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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, 1998
 
                          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.)
</TABLE>
 
<TABLE>
<S>                                            <C>
   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:
 
<TABLE>
<S>                                            <C>
                                                           Name of each exchange
             Title of each class                            on which registered
             -------------------                           ---------------------
        Common Stock, par value $0.01                     New York Stock Exchange
</TABLE>
 
       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 19, 1999 was $172,604,534.
 
  The number of shares of the Registrant's common stock outstanding as of
March 19, 1999 was 150,873,728.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Certain portions of Registrant's proxy statement for the annual meeting to
be held on May 11, 1999 (the "Proxy Statement"), to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the close of the Registrant's fiscal year, are incorporated by
reference under Part III of this Form 10-K.
 
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                                    PART I
 
Item 1. Business
 
General
 
  Metro-Goldwyn-Mayer Inc., a Delaware corporation (together, unless the
context indicates otherwise, with its direct and indirect subsidiaries, "MGM"
or the "Company"), is an entertainment company that is engaged primarily in
the development, production and worldwide distribution of theatrical motion
pictures and television programs. The Company, including Metro-Goldwyn-Mayer
Studios Inc. ("MGM Studios"), United Artists Corporation ("UA"), Orion
Pictures Corporation ("Orion"), G2 Films Inc. (formerly known as Goldwyn Films
Inc.) ("G2 Films") and its other subsidiaries, is one of only seven major film
and television studios worldwide. With over 5,000 film titles and over 8,900
episodes of television programming, the Company's library (the "Library")
constitutes the largest collection of feature films in the world. Motion
pictures in the Library have won over 215 Academy Awards, including Best
Picture Awards for Annie Hall, The Apartment, The Best Years of Our Lives,
Dances With Wolves, Hamlet, In the Heat of the Night, Marty, Midnight Cowboy,
Platoon, Rain Man, Rocky, Silence of the Lambs, Tom Jones and West Side Story.
The Library also includes 20 titles in the James Bond film franchise, five
titles in the Rocky film franchise and nine titles in the Pink Panther film
franchise. The Company is currently celebrating its 75th anniversary.
 
  MGM's executive offices are located at 2500 Broadway Street, Santa Monica,
California 90404. The Company's telephone number is (310) 449-3000.
 
Background of the Company
 
  Metro-Goldwyn-Mayer ("Old MGM") was established in 1924 through the merger
of Metro Pictures, Goldwyn Pictures and Louis B. Mayer Productions. A
corporation wholly owned by Kirk Kerkorian became Old MGM's controlling
shareholder in 1969. In 1981 Old MGM acquired UA, which had been formed in
1919 when Mary Pickford, Douglas Fairbanks, D.W. Griffith and Charlie Chaplin
joined forces to release their own motion pictures, as well as motion pictures
made by independent producers. In 1986 Turner Broadcasting System, Inc.
("Turner") acquired the businesses of Old MGM, and as part of that
transaction, Tracinda Corporation ("Tracinda") and certain of the former
stockholders of Old MGM concurrently acquired UA, including the UA library,
from Old MGM. Shortly thereafter, UA reacquired the Metro-Goldwyn-Mayer name
and logo and certain other assets from Turner. UA was then renamed MGM/UA
Communications Co. ("MGM/UA"). Turner retained the film library created
through the pre-1986 operations of Old MGM (the "Old MGM Library").
 
  In November 1990 MGM/UA was acquired by Pathe Communications Corporation
("Pathe") and was renamed MGM-Pathe Communications Co. ("MGM-Pathe"), the
predecessor to MGM Studios. In May 1992 Credit Lyonnais Bank Nederland N.V.
("CLBN"), Pathe's principal lender, foreclosed on substantially all of the
stock of MGM-Pathe, following default by Pathe, and such stock was ultimately
transferred to Consortium de Realisation ("CDR"), a wholly owned subsidiary of
Credit Lyonnais S. A. ("CL").
 
  In July 1993 Frank G. Mancuso was appointed as Chairman and Chief Executive
Officer of MGM Studios. In January 1996 CDR announced its intention to sell
MGM Studios.
 
