Common Stock (together, the
"Price") preceding a Determination Date, as defined, is greater than (b)
$24.00 and less than $48.00 (adjusted for stock splits, reverse stock splits
and similar events). The cash payment will be equal to (i) the vested portion
of the Bonus Interest at the Determination Date multiplied by (ii) the amount
by which the Price at the Determination Date is less than $48.00 (i.e.,
maximum of $24.00 per Bonus Interest). Bonus Interests generally vest 20% at
October 1, 1997 and 1.67% each month thereafter.
 
  The Company applies Accounting Principles Board ("APB") Opinion No. 25,
"Accounting For Stock Issued to Employees," and related interpretations in
accounting for its plans. Had compensation cost for these plans been
determined consistent with FASB Statement No. 123, the Company's net income
(loss) would have been reduced to the following pro forma amounts:
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED  OCTOBER 11, TO
                                                     DECEMBER 31,  DECEMBER 31,
                                                         1997          1996
                                                     ------------ --------------
     <S>                                             <C>          <C>
     Net income (loss):
       As reported.................................   $(128,114)      $  166
       Pro forma...................................   $(136,187)      $  (15)
       Pro forma loss per share....................   $   (4.76)      $(0.00)
</TABLE>
 
  The fair value of each option grant was estimated using the Black-Scholes
model based on the following assumptions: the weighted average fair value of
Options granted in the year ended December 31, 1997 and in the period from
October 11 to December 31, 1996 was $5.41 and $6.94, respectively. The
dividend yield and expected volatility were 0 percent in both periods. Also,
the calculation uses a weighted average expected life of 5.0 years and 5.5
years, and a weighted average assumed risk-free interest rate of 5.9 percent
and 6.2 percent, for the year ended December 31, 1997 and the period from
October 11 to December 31, 1996, respectively.
 
                                      56
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 8--INCOME TAXES
 
  The Company's domestic and foreign tax liability balances consist of the
following (in thousands):
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31, DECEMBER 31,
                                                           1997         1996
                                                       ------------ ------------
     <S>                                               <C>          <C>
     Current..........................................   $30,879      $29,269
     Deferred.........................................       700          --
                                                         -------      -------
                                                         $31,579      $29,269
                                                         =======      =======
</TABLE>
 
  For income tax purposes, the historical tax basis of the assets and
liabilities of MGM Studios has been retained following MGM Studio's
acquisition by MGM. The income tax effects of temporary differences between
book value and tax basis of assets and liabilities are as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31, DECEMBER 31,
                                                           1997         1996
                                                       ------------ ------------
     <S>                                               <C>          <C>
     Deferred tax assets:
       Film and television costs.....................   $  21,143    $   6,594
       Film revenue..................................         --         4,444
       Participations and residuals payable..........      10,886       15,574
       Reserves and investments......................      52,375       50,521
       Net miscellaneous tax assets..................      34,780       25,368
       Operating loss carryforwards..................      74,069        4,564
                                                        ---------    ---------
         Subtotal gross tax assets...................     193,253      107,065
       Valuation allowance...........................    (173,867)    (107,065)
                                                        ---------    ---------
         Total tax assets............................      19,386          --
                                                        ---------    ---------
     Deferred tax liabilities:
       Film revenue..................................     (18,709)         --
       Goodwill......................................      (1,377)         --
                                                        ---------    ---------
         Total deferred tax liabilities..............     (20,086)         --
                                                        ---------    ---------
     Net deferred tax assets (liability).............   $    (700)   $     --
                                                        =========    =========
</TABLE>
 
  As of December 31, 1997, the Company and its subsidiaries for U.S. federal
income tax purposes had net operating loss carryforwards of $30,323,000 and
$159,598,000, which expire in 2011 and 2012, respectively. Presently, there
are no limitations on the use of these carryforwards.
 
  At December 31, 1997, management has determined that $173,867,000 of
deferred tax assets do not satisfy the recognition criteria set forth in SFAS
No. 109. Accordingly, a valuation allowance has been recorded by the Company
for this amount.
 
  Details of the provision for income taxes are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                   YEAR ENDED  OCTOBER 11 TO
                                  DECEMBER 31, DECEMBER 31,
                                      1997         1996
                                  ------------ -------------
     <S>                          <C>          <C>
     Current taxes:
       Foreign taxes.............   $  9,645      $ 3,140
     Deferred taxes:
       Federal and state taxes
        (benefit)................    (66,102)       6,055
       Adjustment for change in
        valuation allowance......     66,802       (4,849)
                                    --------      -------
         Total tax provision.....   $ 10,345      $ 4,346
                                    ========      =======
</TABLE>
 
                                      57
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following is a summary reconciliation of the effective tax rate to the
assumed federal tax rate:
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED  OCTOBER 11 TO
                                                    DECEMBER 31, DECEMBER 31,
                                                        1997         1996
                                                    ------------ -------------
   <S>                                              <C>          <C>
   Assumed federal tax rate on pre-tax book income
    (loss).........................................     (35)%          35%
   Goodwill and other permanent differences........       3 %          14%
   Foreign taxes, net of available federal tax
    benefit........................................       8 %          45%
   Loss carryforward not benefitted................      32 %          --
                                                        ---           ---
   Effective tax rate..............................       8 %          94%
                                                        ===           ===
</TABLE>
 
  The Company has various foreign subsidiaries formed or acquired to produce
or distribute motion pictures outside the United States. In the opinion of
management, the earnings of these subsidiaries are not permanently invested
outside the United States. Pursuant to APB No. 23, "Accounting For Income
Taxes--Special Areas," tax expense has accordingly been provided for these
unremitted earnings.
 
NOTE 9--RETIREMENT PLANS
 
  The Company has a non-contributory retirement plan (the "Basic Plan")
covering substantially all regular full-time, non-union employees. Benefits
are based on years of service and compensation, as defined.
 
  The following table summarizes the funded status of the Basic Plan (in
thousands):
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31, DECEMBER 31,
                                                           1997         1996
                                                       ------------ ------------
   <S>                                                 <C>          <C>
   Actuarial present value of benefit obligations
    (including vested benefits of $7,735 and
    $7,427)..........................................    $ 8,834      $ 8,469
                                                         =======      =======
   Projected benefit obligations.....................    $10,500      $ 9,913
   Plan assets at fair value (primarily debt
    securities)......................................      8,741        8,403
                                                         -------      -------
   Projected benefit obligations in excess of plan
    assets...........................................     (1,759)      (1,510)
   Unrecognized net asset as of beginning of year....       (160)        (180)
   Unrecognized net loss.............................        860          505
   Unrecognized prior service cost...................       (163)        (177)
                                                         -------      -------
   Accrued pension liability.........................    $(1,222)     $(1,362)
                                                         =======      =======
   Key assumptions used in the actuarial computations
    were as follows:
   Discount rate.....................................       7.50%        7.50%
                                                         =======      =======
   Long-term rate of return on assets................       7.25%        7.25%
                                                         =======      =======
   Rate of increase in future compensation levels....       5.00%        5.00%
                                                         =======      =======
</TABLE>
 
  The unrecognized net asset is being amortized over the estimated remaining
service life of 19.4 years. Domestic pension benefits and expense were
determined under the entry age actuarial cost method.
 
                                      58
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Pension costs includes the following components (in thousands):
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED  OCTOBER 11 TO
                                                      DECEMBER 31, DECEMBER 31,
                                                          1997         1996
                                                      ------------ -------------
   <S>                                                <C>          <C>
   Service cost......................................    $1,213        $ 244
   Interest cost on projected benefit obligation.....       841          163
   Actual (return) loss on plan assets...............      (636)         224
   Net amortization and deferral.....................       (34)        (330)
                                                         ------        -----
   Net periodic pension cost.........................    $1,384        $ 301
                                                         ======        =====
</TABLE>
 
  A significant number of the Company's production employees are covered by
union sponsored, collectively bargained multi-employer pension plans. The
Company contributed approximately $12,366,000 and $2,824,000 for such plans in
year ended December 31, 1997 and the period from October 11, 1996 to December
31, 1996. Information from the plans' administrators is not sufficient to
permit the Company to determine its share of unfunded vested benefits, if any.
 
  The Company also provides each of its employees, including its officers, who
have completed one year of service with the Company the opportunity to
participate in the MGM Savings Plan (the "Savings Plan"). The Company
contributed approximately $1,172,000 and $219,000 to the Savings Plan in the
year ended December 31, 1997 and the period from October 11, 1996 to December
31, 1996.
 
NOTE 10--RELATED PARTY TRANSACTIONS
 
  In 1980 a predecessor-in-interest to MGM Studios granted to a predecessor-
in-interest to MGM Grand, Inc. an exclusive open-ended royalty-free license to
use certain trademarks, tradenames and logos in MGM Grand, Inc.'s hotel/gaming
business and other businesses that are not entertainment-related. Tracinda
owns a majority of the outstanding common stock of MGM Grand, Inc., the parent
of MGM Grand Hotel, Inc. ("Grand Hotel").
 
  The Company has granted to Grand Hotel, or certain of its affiliates,
limited short-term, nonexclusive licenses to (i) key art and still photographs
of artwork from certain theatrical releases of the Company for use in an "in-
room" only publication at the Grand Hotel and (ii) one minute film clips of
such releases in a clip reel program for the benefit of a charitable
foundation and to promote the sale of videocassettes containing such releases
at the Grand Hotel. The Company did not receive any monetary compensation for
these licenses.
 
  The Company sells to Grand Hotel, and certain of its affiliates, on a
wholesale basis videocassettes and merchandise such as baseball caps,
clothing, keychains and watches bearing the Company's trademarks and logos for
resale to consumers in retail shops located within Grand Hotel's hotels. Grand
Hotel currently is the Company's largest wholesale customer of the Company's
merchandise and, consequently, receives customary volume discounts from the
Company. During the year ended December 31, 1997 and the period from
October 11, 1996 to December 31, 1996, the Company recognized revenues of
$257,000 and $70,000, respectively, for such videocassettes and merchandise.
 
  In 1997 MGM Studios and Grand Hotel entered into a site location agreement
with respect to production of a pilot episode of a television series being
developed by MGM Studios. Grand Hotel was not compensated for the use of the
site, but was compensated, on customary terms, for goods and services provided
by Grand Hotel in the amount of $462,000 in fiscal 1997.
 
  From time to time, the Company charters airplanes from Tracinda for use in
the Company's business. The Company believes that the terms of the charter
arrangements are no less favorable to the Company than those
 
                                      59
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
that could be obtained from unrelated third parties. During the year ended
December 31, 1997 and the period from October 11, 1996 to December 31, 1996,
the aggregate of the payments made to Tracinda for such charters was
approximately $308,000 and $10,000, respectively.
 
  The Company has entered into various television license agreements with a
subsidiary of Seven providing for broadcast of the Company's films and
television programs in Australia. During the year ended December 31, 1997 and
the period from October 11, 1996 to December 31, 1996, the Company recognized
revenues of $4,454,000 and $1,055,000, respectively, under these agreements.
Management believes that the terms of these agreements are consistent with the
terms of comparable television license arrangements with third parties.
 
  In 1994, in connection with the formation of MovieVision, a joint venture in
which the Company and a subsidiary of Seven have non-controlling interests,
the Company licensed to the joint venture certain of its current theatrical
and television motion pictures for distribution on Australian pay and basic
cable television. The agreement expires on June 30, 2000, with all motion
pictures covered by the agreement reverting to the Company within one year
after that date, but both the Company and MovieVision have the right to extend
the license for a further five years. The Company receives a license fee for
each picture that is based on the number of MovieVision's subscribers. The
Company recognized revenues of $3,056,000 and $292,000 during the year ended
December 31, 1997 and the period from October 11, 1996 to December 31, 1996,
respectively. The Company believes that the terms of the agreement are no less
favorable to the Company than those contained in its licenses with
unaffiliated licensees.
 
  Seven has agreed to reimburse the Company for losses that the Company may
incur in connection with the distribution of an Australian film with respect
to which the Company has acquired distribution rights from an unrelated third
party.
 
  The Company has entered into various agreements to develop and produce
certain films and television programs with Mr. Frank Mancuso, Jr., the son of
the Company's Chairman of the Board and Chief Executive Officer. Pursuant to
these agreements, the Company paid Mr. Mancuso, Jr. approximately $1,916,000
and $39,000 during the year ended December 31, 1997 and the period from
October 11, 1996 to December 31, 1996, respectively. The agreements provide
for additional producer fees and potential profit participations to be paid in
the future at terms consistent with comparable development and production
agreements with third parties.
 
  On January 14, 1997, MGM Studios and Tracinda entered into an agreement to
share the proceeds from certain insurance claims relating to litigation which
arose prior to 1991. The potential insurance proceeds of up to approximately
$15,000,000 will be paid 65% to MGM Studios and 35% to Tracinda based on the
relative value of each company's respective claims, as determined by the
parties. The Company received $8,031,000 in insurance proceeds under such
policies during the year ended December 31, 1997, of which $2,811,000 was paid
to Tracinda.
 
NOTE 11--FOREIGN OPERATIONS AND EXPORT SALES
 
  The Company's foreign activities are principally motion picture and
television production and distribution in territories outside of the United
States and Canada. Net foreign assets of subsidiaries operating in foreign
countries are not material in relation to consolidated net assets.
 
                                      60
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Foreign export revenues are revenues earned from motion picture and
television films produced in the United States. Export revenues were as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED  OCTOBER 11 TO
                                                      DECEMBER 31, DECEMBER 31,
                                                          1997         1996
                                                      ------------ -------------
       <S>                                            <C>          <C>
       Europe........................................   $255,396      $62,298
       Latin America.................................     21,173       12,485
       Other.........................................     95,756       16,743
                                                        --------      -------
                                                        $372,325      $91,526
                                                        ========      =======
</TABLE>
 
NOTE 12--COMMITMENTS AND CONTINGENCIES
 
  Leases. The Company has operating leases for offices and equipment. Certain
property leases include provisions for increases over base year rents as well
as for escalation clauses for maintenance and other building operations. Rent
expense was approximately $12,915,000 and $2,936,000 for the year ended
December 31, 1997 and the period from October 11, 1996 to December 31, 1996,
respectively.
 
  Employment Agreements. The Company has employment agreements with several
principal officers and employees. The agreements provide for minimum salary
levels as well as, in some cases, bonuses.
 
  Creative Talent Agreements. The Company has entered into contractual
agreements for creative talent related to future film production. Such amounts
are scheduled to be paid through 1999.
 
  Future minimum annual commitments under non-cancelable operating leases,
employment agreements, and creative talent agreements as of December 31, 1997
are as follows (in thousands):
 
<TABLE>
        <S>                                                 <C>
        1998............................................... $ 67,263
        1999...............................................   42,372
        2000...............................................   34,340
        2001...............................................   23,411
        2002...............................................   11,086
        Thereafter.........................................    6,278
                                                            --------
                                                            $184,750
                                                            ========
</TABLE>
 
  Litigation. The Company, together with other major companies in the filmed
entertainment industry, has been subject to numerous antitrust suits brought
by various motion picture exhibitors, producers and others. In addition,
various legal proceedings involving alleged breaches of contract, antitrust
violations, copyright infringement and other claims are now pending, which the
Company considers routine to its business activities.
 
  In the opinion of Company management, any liability under pending litigation
is likely to be not material in relation to the Company's financial condition.
 
NOTE 13--SUPPLEMENTARY CASH FLOW INFORMATION
 
  The Company paid interest, net of capitalized interest, of $45,394,000 and
$7,103,000 during the year ended December 31, 1997 and the period from October
11, 1996 to December 31, 1996, respectively. The Company paid income taxes of
$8,425,000 and received foreign remittance tax refunds of $12,296,000 during
the year ended December 31, 1997. Income taxes paid were $922,000 during the
period from October 11, 1996 to December 31, 1996.
 
                                      61
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 14--QUARTERLY FINANCIAL DATA (UNAUDITED)
 
  Certain quarterly information is presented below (in thousands):
 
<TABLE>
<CAPTION>
                                                 SECOND
                                       FIRST    QUARTER     THIRD     FOURTH
                                     QUARTER OF    OF     QUARTER OF QUARTER OF
                                        1997      1997       1997       1997
                                     ---------- --------  ---------- ----------
     <S>                             <C>        <C>       <C>        <C>
     Revenues.......................  $197,629  $153,385   $221,068   $259,220
     Operating income (loss)........  $ (1,084) $ (4,775)  $  1,254   $(62,506)
     Interest expense, net of
      amounts capitalized...........  $ 11,016  $  9,583   $ 15,415   $ 17,091
     Net loss.......................  $(14,193) $(14,812)  $(16,560)  $(82,549)
     Basic and diluted loss per
      share.........................  $  (0.85) $  (0.88)  $  (0.55)  $  (1.64)
</TABLE>
 
                                       62
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Shareholder of Metro-Goldwyn-Mayer Studios Inc.
 
  We have audited the accompanying consolidated balance sheet of Metro-
Goldwyn-Mayer Studios Inc. (formerly known as Metro-Goldwyn-Mayer Inc.) and
its subsidiaries (the "Company") as of October 10, 1996, and the related
consolidated statements of operations and equity and cash flows for the period
from January 1, 1996 to October 10, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
 
  We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
 
  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the
Company as of October 10, 1996 and the results of their operations and their
cash flows for the period from January 1, 1996 to October 10, 1996 in
conformity with generally accepted accounting principles.
 
                                          Arthur Andersen LLP
 
Los Angeles, California
December 16, 1996
 
                                      63
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors and Shareholder of
Metro-Goldwyn-Mayer Studios Inc.
 
  We have audited the accompanying consolidated balance sheet of Metro-
Goldwyn-Mayer Studios Inc. (formerly known as Metro-Goldwyn-Mayer Inc.), and
its subsidiaries (the "Company") as of December 31, 1995, and the related
consolidated statements of operations, stockholder's equity and of cash flows
for each of the two years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We have not audited the consolidated financial statements of the
Company and its subsidiaries for any period subsequent to December 31, 1995.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the consolidated financial statements audited by us present
fairly, in all material respects, the financial position of Metro-Goldwyn-
Mayer Studios Inc., and its subsidiaries at December 31, 1995, and the results
of their operations and their cash flows for each of the two years in the
period ended December 31, 1995, in conformity with generally accepted
accounting principles.
 