  Tracinda, senior management of MGM Studios and Seven Network Limited, a
company formed under the laws of Australia ("Seven"), formed the Company to
acquire all of the outstanding capital stock of MGM Studios and its
subsidiaries, including UA, in October 1996 for an aggregate consideration of
$1.3 billion (the "MGM Acquisition"). Tracinda is wholly-owned by Mr.
Kerkorian.
 
  In July 1997 the Company acquired all of the outstanding capital stock of
Orion and its subsidiaries (the "Orion Companies"), including the entity
formerly known as The Samuel Goldwyn Company ("Goldwyn") and now known as G2
Films, from Metromedia International Group, Inc. (the "Orion Acquisition"). In
connection with the Orion Acquisition, the Company obtained the film and
television libraries of the Orion
 
                                       2
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Companies consisting of approximately 1,900 film titles and 3,000 television
episodes. The Landmark Theatres owned by the Orion Companies were excluded
from the Orion Acquisition.
 
  In November 1997 the Company completed an initial public offering, whereby
it issued and sold 9,000,000 new shares of common stock, $.01 par value per
share (the "Common Stock") at a price per share of $20, less an underwriting
discount, for net proceeds (after expenses of the initial public offering) to
the Company of $165 million (the "IPO"). Concurrent with the consummation of
the IPO, Tracinda purchased directly from the Company, at a purchase price of
$18.85 per share (equal to the per share price to the public in the IPO, less
the underwriting discount), 3,978,780 shares of the Common Stock for an
aggregate purchase price of $75 million (the "Tracinda Purchase").
 
  On September 1, 1998, Tracinda and a Delaware corporation that is
principally owned by Tracinda (collectively, the "Tracinda Group") purchased
16,208,463 shares of the Common Stock from Seven, representing all of the
capital stock of the Company held by Seven, for a price per share of $24 and
an aggregate purchase price of $389 million.
 
  In November 1998 the Company completed a rights offering (the "Rights
Offering"), whereby it issued and sold 84,848,485 new shares of the Common
Stock at a subscription price of $8.25 per share for net proceeds (after
expenses of the Rights Offering) to the Company of $696.5 million. After
giving effect to the completion of the Rights Offering and the exercise of the
subscription rights distributed in connection therewith, the Tracinda Group
continued to beneficially own approximately 89.5 percent of the outstanding
Common Stock. In connection with the Rights Offering, the Company amended its
Amended and Restated Certificate of Incorporation to increase the number of
shares of the Common Stock authorized thereunder from 125,000,000 to
250,000,000. See "Item 4. Submission of Matters to a Vote of Securityholders."
 
  In January 1999 the Company acquired from PolyGram N.V. and its subsidiaries
("PolyGram") certain film libraries and film-related rights (the "PFE
Libraries") for consideration of $235 million (the "PFE Library Acquisition").
The PFE Libraries contain over 1,300 feature films and are comprised of (i)
the Epic library, which consists of approximately 1,000 film titles acquired
between 1992 and 1997 by CLBN and CDR from various filmed entertainment
companies, (ii) the library of films released by PolyGram before March 31,
1996 and (iii) the Island/Atlantic and Vision/Palace libraries, which were
acquired by PolyGram. After giving effect to the PFE Library Acquisition, the
Library currently contains over 5,000 film titles and over 8,900 episodes of
television programming.
 
  On March 12, 1999, the Company and Warner Home Video ("WHV") entered into an
agreement that terminates WHV's distribution of the Company's product in the
home video markets on January 31, 2000. In connection with such agreement, the
Company agreed to pay WHV $225 million, $112.5 million of which was paid on
March 12, 1999 and the remaining $112.5 million (plus interest at a rate of
eight percent per annum from March 1999) of which is payable in September
1999. For a further discussion, see "--Distribution--Home Video Distribution."
 