                                          Price Waterhouse LLP
 
Century City, California
February 29, 1996, except for the incentive bonus described in Note 12, as to
 which the date is July 31, 1996
 
                                      64
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                      OCTOBER 10,  DECEMBER 31,
                                                         1996          1995
                                                      -----------  ------------
<S>                                                   <C>          <C>
                       ASSETS
                       ------
Cash and cash equivalents...........................  $    24,717  $    17,128
Accounts and contracts receivable (net of allowance
 for doubtful accounts of $12,718 and $18,479 in
 1996 and 1995, respectively).......................      291,550      255,444
Film and television costs, including film distribu-
 tion organization, net.............................    1,006,402    1,565,438
Investments and advances to affiliates..............       26,420       15,238
Property and equipment, net.........................       26,686       32,078
Trademarks, logos and excess of cost over net assets
 of acquired businesses, net........................      349,158      520,199
Other assets........................................       19,301       34,729
                                                      -----------  -----------
                                                      $ 1,744,234  $ 2,440,254
                                                      ===========  ===========
<CAPTION>
        LIABILITIES AND STOCKHOLDER'S EQUITY
        ------------------------------------
<S>                                                   <C>          <C>
Liabilities:
  Bank and other debt...............................  $ 1,229,499  $ 1,217,316
  Accounts payable and accrued liabilities..........       84,379      112,521
  Interest payable..................................       72,079       76,859
  Accrued participants' share.......................      170,257      140,316
  Income taxes payable..............................       27,313       58,900
  Due to affiliate..................................       11,900           --
  Advances and deferred revenues....................      110,774      161,973
  Other liabilities.................................       38,033       12,870
                                                      -----------  -----------
    Total liabilities...............................    1,744,234    1,780,755
Commitments and contingencies
Stockholder's equity:
  Common Stock, $1.00 par value, 1,000 shares
   authorized, 10 shares issued and outstanding in
   1996 and 1995....................................            1            1
  Additional paid-in capital........................  $ 2,222,133  $ 2,132,694
  Cumulative translation adjustment.................         (318)        (413)
  Accumulated deficit...............................   (2,221,816)  (1,472,783)
                                                      -----------  -----------
    Stockholder's equity............................          --       659,499
                                                      -----------  -----------
                                                      $ 1,744,234  $ 2,440,254
                                                      ===========  ===========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       65
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                         PERIOD ENDED  YEAR ENDED   YEAR ENDED
                                         OCTOBER 10,  DECEMBER 31, DECEMBER 31,
                                             1996         1995         1994
                                         ------------ ------------ ------------
<S>                                      <C>          <C>          <C>
Revenues................................  $ 912,706    $ 860,971    $ 597,121
Expenses:
  Film and television production and
   distribution.........................    953,820      894,280      668,516
  General and administrative............     60,056       64,175       49,314
  Goodwill amortization.................     11,570       14,876       14,876
  Provision for impairment..............    563,829          --           --
                                          ---------    ---------    ---------
    Total expenses......................  1,589,275      973,331      732,706
                                          ---------    ---------    ---------
Operating loss..........................   (676,569)    (112,360)    (135,585)
Other income (expense):
  Interest expense, net of amounts capi-
   talized..............................    (71,375)     (66,386)     (33,860)
  Interest and other income, net........      3,179       10,372        2,070
                                          ---------    ---------    ---------
    Total other expense.................    (68,196)     (56,014)     (31,790)
                                          ---------    ---------    ---------
Loss from operations before provision
 for income taxes.......................   (744,765)    (168,374)    (167,375)
Income tax provision....................       (273)        (935)      (3,877)
                                          ---------    ---------    ---------
Net loss................................  $(745,038)   $(169,309)   $(171,252)
                                          =========    =========    =========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       66
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                           COMMON STOCK
                          --------------- ADDITIONAL              CUMULATIVE      TOTAL
                          NUMBER OF  PAR   PAID-IN    RETAINED    TRANSLATION STOCKHOLDER'S
                           SHARES   VALUE  CAPITAL    EARNINGS    ADJUSTMENT     EQUITY
                          --------- ----- ---------- -----------  ----------- ------------- ---
                                         (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                       <C>       <C>   <C>        <C>          <C>         <C>           <C>
BALANCE DECEMBER 31,
 1993...................      10     $ 1  $2,100,000 $(1,116,774)   $ 1,380     $ 984,607
Foreign currency
 translation adjustment.      --      --         --          --      (1,090)       (1,090)
Forgiveness of interest
 payable to affiliate...      --      --      16,794         --         --         16,794
Net loss................      --      --         --     (171,252)       --       (171,252)
                             ---     ---  ---------- -----------    -------     ---------
BALANCE DECEMBER 31,
 1994...................      10       1   2,116,794  (1,288,026)       290       829,059
Contributions received
 from affiliate.........      --      --      15,900         --         --         15,900
Dividends declared......      --      --         --      (15,448)       --        (15,448)
Foreign currency
 translation adjustment.      --      --         --          --        (703)         (703)
Net loss................      --      --         --     (169,309)       --       (169,309)
                             ---     ---  ---------- -----------    -------     ---------
BALANCE DECEMBER 31,
 1995...................      10       1   2,132,694  (1,472,783)      (413)      659,499
Contributions received
 from affiliate.........      --      --      89,439         --         --         89,439
Dividends declared......      --      --         --       (3,995)       --         (3,995)
Foreign currency
 translation adjustment.      --      --         --          --          95            95
Net loss................      --      --         --     (745,038)       --       (745,038)
                             ---     ---  ---------- -----------    -------     ---------
BALANCE OCTOBER 10,
 1996...................      10     $ 1  $2,222,133 $(2,221,816)   $  (318)    $     --
                             ===     ===  ========== ===========    =======     =========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       67
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                          PERIOD ENDED  YEAR ENDED   YEAR ENDED
                                          OCTOBER 10,  DECEMBER 31, DECEMBER 31,
                                              1996         1995         1994
                                          ------------ ------------ ------------
<S>                                       <C>          <C>          <C>
Operating activities:
 Net loss...............................   $(745,038)   $(169,309)   $(171,252)
 Adjustments to reconcile net loss from
  operations to net cash provided by
  operating activities:
  Amortization of film and television
   costs, film distribution organization
   and participants' share..............     608,704      628,420      434,354
  Depreciation and amortization of
   property and equipment...............       4,645        4,021        5,335
  Provision for impairment and
   amortization of intangibles..........     575,399       14,876       14,876
  (Decrease) increase in bad debt and
   other reserves.......................         430      (17,425)       3,266
  Losses (gains) on equity investments..      (1,967)       1,620       (1,762)
  Increase in accounts and contracts
   receivable, advances to affiliates
   and other assets.....................     (28,192)     (65,454)     (32,905)
  Increase (decrease) in accounts
   payable, accrued and other
   liabilities, accrued participants'
   share and domestic and foreign taxes.     (19,970)         680       (8,967)
  Decrease in advances and deferred
   revenues.............................     (51,199)     (24,597)     (27,458)
  Foreign currency exchange (gain) loss
   and other............................         325       (1,175)         802
                                           ---------    ---------    ---------
   Net cash provided by operating
    activities..........................     343,137      371,657      216,289
                                           ---------    ---------    ---------
Investing activities:
 Additions to film costs, net...........    (369,148)    (701,436)    (454,932)
 Additions to property and equipment....      (6,901)      (9,376)      (9,099)
 Other investing activities.............      (4,093)          --           --
                                           ---------    ---------    ---------
   Net cash used in investing
    activities..........................    (380,142)    (710,812)    (464,031)
                                           ---------    ---------    ---------
Financing activities:
 Net bank advances......................      51,012      340,148      251,918
 Contribution received from parent......          --        5,900           --
 Dividends paid.........................      (6,160)     (13,283)          --
 Financing costs and other..............          --       (4,736)     (11,953)
                                           ---------    ---------    ---------
   Net cash provided by financing activ-
    ities...............................      44,852      328,029      239,965
                                           ---------    ---------    ---------
Net change in cash and cash equivalents
 from operating, investing and financing
 activities.............................       7,847      (11,126)      (7,777)
Net decrease in cash due to foreign cur-
 rency fluctuations.....................        (258)        (543)        (199)
                                           ---------    ---------    ---------
Net change in cash and cash equivalents.       7,589      (11,669)      (7,976)
Cash and cash equivalents at beginning
 of period..............................      17,128       28,797       36,773
                                           ---------    ---------    ---------
Cash and cash equivalents at end of the
 period.................................   $  24,717    $  17,128    $  28,797
                                           =========    =========    =========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       68
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               OCTOBER 10, 1996
 
NOTE 1--BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Presentation. The accompanying consolidated financial statements
include the accounts of Metro-Goldwyn-Mayer Studios Inc. (formerly known as
Metro-Goldwyn-Mayer Inc.). and its majority-owned subsidiaries ("MGM Studios"
or "the Company"). The Company is wholly owned by MGM Group Holdings
Corporation ("MGM Group Holdings"), an indirect wholly owned subsidiary of
Consortium de Realisation ("CDR"). CDR is a wholly owned subsidiary of Credit
Lyonnais S.A. ("Credit Lyonnais") and is controlled by the French State. On
October 10, 1996, the Company was sold to an unaffiliated group of investors
(see Note 15). The sale transaction has not been reflected in the accompanying
historical financial statements, except to reduce certain long-lived assets to
their net realizable value (see Note 5).
 
  As permitted by Statement of Financial Accounting Standards ("SFAS") No. 53,
"Financial Reporting by Producers and Distributors of Motion Pictures", the
Company has presented unclassified consolidated balance sheets. Certain
reclassifications have been made to amounts reported in prior periods to
conform with the current presentation.
 
  Business. The Company is engaged in the financing, production and worldwide
distribution of theatrical motion pictures and television programming, as well
as new media and interactive products. The Company also distributes films
produced or financed, in whole or in part, by third parties.
 
  Principles of Consolidation. The consolidated financial statements include
the accounts of MGM Studios and all of its majority-owned and controlled
subsidiaries. The Company's investments in related companies which represent a
20% to 50% ownership interest over which the Company has significant influence
but not control are accounted for using the equity method (see Note 4). All
significant intercompany balances and transactions have been eliminated.
 
  Cash and Cash Equivalents. The Company considers all highly liquid debt
instruments, purchased with an initial maturity of three months or less, to be
cash equivalents. Included in other assets at October 10, 1996 and December
31, 1995 is approximately $12,774,000 and $12,354,000, respectively, of cash
restricted by various escrow agreements. The carrying value of the Company's
cash equivalents approximated cost at each balance sheet date.
 
  Revenue Recognition. Revenues from theatrical distribution of feature films
are recognized on the dates of exhibition. Revenues from direct home video
distribution are recognized, net of an allowance for estimated returns,
together with related costs, in the period in which the product is available
for sale by the Company's customers. Revenues from television licensing,
together with related costs, are recognized when the feature film or
television program is available to the licensee for telecast. Generally,
feature films are first made available for home video release in a particular
territory six months after theatrical release in such territory; for pay
television, one year after theatrical release; for initial free television,
two to three years after theatrical release; and for syndication,
approximately three to five years after theatrical release. Long-term non-
interest-bearing receivables arising from licensing agreements are discounted
to present value.
 
  Accounting for Film Costs. Except for purchase accounting adjustments, film
costs include the costs of production, prints, pre-release and other
advertising expected to benefit future periods and capitalized overhead and
interest. These costs, as well as participations and talent residuals, are
charged against earnings on an individual film basis in the ratio that the
current year's gross film revenues bear to management's estimate of total
remaining ultimate gross film revenues from all sources.
 
  Film costs are stated at the lower of cost or estimated net realizable value
on an individual film basis. Revenue and cost forecasts are continually
reviewed by management and revised when warranted by changing
 
                                      69
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
conditions. When estimates of total revenues and costs indicate that a feature
film or television program will result in an ultimate loss, additional
amortization is recognized to the extent required to produce a zero gross
margin over the remaining life of the film or television program.
 
  The film distribution organization is an intangible asset reflecting the
estimated value of the Company's investment in its worldwide distribution
organization; these costs are being amortized on a straight-line basis over 40
years. During the period ended October 10, 1996, the Company recorded a charge
of $404,409,000 to write off its remaining investment in the film distribution
organization (see Notes 2 and 5).
 
  Property and equipment. Property and equipment are stated at cost.
Depreciation of property and equipment is computed under the straight-line
method over the expected useful lives of applicable assets, ranging from three
to five years. Amortization of leasehold assets is computed under the
straight-line method over the shorter of the estimated useful lives of the
assets or the terms of the related leases. When property is sold or otherwise
disposed of, the cost and related accumulated depreciation is removed from the
accounts, and any resulting gain or loss is included in income. The costs of
normal maintenance and repairs and minor replacements are charged to expense
when incurred.
 
  Trademarks, Logos and Goodwill. Trademarks, logos and the excess cost of
acquisitions over the fair market values of identifiable net assets acquired
(goodwill) are amortized over an estimated useful life of 40 years using the
straight-line method. During 1996, the Company adopted SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of". This statement establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangibles, and
goodwill related to those assets to be held and used and for long-lived assets
and certain identifiable intangibles to be disposed of. The carrying value of
existing assets are reviewed when events or changes in circumstances indicate
that an impairment test is necessary in order to determine if an impairment
has occurred. When factors indicate that such assets should be evaluated for
possible impairment, the Company will estimate the future cash flows expected
to result from the use of the assets and their eventual disposition, and
compare the amounts to the carrying value of the assets to determine if an
impairment loss has occurred. Accordingly, the Company recorded a charge of
$159,420,000 to reduce the net realizable value of goodwill (see Note 5).
 
  Income Taxes. In accordance with SFAS No. 109, "Accounting For Income
Taxes", deferred tax assets and liabilities are recognized with respect to the
tax consequences attributable to differences between the financial statement
carrying values and tax bases of existing assets and liabilities. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which these temporary differences are
expected to be recovered or settled. Further, the effect on deferred tax
assets and liabilities of changes in tax rates is recognized in income in the
period that includes the enactment date.
 
  From May 7, 1992 to October 10, 1996, the Company has been included in the
consolidated federal income tax return of MGM Holdings. The Company's income
tax provision has been computed on a separate return basis, modified to
allocate to MGM Studios the benefits calculated at the MGM Holdings level
which results from the Company's tax attributes. Foreign subsidiaries file
separate or consolidated returns depending on the statutes and elections
available in each foreign jurisdiction.
 
  Foreign Currency Translation. Generally, foreign subsidiary assets and
liabilities are translated into United States dollars at the exchange rates in
effect at the balance sheet date. Revenues and expenses of foreign
subsidiaries are translated into United States dollars at the average exchange
rates that prevailed during the period. The gains or losses that result from
this process are included as a component of the cumulative translation
adjustment balance in stockholder's equity. Foreign currency denominated
transactions are recorded at the exchange rate in effect at the time of
occurrence, and the gains or losses resulting from subsequent translation at
current exchange rates are included in the statement of operations.
 
                                      70
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Financial Instruments. The carrying values of short-term trade receivables
and payables approximate their estimated fair values because of the short
maturity of these instruments. The carrying values of receivables with
maturities greater than one year have been discounted at LIBOR plus 2.25%
(approximately 7.78% at October 10, 1996), which approximates current market
rates.
 
  Accounts and Contracts Receivable. At October 10, 1996, accounts and
contracts receivable aggregated $304,268,000 (before allowance for doubtful
accounts), of which approximately $240,000,000 is due within one year.
Concentration of credit risk with respect to accounts receivable is limited
due to the large number and general dispersion of accounts which constitute
the Company's customer base. The Company performs credit evaluations of its
customers and in some instances requires collateral. At October 10, 1996 and
December 31, 1995, approximately 41% and 18%, respectively, of the Company's
accounts and contracts receivable arose from an exclusive home video
distribution agreement with Warner Home Video.
 
  Use of Estimates in the Preparation of Financial Statements. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities. Management estimates ultimate
revenues and costs for feature films and television programs for each market
based on anticipated release patterns, public acceptance and historical
results for similar products. Actual results could differ from those
estimates.
 
NOTE 2--FILM AND TELEVISION COSTS, INCLUDING FILM DISTRIBUTION ORGANIZATION
 
  Film costs, net of amortization, are summarized as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                        OCTOBER 10, DECEMBER 31,
                                                           1996         1995
                                                        ----------- ------------
   <S>                                                  <C>         <C>
   Theatrical productions:
     Released.......................................... $  796,715   $  825,623
     Completed not released............................     25,782          --
     In process and development........................     72,678      210,955
   Television programming..............................    111,227      115,216
   Film distribution organization......................        --       413,644
                                                        ----------   ----------
                                                        $1,006,402   $1,565,438
                                                        ==========   ==========
</TABLE>
 
  Interest costs capitalized to theatrical productions were $4,112,000,
$21,498,000 and $7,022,000 during the period ended October 10, 1996 and the
years ended December 31, 1995 and 1994, respectively.
 
  Based on the Company's estimates of projected gross revenues as of October
10, 1996, approximately 64% of unamortized film costs applicable to released
theatrical films and released television programs will be amortized during the
three years ending September 30, 1999.
 
NOTE 3--INVESTMENTS
 
  Distribution of foreign theatrical and certain pay television product is
performed by United International Pictures B.V. ("UIP"), in which the Company
has a one-third interest. The Company's investment in UIP, which is included
in investments and advances to affiliates, is stated at cost plus equity in
undistributed earnings. The Company includes in its financial statements the
revenues and related costs associated with its films distributed by UIP. The
distribution fees paid to UIP by the Company are included in film and
television production and distribution expense. Due to timing differences
there are no taxable earnings and, therefore, there is no tax provision on
undistributed earnings. The Company's carrying value of its investment in UIP
at October 10, 1996 and December 31, 1995 was $9,898,000 and $10,008,000,
respectively.
 
                                      71
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 4--PROPERTY AND EQUIPMENT
 
  Property and equipment, stated at cost, are summarized as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                        OCTOBER 10, DECEMBER 31,
                                                           1996         1996
                                                        ----------- ------------
   <S>                                                  <C>         <C>
   Leasehold improvements..............................  $ 17,923     $ 22,867
   Furniture, fixtures and equipment...................    50,490       50,082
                                                         --------     --------
                                                           68,413       72,949
   Less accumulated depreciation and amortization......   (41,727)     (40,871)
                                                         --------     --------
                                                         $ 26,686     $ 32,078
                                                         ========     ========
</TABLE>
 
NOTE 5--IMPAIRMENT OF INTANGIBLE ASSETS
 
  As discussed in Note 15, the Company was sold to an unaffiliated group of
investors effective on October 10, 1996. The proceeds from the sale of
$1,300,000,000 were insufficient to recover the net asset value of the Company
on the date of the disposition, and were insufficient to repay the bank debt
and related accrued interest due to Credit Lyonnais (see Note 6). In
accordance with SFAS No. 121, the Company recorded a charge of $404,409,000 to
write off its remaining investment in the film distribution organization (see
Note 2) and a charge of $159,420,000 to reduce its investment in goodwill to
net realizable value during the period ended October 10, 1996.
 