The Motion Picture and Television Industry
 
  Motion Pictures--General. The motion picture industry consists of two
principal activities: production and distribution. Production involves the
development, financing and production of feature-length motion pictures.
Distribution involves the promotion and exploitation of motion pictures
throughout the world in a variety of media, including theatrical exhibition,
home video, television and other ancillary markets. The U.S. motion picture
industry can be divided into major studios and independent companies, with the
major studios dominating the industry in the number of theatrical releases. In
addition to the Company (including Metro-Goldwyn-Mayer-Pictures Inc. ("MGM
Pictures"), United Artists Pictures Inc. ("UA Pictures"), Orion and G2 Films),
the major studios as defined by the Motion Picture Association of America
("MPAA") are The Walt Disney Company (including Buena Vista, Touchstone and
Miramax) ("Walt Disney"), Paramount Pictures Corporation ("Paramount"), Sony
Pictures Entertainment, Inc. (including Columbia (as defined below)) ("Sony
Pictures"),
 
                                       3
<PAGE>
 
Twentieth Century Fox Film Corp. ("Fox"), Universal Studios, Inc.
("Universal"), and Warner Bros. (including Turner, New Line Cinema and Castle
Rock Entertainment) ("Warner"). The major studios are typically large
diversified corporations that have strong relationships with creative talent,
exhibitors and others involved in the entertainment industry and have global
film production and distribution capabilities.
 
  Historically, the major studios have produced and distributed the majority
of high grossing theatrical motion pictures released annually in the United
States. Over the past decade, the number of feature-length motion pictures
released by the major studios has increased dramatically from 157 in 1989
(34.3 percent of the total) to 221 in 1998 (45.1 percent of the total). In
addition, most of the studios have created or accumulated substantial and
valuable motion picture libraries that generate significant revenues. These
revenues can provide the major studios with a stable source of earnings that
offsets the variations in the financial performance of their motion picture
releases and other aspects of their motion picture operations.
 
  The independent companies generally have more limited production and
distribution capabilities than do the major studios. While certain independent
companies may produce as many films as a major studio in any year, independent
motion pictures typically have lower negative costs and are not as widely
released as motion pictures produced and distributed by the major studios.
Additionally, the independent companies may have limited or no internal
distribution organizations and may rely on the major studios for distribution
and financing.
 
  Motion Picture Production. The production of a motion picture begins with
the screenplay adaptation of a popular novel or other literary work acquired
by the producer of the motion picture or the development of an original
screenplay based upon a story line or scenario conceived or acquired by the
producer. In the development phase, the producer may seek production financing
and tentative commitments from a director, the principal cast members and
other creative personnel. A proposed production schedule and budget are
prepared. At the end of this phase, the decision is made whether or not to
"greenlight," or approve for production, the motion picture.
 
  After greenlighting, pre-production of the motion picture begins. In this
phase, the producer engages creative personnel to the extent not previously
committed, finalizes the filming schedule and production budget, obtains
insurance and secures completion guaranties, if necessary. Moreover, the
producer establishes filming locations, secures any necessary studio
facilities and stages and prepares for the start of actual filming.
 
  Principal photography, or the actual filming of the screenplay, generally
extends from seven to 16 weeks, depending upon such factors as budget,
location, weather and complications inherent in the screenplay. Following
completion of principal photography, the motion picture enters what is
typically referred to as post-production. In this phase, the motion picture is
edited, opticals, dialogue, music and any special effects are added, and
voice, effects and music soundtracks and pictures are synchronized. This
results in the production of the negative from which release prints of the
motion picture are made. Major studios and independent film companies hire
editors, composers and special effects technicians on the basis of their
suitability for a particular picture.
 
  The production and marketing of theatrical motion pictures requires
substantial capital. The costs of producing and marketing motion pictures have
increased substantially in recent years. These costs may continue to increase
in the future, thereby increasing the costs to the Company of its motion
pictures. Production costs and marketing costs are rising at a faster rate
than increases in either domestic admissions to movie theaters or admission
ticket prices, leaving the Company and all producers of motion pictures more
dependent on other media, such as home video and television, and foreign
markets.
 