NOTE 6--BANK AND OTHER DEBT
 
  Bank and other debt is summarized as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                       OCTOBER 10, DECEMBER 31,
                                                          1996         1996
                                                       ----------- ------------
   <S>                                                 <C>         <C>
   Senior Facility.................................... $  390,000   $  339,000
   CL Facility........................................    298,936      333,926
   Term Loan..........................................    539,760      539,504
   Capitalized lease obligations and other
    borrowings........................................        803        4,886
                                                       ----------   ----------
                                                       $1,229,499   $1,217,316
                                                       ==========   ==========
</TABLE>
 
  Senior Facility. On September 16, 1994, the Company obtained from a
syndicate of banks a $450,000,000 senior secured credit facility, as amended
(the "Senior Facility"). Borrowings under the Senior Facility bear interest at
2.25% over the three-month LIBOR (7.78% at October 10, 1996), subject to
adjustment under certain conditions. Borrowings outstanding under the Senior
Facility prior to extinguishment (see Note 15) as of October 10, 1996 were
$390,000,000.
 
  CL Facility. On September 14, 1994, the Company obtained a $400,000,000
credit facility (the "CL Facility") from Credit Lyonnais, a portion of which
was used to retire a previously outstanding $190,000,000 credit facility with
CLBN. Borrowings under the CL Facility bear interest at 0.25% over the three-
month LIBOR (5.78% at October 10, 1996). The principal amount outstanding at
October 10, 1996 prior to extinguishment (see Note 15) was $298,936,000.
 
  Term Loan. Prior to April, 1993, the Company was financed under two credit
facilities with CLBN (the "CLBN Facilities"). As of September 14, 1994, all of
the Company's outstanding borrowings under the CLBN Facilities, together with
accrued interest of $67,290,000, were converted into a term loan (the "Term
Loan"). The Term Loan bears interest at 0.25% over the three-month LIBOR
(5.78% at October 10, 1996). The principal amount outstanding at October 10,
1996 prior to extinguishment (see Note 15) was $539,760,000.
 
                                      72
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The Company's borrowings under the Senior Facility, the CL Facility and the
Term Loan are secured by all the assets of the Company. The security interests
under the CL Facility and the Term Loan are subordinate to the Senior
Facility. The Senior Facility contains various covenants including limitations
on dividends, capital expenditures and indebtedness, and the maintenance of
certain financial ratios.
 
  The Senior Facility, CL Facility and Term Loan aggregating $1,379,797,000,
including accrued interest, were extinguished on October 10, 1996 upon the
sale of the Company (see Notes 7 and 15). At that time, the Company obtained
$800,000,000 in Senior Secured Credit Facilities to partially finance the
acquisition of the Company and to provide for ongoing operations of the
Company.
 
  Lease and other borrowings. The capitalized lease obligations relate
principally to computer equipment financing at interest rates of approximately
10%.
 
  Maturity schedule. Credit facilities, lease and other borrowings are
scheduled to mature as follows (in thousands):
 
<TABLE>
      <S>                                                             <C>
      October 10, 1996............................................... $1,228,696
      December 31, 1996..............................................          6
      December 31, 1997..............................................        788
      December 31, 1998..............................................          9
                                                                      ----------
                                                                      $1,229,499
                                                                      ==========
</TABLE>
 
NOTE 7--STOCKHOLDER'S EQUITY
 
  Capital Contributions. Pursuant to the terms of the sale of the Company, the
proceeds from the transaction were insufficient to repay the entire bank debt
and accrued interest due to Credit Lyonnais as of October 10, 1996.
Accordingly, the deficit of $79,798,000 has been accounted for as a
contribution of capital from the parent in the accompanying financial
statements.
 
  Additionally, an affiliate of Credit Lyonnais has agreed to pay bonuses of
$19,641,000 to certain executives of the Company due upon the sale of the
Company (see Note 15). Accordingly, the Company has recorded compensation
expense and a corresponding contribution to capital of $9,641,000 during the
period ended October 10, 1996 and $10,000,000 during the year ended December
31, 1995, respectively.
 
  Upon commencement of the CL Facility in 1994 (see Note 6), CLBN agreed to
waive $16,794,000 in accrued interest charges on the Company's credit
facilities for the period from January 1, 1994 through September 14, 1994.
Accordingly, the Company has included this amount as a contribution to paid-in
capital in the consolidated financial statements.
 
NOTE 8--INCOME TAXES
 
  The Company's domestic and foreign tax liability balances consist of the
following (in thousands):
 
<TABLE>
<CAPTION>
                                                        OCTOBER 10, DECEMBER 31,
                                                           1996         1995
                                                        ----------- ------------
   <S>                                                  <C>         <C>
   Current.............................................   $27,313     $58,900
   Deferred............................................       --          --
                                                          -------     -------
                                                          $27,313     $58,900
                                                          =======     =======
</TABLE>
 
                                      73
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Prior to December 30, 1993, the assets and operations of the Company had
been held by MGM Group Holdings. On that date, pursuant to a financial
restructuring program approved by the Company's Board of Directors,
substantially all the assets and operations of MGM Group Holdings, other than
certain litigation claims and deferred tax assets, were transferred to the
Company. At the same time, the Company assumed all of the liabilities of MGM
Group Holdings other than (i) certain litigation liabilities; (ii) certain
deferred tax liabilities; and (iii) certain of the outstanding indebtedness of
MGM Group Holdings owing to General Bank Nederland N.V. (formerly Credit
Lyonnais Bank Nederland B.V. or "CLBN"), an affiliate of Credit Lyonnais.
Under the tax sharing agreement arising out of the restructuring, the Company
is deemed to have tax basis in the transferred assets and liabilities equal to
the book values at the date of the restructuring. The deferred tax liabilities
and assets for the temporary differences between book value and tax basis of
assets and liabilities transferred to the Company are recorded by MGM Group
Holdings.
 
  Pursuant to the tax sharing agreement, the Company computes its income tax
provision and corresponding deferred tax liabilities and assets, net of a
valuation allowance, on a separate tax return basis, modified as discussed
above with respect to the tax basis of assets transferred in the
restructuring, and further modified to reflect the allocation to the Company
of any tax benefits recognized by the consolidated filing group to the extent
that the Company's losses in the current period reduce the current or deferred
income taxes payable.
 
  Management believes certain of the Company's deferred tax assets are more
likely than not to be realized. For deferred tax assets which do not meet that
standard, a valuation allowance is applied. At October 10, 1996, management
has determined that $69,161,000 of deferred tax assets related to assets and
liabilities existing at the time of restructuring do not satisfy the
recognition criteria set forth in SFAS No. 109. Similarly, deferred tax assets
of $270,427,000 related to the period after the restructuring have been
determined not to satisfy the recognition criteria. Accordingly, a valuation
allowance has been recorded by the Company for these amounts.
 
  The tax effects of temporary differences between book value and tax bases of
assets and liabilities transferred to the Company in the restructuring (for
which the deferred tax benefits are recorded by MGM Group Holdings) are as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                        OCTOBER 10, DECEMBER 31,
                                                           1996         1995
                                                        ----------- ------------
   <S>                                                  <C>         <C>
   Deferred tax (assets):
     Film revenue......................................  $ (25,678)  $ (66,153)
     Reserves/investments..............................    (86,872)   (121,320)
     Participations and residuals payable..............     (6,208)     (8,174)
     Net miscellaneous assets..........................     (6,707)    (17,289)
                                                         ---------   ---------
       Subtotal gross tax (assets).....................   (125,465)   (212,936)
     Valuation allowance...............................     69,161      61,650
                                                         ---------   ---------
       Total tax (assets)..............................  $ (56,304)  $(151,286)
                                                         ---------   ---------
   Deferred tax liabilities:
     Film distribution system..........................  $     --    $ 161,321
     Film and television costs.........................     56,304      67,261
     Net miscellaneous liabilities.....................        --          --
                                                         ---------   ---------
       Total tax liabilities...........................  $  56,304   $ 228,582
                                                         ---------   ---------
   Net deferred tax liability..........................  $     --    $  77,296
                                                         =========   =========
</TABLE>
 
  The net operating loss carryforwards of MGM Group Holdings are in excess of
the net deferred tax liabilities for the temporary differences related to
assets and liabilities transferred to the Company.
 
                                      74
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The tax effects of temporary differences and carryforwards arising after the
restructuring date which give rise to deferred tax assets and liabilities for
1996 and 1995 are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                        OCTOBER 10, DECEMBER 31,
                                                           1996         1995
                                                        ----------- ------------
   <S>                                                  <C>         <C>
   Deferred tax (assets):
     Film and television costs.........................  $(109,302)  $ (33,526)
     Miscellaneous liabilities.........................    (53,425)    (36,185)
     Investment tax credit carryforwards...............    (12,836)    (16,575)
     Net operating loss carryforwards..................   (116,417)    (50,429)
                                                         ---------   ---------
       Subtotal gross tax (assets).....................   (291,980)   (136,715)
     Valuation allowance...............................    270,427      36,308
                                                         ---------   ---------
       Total tax (assets)..............................    (21,553)   (100,407)
   Deferred tax liabilities
     Film revenue......................................     17,153      96,007
                                                         ---------   ---------
       Total tax liabilities...........................     17,153      96,007
                                                         ---------   ---------
   Net deferred tax (asset)............................  $  (4,400)  $  (4,400)
                                                         =========   =========
</TABLE>
 
  Under the terms of the tax sharing agreement discussed above, the deductible
temporary differences of the Company which originate after the restructuring
date are available to be used against the deferred tax liability retained by
MGM Group Holdings.
 
  As of October 10, 1996, the Company and its subsidiaries had net operating
loss carryforwards of $268,888,000, capital loss carryforwards of $29,616,000
and investment tax credit carryforwards of $12,836,000, before adjustments for
the effect of the tax sharing agreement, which expire through 2010. These
carryforwards are available for use in the U.S. consolidated tax return group,
of which the Company is a member, and are subject to the tax sharing agreement
between the Company and MGM Group Holdings. A portion of these losses are
subject to substantial limitations on utilization because of various income
tax rules.
 
  Details of the provision for income taxes are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                         PERIOD ENDED  YEAR ENDED   YEAR ENDED
                                         OCTOBER 10,  DECEMBER 31, DECEMBER 31,
                                             1996         1995         1994
                                         ------------ ------------ ------------
   <S>                                   <C>          <C>          <C>
   Current taxes:
     Foreign taxes......................  $     273     $   935      $  8,277
   Deferred taxes:
     Federal and state taxes (benefit)..   (241,630)      1,997       (26,130)
     Adjustment for change in enacted
      tax rate..........................        --          --            --
     Adjustment for change in valuation
      allowance.........................    241,630      (1,997)       21,730
                                          ---------     -------      --------
       Total tax provision..............  $     273     $   935      $  3,877
                                          =========     =======      ========
</TABLE>
 
  Tax expense for 1994 reflects a $4,400,000 deferred tax benefit arising from
the carryforward and use by MGM Group Holdings of a portion of the Company's
current year net operating losses. As a result, the Company has recorded a
corresponding $4,400,000 receivable from MGM Group Holdings.
 
 
                                      75
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following is a summary reconciliation of the effective tax rate to the
assumed federal tax rate:
 
<TABLE>
<CAPTION>
                                         PERIOD ENDED  YEAR ENDED   YEAR ENDED
                                         OCTOBER 10,  DECEMBER 31, DECEMBER 31,
                                             1996         1995         1994
                                         ------------ ------------ ------------
   <S>                                   <C>          <C>          <C>
   Assumed federal tax rate on loss.....     (35)%        (35)%        (35)%
   Goodwill and other permanent differ-
    ences...............................       8 %          3 %          3 %
   Foreign taxes, net of available fed-
    eral tax benefit....................       1 %         (2)%          5 %
   Loss carryforward not benefited......      27 %         35 %         29 %
                                             ---          ---          ---
     Effective tax rate.................       1 %          1 %          2 %
                                             ===          ===          ===
</TABLE>
 
  The Company has various foreign subsidiaries formed or acquired to produce
or distribute motion pictures outside the United States. In the opinion of
management, the earnings of these subsidiaries are not permanently invested
outside the United States. Pursuant to APB 23, tax expense has accordingly
been provided for these unremitted earnings.
 
  Federal income tax returns for the periods ended through March 25, 1986 have
been examined by the Internal Revenue Service. In the opinion of management,
any adjustments which may result from the examination of subsequent periods
for which the Company is responsible will not have a material effect on
the Company's consolidated financial position or results of operations.
 
NOTE 9--RETIREMENT PLANS
 
  The Company has a non-contributory retirement plan (the "Basic Plan")
covering substantially all regular full-time, non-union employees. Benefits
are based on years of service and compensation, as defined.
 
  The following table summarizes the funded status of the Basic Plan (in
thousands):
 
<TABLE>
<CAPTION>
                                                        OCTOBER 10, DECEMBER 31,
                                                           1996         1995
                                                        ----------- ------------
   <S>                                                  <C>         <C>
   Actuarial present value of benefit obligations (in-
    cluding vested benefits of $6,880 and $7,348, re-
    spectively).......................................    $ 7,870     $ 8,030
                                                          =======     =======
   Projected benefit obligations......................    $ 9,182     $ 9,361
   Plan assets at fair value (primarily debt securi-
    ties).............................................      8,700       6,287
                                                          -------     -------
   Projected benefit obligations in excess of plan as-
    sets..............................................       (482)     (3,074)
   Unrecognized net asset as of beginning of year.....       (184)       (200)
   Unrecognized net (gain) loss.......................       (215)      1,359
   Unrecognized prior service cost....................       (181)       (191)
                                                          -------     -------
   Accrued pension liability..........................    $(1,062)    $(2,106)
                                                          =======     =======
</TABLE>
 
  Key assumptions used in the actuarial computations for the reported periods
were as follows:
 
<TABLE>
<CAPTION>
                                                                     1996  1995
                                                                     ----  ----
   <S>                                                               <C>   <C>
   Discount rate.................................................... 7.75% 7.00%
                                                                     ====  ====
   Long-term rate of return on assets............................... 7.25% 7.25%
                                                                     ====  ====
   Rate of increase in future compensation levels................... 5.00% 5.00%
                                                                     ====  ====
</TABLE>
 
  The unrecognized net asset is being amortized over the estimated remaining
service life of 19.4 years. Domestic pension benefits and expense were
determined under the entry age actuarial cost method.
 
                                      76
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Pension costs includes the following components (in thousands):
 
<TABLE>
<CAPTION>
                                         PERIOD ENDED  YEAR ENDED   YEAR ENDED
                                         OCTOBER 10,  DECEMBER 31, DECEMBER 31,
                                             1996         1995         1994
                                         ------------ ------------ ------------
   <S>                                   <C>          <C>          <C>
   Service cost.........................    $  854       $ 658        $ 805
   Interest cost on projected benefit
    obligation..........................       570         630          633
   Actual return on plan assets.........      (521)       (797)          24
   Net amortization and deferral........       148         329         (529)
                                            ------       -----        -----
   Net periodic pension cost............    $1,051       $ 820        $ 933
                                            ======       =====        =====
</TABLE>
 
  A significant number of the Company's production employees are covered by
union sponsored, collectively bargained multi-employer pension plans. The
Company contributed approximately $5,775,000, $11,950,000 and $6,521,000 in
1996, 1995 and 1994, respectively, for such plans. Information from the plans'
administrators is not sufficient to permit the Company to determine its share
of unfunded vested benefits, if any.
 
NOTE 10--RELATED PARTY TRANSACTIONS
 
  See Note 6 regarding the Company's credit arrangements with CLBN and Credit
Lyonnais (collectively, the "Bank").
 
  Interest of approximately $45,000,000, $58,000,000 and $36,000,000 was
charged by the Bank during the period ended October 10, 1996 and the years
ended December 31, 1995 and 1994, respectively. Of the total interest charged
during 1994, the Bank waived $16,794,000 representing interest on the
Company's credit facilities for the period from January 1, 1994 through
September 14, 1994 (see Note 7). Pursuant to the terms
of its credit facilities, the Company also paid to the Bank charges related to
letters of credit and other fees of approximately $19,000, $52,000 and
$278,000, respectively, during these periods.
 
  The Company has entered into various agreements to develop and produce
certain films and television programs with Hometown Films Inc., an entity
controlled by Mr. Frank Mancuso, Jr., who is a relative of the Company's
Chairman of the Board and Chief Executive Officer. Pursuant to these
agreements, the Company paid Hometown Films Inc., approximately $1,582,000
during the period from January 1, 1996 to October 10, 1996 and approximately
$633,000 and $444,000 for the years ended December 31, 1995 and 1994,
respectively. The agreements provide for additional producer fees and
potential profit participations to be paid in the future at terms consistent
with comparable development and production agreements with third parties.
 
  During the period ended October 10, 1996 and the years ended December 31,
1995 and 1994, the Company incurred legal fees of approximately $1,735,000,
$2,737,000 and $802,000, respectively, to White & Case, one of whose partners
is also a director of the Company.
 
NOTE 11--FOREIGN OPERATIONS AND EXPORT SALES
 
  The Company's foreign activities are principally motion picture and
television production and distribution in territories outside of the United
States and Canada. Net foreign assets and income from subsidiaries operating
in foreign countries are not material in relation to consolidated net assets
or consolidated net loss.
 
                                      77
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Foreign export revenues are revenues earned from motion picture and
television films produced in the United States. Export revenues for the period
ended October 10, 1996 and the years ended December 31, 1995 and 1994 were as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                          PERIOD ENDED  YEAR ENDED   YEAR ENDED
                                          OCTOBER 10,  DECEMBER 31, DECEMBER 31,
                                              1996         1995         1994
                                          ------------ ------------ ------------
   <S>                                    <C>          <C>          <C>
   Europe................................   $215,588     $223,830     $132,003
   Latin America.........................     24,066       29,882       18,745
   Other.................................    102,466       90,274       61,706
                                            --------     --------     --------
                                            $342,120     $343,986     $212,454
                                            ========     ========     ========
</TABLE>
 
NOTE 12--COMMITMENTS AND CONTINGENCIES
 
  Leases. The Company has operating leases for offices and equipment. Certain
property leases include provisions for increases over base year rents as well
as for escalation clauses for maintenance and other building operations. Rent
expense was approximately $8,500,000, $8,630,000 and $8,008,000 for the period
ended October 10, 1996 and the years ended December 31, 1995, and 1994,
respectively.
 