  Motion Picture Distribution. The distribution of a motion picture involves
the licensing of the picture for distribution or exploitation in various
markets, both domestically and internationally, pursuant to a release pattern.
These markets include theatrical exhibition, non-theatrical exhibition (which
includes airlines, hotels and armed forces facilities), home video (including
rental and sell-through), presentation on television (including pay-per-view,
pay, network, syndication or basic cable) and marketing of the other rights in
the picture and
 
                                       4
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underlying literary property, which may include publishing, merchandising and
soundtracks. The domestic and international markets generally follow the same
release pattern, with the starting date of the release in the international
market varying from being concurrent with the domestic theatrical release to
being as long as nine months afterwards. A motion picture typically is
distributed by a major studio or one or more distributors that acquire rights
from a studio or other producer in one or more markets or media or a
combination of the foregoing.
 
  Both major studios and independent film companies often acquire pictures for
distribution through a customary industry arrangement known as a "negative
pickup," under which the studio or independent film company agrees to acquire
from a production company all rights to a film upon completion of production,
and also acquire completed films, as well as all associated obligations.
 
  Television Production. The production of television series programming
involves the development of a format based on a creative concept or literary
property into a television script, the hiring of talent, the filming or taping
of the program and the technical and post-production work necessary to produce
a finished program. Television producers may originate projects internally or
acquire them from others. If a concept is deemed suitable for development, the
studio or other producer or network typically commissions and pays for a
script. Once a script is ordered, one or more license agreements are
negotiated with the potential broadcasters of such program. A pilot episode
usually is ordered or commissioned prior to the determination of whether a
series will be produced.
 
  Television production can generally be divided into two distinct businesses:
network production (i.e., television shows for ABC, CBS, NBC, Fox, UPN and WB)
and non-network production (i.e., made-for-cable and first-run syndication).
The economics of the two types of television production are different. In
network production, a network generally orders approximately six to 13 initial
episodes of each new series for a license fee equal to a percentage of the
program's cost. The balance of the production cost can only be recouped
through international sales and syndication if a series is successful and
generally remains unrecouped for at least four years. In the non-network
production or first-run syndication business, a producer seeking to launch a
new series commits to produce a minimum number of episodes if the producer can
"clear" the series by selling to individual television stations in sufficient
markets throughout the country (generally comprising 70 percent of U.S.
television households). Once produced, the episodes are immediately available
for licensing to international broadcasters as well. This approach generally
involves a lower production cost risk and earlier return on investment ("ROI")
than the network production business; however, non-network programming also
generally provides a lower ROI than successful network production. See "--
Production--Television Production."
 
  Television Distribution. The U.S. television market is served by network
affiliated stations, independent stations and cable systems, although the
number of independent stations has decreased as many formerly independent
stations have become affiliated with new networks in recent years. During
"prime time" hours, network affiliates primarily broadcast programming
produced for the network. In non-prime time, network affiliates telecast
network programming, off-network programming, first-run programming
(programming produced for distribution on a syndicated basis) and programming
produced by the local stations themselves. Independent television stations and
cable networks, during both prime and non-prime time, produce their own
programs and telecast off-network programs or first-run programs acquired from
independent producers or syndicators. Syndicators generally are companies that
sell to independent television stations and network affiliates programming
produced or acquired by the syndicator for distribution.
 
Business Strategy
 
  The Company is a premier global entertainment content company. The Company's
goal is to become a fully integrated global entertainment company and thereby
maximize the value of its assets, including the Library and its film and
television production units. To achieve this goal, the Company seeks to:
 
  Build and Leverage the Library. The Company believes that the Library is its
most powerful asset and that the Library will continue to generate relatively
stable cash flows through the worldwide distribution of its
 
                                       5
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titles. Management seeks to maximize the value of the Library by (i) producing
new motion pictures and television programs that will not only be successful
on their own, but will also increase the depth and breadth of the Library,
(ii) aggressively marketing and repackaging the Library's titles, (iii)
developing new distribution channels for delivering MGM branded programming,
(iv) capitalizing on developments in technology and (v) further penetrating
international markets as they grow. As opportunities arise, the Company may
acquire or form partnerships for new distribution channels for the Library.
Although the Company does not currently contemplate pursuing any library
acquisitions following its acquisition of the Orion library and the PFE
Libraries, the Company may elect to evaluate such opportunities as they arise.
Finally, the Company expects to the benefit from the early termination of
WHV's distribution of the Company's product in the home video markets, as well
as the reversion over time of certain rights to its Library that have been
previously licensed to others revert to the Company over time. See "--
Distribution."
 