  Future minimum rental commitments under non-cancelable operating leases as
of October 10, 1996 are as follows (in thousands):
 
<TABLE>
<CAPTION>
            YEAR ENDING
            DECEMBER 31,
            ------------
            <S>                                   <C>
             1996................................ $ 2,624
             1997................................  10,242
             1998................................   6,666
             1999................................  10,808
             2000................................  11,314
             2001................................   7,437
             Thereafter..........................   9,813
                                                  -------
                                                  $58,904
                                                  =======
</TABLE>
 
  Employment Agreements. The Company has employment agreements with several
principal officers and employees. The agreements provide for minimum salary
levels as well as, in some cases, bonuses. In addition, the Company's
shareholder is obligated to pay bonuses to certain executives in the event the
value of the Company is eventually determined to exceed a defined amount.
Based on the sales price of the Company, as described in Note 14, this
incentive bonus amounted to $19,641,000. The Company has recorded compensation
expense and a corresponding contribution to capital of $9,641,000 for the
period ended October 10, 1996 and $10,000,000 for the year ended December 31,
1995. Certain executives are entitled to terminate their employment agreements
upon the sale of the Company.
 
  Creative Talent Agreements. The Company has entered into contractual
agreements for creative talent related to future film production which
aggregate approximately $9,449,000 at October 10, 1996. Such amounts are
scheduled to be paid through 1997.
 
  Litigation. The Company, together with other major companies in the filmed
entertainment industry, has been subject to numerous antitrust suits brought
by various motion picture exhibitors, producers and others. In addition,
various legal proceedings involving alleged breaches of contract, antitrust
violations, copyright infringement and other claims are now pending, which the
Company considers routine to its business activities.
 
                                      78
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  In the opinion of Company management, any liability under pending litigation
is not material in relation to the Company's results of operations.
 
NOTE 13--SUPPLEMENTARY CASH FLOW INFORMATION
 
  Total interest paid, net of capitalized interest, was $29,490,000 and
$15,416,000 in the period ended October 10, 1996 and the years ended December
31, 1995, respectively. No interest was paid in 1994. Income taxes paid were
$17,856,000, $5,140,000 and $5,164,000 in the period ended October 10, 1996
and the years ended December 31, 1995 and 1994, respectively.
 
  The Company recorded a non-cash contribution of capital of $9,641,000 during
the period ended October 10, 1996 and $10,000,000 during the year ended
December 31, 1995, respectively, from CDR due to the payment of compensation
expense (see Note 12).
 
NOTE 14--QUARTERLY FINANCIAL DATA (UNAUDITED)
 
  Certain quarterly information is presented below (in thousands):
 
<TABLE>
<CAPTION>
                               FIRST QUARTER OF              SECOND QUARTER OF
                         ------------------------------  ----------------------------
                           1996       1995      1994       1996      1995      1994
                         ---------  --------  ---------  --------  --------  --------
<S>                      <C>        <C>       <C>        <C>       <C>       <C>
Revenues................ $ 286,947  $156,804  $ 150,115  $308,185  $162,029  $106,613
Operating loss.......... $ (24,724) $(27,144) $ (17,926) $(25,086) $(29,562) $(44,197)
Interest expense, net... $  22,361  $ 13,014  $   5,699  $ 22,725  $ 15,256  $  6,600
Net loss................ $ (53,678) $(38,716) $ (25,347) $(49,874) $(45,814) $(50,787)
<CAPTION>
                               THIRD QUARTER OF                    FOURTH QUARTER OF
                         ------------------------------            ------------------
                           1996       1995      1994                 1995      1994
                         ---------  --------  ---------            --------  --------
<S>                      <C>        <C>       <C>        <C>       <C>       <C>
Revenues................ $ 317,574  $206,239  $ 139,572            $335,845  $200,821
Operating loss.......... $(626,759) $(27,114) $ (34,938)           $(18,540) $(38,524)
Interest expense, net... $  26,289  $ 17,281  $   9,378            $ 20,835  $ 12,183
Net loss................ $(641,486) $(46,048) $ (44,429)           $(28,731) $(50,689)
</TABLE>
 
  1996 Quarterly Results. The third quarter of 1996 includes the period from
July 1, 1996 to October 10, 1996, the date of the Acquisition. In the third
quarter of 1996, the Company recorded a charge of $563,829,000 to write off
its remaining investment in the film distribution organization and to reduce
its investment in goodwill to net realizable value (see Note 5).
 
  The 1994 and 1995 interim financial information was not reviewed by the
Company's independent accountants in accordance with standards established for
such review.
 
NOTE 15--SUBSEQUENT EVENT
 
  On October 10, 1996, CDR completed the sale of all of the Company's
outstanding stock to Metro-Goldwyn-Mayer Inc. (formerly P&F Acquisition Corp.)
an entity formed by Tracinda Corporation, Seven Network Limited and Mr. Frank
G. Mancuso, for $1,300,000,000. In connection with the sale of the Company,
Mr. Mancuso has entered into a new five year employment agreement to remain as
Chief Executive Officer and Chairman of the Board of Directors of the Company.
The acquisition price was financed with equity contributions of $900,000,000
and new bank debt of $400,000,000. The Company obtained $800,000,000 in Senior
Secured Credit Facilities to partially finance the acquisition of the Company
and to provide for ongoing operations of the Company. The Company's existing
bank debt, including the Senior Facility, the CL Facility and the Term Loan
(see Note 6), were extinguished upon the closing of the transaction. The
acquisition will be accounted for as a purchase.
 
                                      79
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Metro-Goldwyn-Mayer Inc.:
 
  We have audited in accordance with generally accepted auditing standards,
the financial statements of Metro-Goldwyn-Mayer Inc. included in this Report
on Form 10-K and have issued our report thereon dated February 26, 1998. Our
audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The accompanying schedules are the responsibility
of the Company's management and are presented for purposes of complying with
the Securities and Exchange Commission's rules and are not part of the basic
financial statements. These schedules have been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly state in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
 
                                       Arthur Andersen LLP
 
Los Angeles, California
February 26, 1998
 
                                      80
<PAGE>
 
         SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
                                 BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                      DECEMBER 31, DECEMBER 31,
                                                          1997         1996
                                                      ------------ ------------
<S>                                                   <C>          <C>
                       ASSETS
                       ------
Investments and advances to affiliates...............  $1,378,555   $1,323,756
Other assets.........................................         --        24,569
                                                       ----------   ----------
                                                       $1,378,555   $1,348,325
                                                       ==========   ==========
<CAPTION>
        LIABILITIES AND STOCKHOLDERS' EQUITY
        ------------------------------------
<S>                                                   <C>          <C>
Liabilities:
  Bank debt..........................................  $      --    $  443,750
  Accrued interest...................................         --         1,453
                                                       ----------   ----------
    Total liabilities................................         --       445,203
                                                       ----------   ----------
Commitments and contingencies
Stockholders' equity:
  Preferred Stock, $.01 par value, 25,000,000 shares
   authorized, 501,006 shares issued and outstanding
   at December 31, 1996..............................         --             5
  Common Stock, $.01 par value, 125,000,000 shares
   authorized, 65,765,655 and 16,700,342 shares
   issued and outstanding............................         658          167
  Additional paid-in capital.........................   1,504,850      901,639
  Retained earnings (deficit)........................    (127,948)         166
  Cumulative translation adjustment..................         995        1,145
                                                       ----------   ----------
    Stockholders' equity.............................   1,378,555      903,122
                                                       ----------   ----------
                                                       $1,378,555   $1,348,325
                                                       ==========   ==========
</TABLE>
 
 
  The accompanying Notes to Financial Statements are an integral part of these
                                  statements.
 
                                       81
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
                            STATEMENTS OF OPERATIONS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED  OCTOBER 11 TO
                                                      DECEMBER 31, DECEMBER 31,
                                                          1997         1996
                                                      ------------ -------------
<S>                                                   <C>          <C>
Revenues.............................................  $      --    $      --
Expenses:
  Equity in net (income) losses of subsidiaries......      94,760       (9,776)
  Interest expense, net..............................      33,354        9,610
                                                       ----------   ----------
    Total expenses...................................     128,114         (166)
                                                       ----------   ----------
Net income (loss)....................................    (128,114)  $      166
                                                       ==========   ==========
Basic and diluted earnings (loss) per share..........  $    (4.47)  $     0.01
                                                       ==========   ==========
Weighted average number of common and common
 equivalent shares outstanding.......................  28,634,362   16,692,217
                                                       ==========   ==========
</TABLE>
 
 
  The accompanying Notes to Financial Statements are an integral part of these
                                  statements.
 
                                       82
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
                            STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                      YEAR ENDED  OCTOBER 11 TO
                                                     DECEMBER 31, DECEMBER 31,
                                                         1997         1996
                                                     ------------ -------------
<S>                                                  <C>          <C>
Operating activities:
Net income (loss)..................................   $(128,114)   $       166
Adjustments to reconcile net income from operations
 to net cash provided by operating activities:
  Losses (gains) on equity investments, net........      94,760         (9,776)
  Amortization of debt issuance costs..............       3,934          1,068
  Increase (decrease) in accrued liabilities.......      (1,453)         1,453
                                                      ---------    -----------
    Net cash used by operating activities..........     (30,873)        (7,089)
                                                      ---------    -----------
Investing activities:
  Acquisition of MGM Studios Inc...................         --      (1,331,430)
  Acquisition of Orion Pictures Corporation........    (565,965)           --
                                                      ---------    -----------
    Net cash used in investing activities..........    (565,965)    (1,331,430)
                                                      ---------    -----------
Financing activities:
  Proceeds from issuance of preferred and common
   stock...........................................     603,697        901,811
  Proceeds from debt issuance......................         --         475,000
  Net bank repayments..............................    (443,750)       (31,417)
  Net intercompany advances (repayments)...........     436,891         (6,875)
                                                      ---------    -----------
    Net cash provided by financing activities......     596,838      1,338,519
                                                      ---------    -----------
Net change in cash and cash equivalents............         --             --
Cash and cash equivalents at beginning of period...         --             --
                                                      ---------    -----------
Cash and cash equivalents at end of the period.....   $     --     $       --
                                                      =========    ===========
</TABLE>
 
 
  The accompanying Notes to Financial Statements are an integral part of these
                                  statements.
 
                                       83
<PAGE>
 
                    METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               DECEMBER 31, 1997
 
NOTE 1--BASIS OF PRESENTATION
 
  The accompanying financial statements include the accounts of Metro-Goldwyn-
Mayer Inc. (formerly known as P&F Acquisition Corp.) ("MGM", or "the Company")
presented on a separate company (parent only) basis. MGM is a Delaware
corporation formed on July 10, 1996 specifically to acquire MGM Studios. The
acquisition of MGM Studios by MGM was completed on October 10, 1996 (see Notes
2), at which time MGM commenced principal operations. Prior to its acquisition
by MGM, MGM Studios was wholly owned by MGM Group Holdings Corporation, an
indirect wholly owned subsidiary of Consortium de Realisation ("CDR"). CDR is
a wholly owned subsidiary of Credit Lyonnais S.A. and is controlled by the
French State.
 
NOTE 2--BANK DEBT
 
  On October 15, 1997, MGM Studios entered into an amended and restated credit
facility with a syndicate of banks aggregating $1.3 billion (the "Amended
Credit Facility"). Concurrent with the Amended Credit Facility, MGM Studios
repaid $739,653,000 of bank debt and accrued interest on behalf of the
Company. For additional information regarding the Registrant's borrowings
under debt agreements and other borrowings, see Note 6 to the Consolidated
Financial Statements.
 
                                      84
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
          SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                             ADDITIONS
                                        -------------------
                             BALANCE AT CHARGED TO                      BALANCE
                             BEGINNING  COSTS AND                       AT END
                             OF PERIOD   EXPENSES  ACQUIRED DEDUCTIONS OF PERIOD
                             ---------- ---------- -------- ---------- ---------
<S>                          <C>        <C>        <C>      <C>        <C>
FOR THE YEAR ENDED
 DECEMBER 31, 1997:
Reserve for allowances and
 doubtful accounts.........   $11,730    $ 3,166   $13,600   $  (893)   $27,603
                              =======    =======   =======   =======    =======
FOR THE PERIOD FROM OCTOBER
 11, 1996 TO DECEMBER 31,
 1996:
Reserve for allowances and
 doubtful accounts.........   $12,718    $   (21)  $   --    $  (967)   $11,730
                              =======    =======   =======   =======    =======
FOR THE PERIOD FROM JANUARY
 1, 1996 TO
 OCTOBER 10, 1996:
Reserve for allowances and
 doubtful accounts.........   $18,479    $   430   $   --    $(6,191)   $12,718
                              =======    =======   =======   =======    =======
Reserve for home video
 inventory obsolescence,
 shrinkage, and
 reduplication.............   $ 1,769    $   --    $   --    $(1,769)   $   --
                              =======    =======   =======   =======    =======
FOR THE YEAR ENDED DECEMBER
 31, 1995:
Reserve for allowances and
 doubtful accounts.........   $26,059    $(2,565)  $   --    $(5,015)   $18,479
                              =======    =======   =======   =======    =======
Reserve for home video
 inventory obsolescence,
 shrinkage, and
 reduplication.............   $ 5,933    $   --    $   --    $(4,164)   $ 1,769
                              =======    =======   =======   =======    =======
FOR THE YEAR ENDED DECEMBER
 31, 1994:
Reserve for allowances and
 doubtful accounts.........   $26,276    $ 1,881   $   --    $(2,098)   $26,059
                              =======    =======   =======   =======    =======
Reserve for home video
 inventory obsolescence,
 shrinkage, and
 reduplication.............   $ 6,013    $   --    $   --    $   (80)   $ 5,933
                              =======    =======   =======   =======    =======
</TABLE>
 
                                       85
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            DOCUMENT DESCRIPTION
 -------                           --------------------
 <C>      <S>
  2.1(2)  Stock Purchase Agreement, dated as of July 16, 1996, by and among the
           Company, CDR, MGM Holdings Corporation, MGM Group Holdings
           Corporation and MGM Studios (f/k/a Metro-Goldwyn-Mayer Inc.)*
  2.2(2)  Stock Purchase Agreement, dated as of May 2, 1997, by and among the
           Company, Orion and Metromedia International Group, Inc. ("MIG")*
  2.3(2)  Agreement and Plan of Merger, dated as of January 31, 1996, by and
           among MIG, SGC Merger Corp. and the Samuel Goldwyn Company (the
           "Goldwyn Merger Agreement")*
  2.4(2)  Amendment No. 1 to Goldwyn Merger Agreement dated as of May 29, 1996
  2.5(2)  Amendment and Restated Plan of Merger, dated as of May 17, 1996,
           between MIG, MPCA Merger Corp., Bradley Krevoy, Steven Stabler and
           the Motion Picture Corporation of America*
  3.1(2)  Amended and Restated Certificate of Incorporation of the Company
  3.2(2)  Amended and Restated Bylaws of the Company
 10.1(2)  Credit Agreement, dated as of October 10, 1996, among the Company,
           MGM Studios, certain lenders and Morgan, as agent*
 10.2(2)  Credit Agreement, dated as of July 10, 1997, among Orion, certain
           lenders and Morgan Guaranty Trust Company of New York ("Morgan"), as
           agent*
 10.3(2)  Amended and Restated Credit Agreement, dated as of October 15, 1997,
           among the Company, MGM Studios, Orion, certain lenders, Morgan, as
           agent and Bank of America, as syndication agent*
 10.4(2)  Form of Modification and Cancellation Agreement, dated as of November
           5, 1997
 10.5(2)  Amended and Restated 1996 Stock Incentive Plan dated November 12,
           1997 and form of related Stock Option Agreement
 10.6(2)  Senior Management Bonus Plan dated as of November 12, 1997 and form
           of related Bonus Interest Agreement
 10.7(2)  Form of Amended and Restated Employment Agreement of Frank G. Mancuso
           dated as of August 4, 1997
 10.8(2)  Employment Agreement of A. Robert Pisano dated as of October 10, 1996
 10.9(2)  Employment Agreement of Michael G. Corrigan dated as of July 1, 1997
 10.10(2) Employment Agreement of David G. Johnson dated as of October 10, 1996
 10.11(2) Employment Agreement of William A. Jones dated as of October 10, 1996
 10.12(2) Indemnification Agreement dated as of October 10, 1996--Frank G.
           Mancuso
 10.13(2) Indemnification Agreement dated as of October 10, 1996--A. Robert
           Pisano
 10.14(2) Form of Indemnification Agreement dated as of July 1, 1997--Michael
           G. Corrigan
 10.15(2) Indemnification Agreement dated as of October 10, 1996--David G.
           Johnson
 10.16(2) Indemnification Agreement dated as of October 10, 1996--William A.
           Jones
 10.17(2) Indemnification Agreement dated as of October 10, 1996--James D.
           Aljian
 10.18(2) Indemnification Agreement dated as of October 10, 1996--Michael R.
           Gleason
 10.19(2) Indemnification Agreement dated as of October 10, 1996--Kirk
           Kerkorian
 10.20(2) Indemnification Agreement dated as of October 10, 1996--Kerry M.
           Stokes
 10.21(2) Indemnification Agreement dated as of October 10, 1996--Jerome B.
           York
 10.22(1) Indemnification Agreement dated as of November 7, 1997--Alex
           Yemenidjian
</TABLE>
 
                                       86
<PAGE>
 
                           EXHIBIT INDEX--(CONTINUED)
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            DOCUMENT DESCRIPTION
 -------                           --------------------
 <C>      <S>
 10.23(1) Indemnification Agreement dated as of January 28, 1998--Francis Ford
           Coppola
 10.24(2) Amended and Restated Supplemental Executive Retirement Agreement
           dated as of July 18, 1997--A. Robert Pisano
 10.25(2) Form of Amended and Restated Shareholders Agreement dated as of
           August 4, 1997
 10.26(2) Form of Amended and Restated Investors Shareholder Agreement dated as
           of August 4, 1997
 10.27(2) Form of Amended and Restated Stock Option Agreement between the
           Company and Tracinda
 10.28(2) Form of Amended and Restated Stock Option Agreement between the
           Company and Celsus Financial Corp.
 10.29(2) Form of Inducement Agreement dated as of November 5, 1997*
 10.30(2) Form of Investment Agreement dated November 12, 1997 between the
           Company and Tracinda
 21.1(1)  List of Subsidiaries of Metro-Goldwyn-Mayer Inc.
 27.1(1)  Financial Data Schedule
</TABLE>
--------
 * Filed without Schedules.
 
(1) Filed herewith.
 
(2) Filed as an exhibit to the Company's Registration Statement on Form S-1, as
    amended (File No. 333-35411) and incorporated herein by reference.
 
 
                                       87