  Develop, Produce and Distribute Theatrical Motion Pictures. Through MGM
Pictures and UA Pictures, the Company plans to produce or co-produce and
distribute six to ten motion pictures annually across a variety of genres. The
Company intends to (i) actively manage its production and release schedules to
maximize overall performance of those motion pictures, (ii) tightly control
development and production expenditures while maintaining the artistic
integrity required to develop and produce successful feature films and (iii)
utilize the Library as an inexpensive source for sequels and remakes and the
expansion of certain well-tested, familiar film franchises. Additionally, the
Company plans to produce, acquire or distribute approximately two to four
specialty motion pictures annually through G2 Films. The Company may also
distribute motion pictures produced by others.
 
  Develop, Produce and Distribute Television Programming. The Company intends
to focus primarily on the development and production of series for pay
television and the first-run syndication business and intends to use its
extensive Library as a source of ideas. Under its non-network television
programming strategy, the Company generally has been able to enter into
contracts during or shortly after completion of production of a series that
provide for the recovery over time of substantially all production costs for
the series. In addition to non-network television programming, the Company
also develops programs such as two-hour television movies and mini-series and
recently produced a series for network television, The Magnificent Seven. The
Company may also consider joint ventures, co-productions and other partnering
arrangements for certain of its series. See "--Production--Television
Production."
 
  Leverage the MGM Brand Name. The Company believes that the MGM name and its
lion logo are among the most recognized in the world. The Company intends to
capitalize on the value inherent in its name and logo through the distribution
of branded programming and the selective development of high quality consumer
products.
 
  The Company intends to continue to pursue its goal of becoming an integrated
global entertainment company. In connection with its pursuit of this goal, the
Company may consider various strategic alternatives, such as business
combinations with companies with strengths complementary to those of the
Company and other acquisitions, as such opportunities arise. The Company may
need to seek additional financing in order to complete any acquisitions.
Acquisitions involve numerous risks, including diversion of management's
attention away from the Company's operating activities. There can be no
assurance that the Company will not encounter unanticipated problems or
liabilities with respect to any acquisitions that have been or may be
completed by the Company or with the integration of an acquired company's
operations with those of the Company, and there can be no assurance that the
anticipated benefits of any acquisitions that have been or will be completed
by the Company will be achieved.
 
Film and Television Library
 
  With the completion of the PFE Library Acquisition in January 1999, the
Library became the largest motion picture library in the world. The Company
currently owns or holds certain distribution rights to over 5,000 theatrical
motion pictures. The Library also contains over half of all Hollywood studio
feature films produced
 
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since 1948. In 1948, certain major studios negotiated consent decrees
requiring that the studios separate their exhibition businesses from their
production and distribution businesses and mandating the divestiture of
certain theater holdings. This is generally believed to have triggered greater
competition among the studios and an increased emphasis on the potential for
commercial success in the development and production stages, resulting in a
greater focus on the content and quality of the motion pictures produced and
distributed by the studios. The Company believes that films produced and
developed after 1948 generally are more valuable than films that were
previously produced and developed.
 
  In addition to being the largest motion picture library in the world, the
Library is also one of the most critically acclaimed libraries in the motion
picture industry, representing one of the largest collections of Academy
Award-winning films. The motion pictures in the Company's Library have won
over 215 Academy Awards. Fourteen motion pictures in the Library have won the
Academy Award for Best Picture, including Annie Hall, The Apartment, The Best
Years of Our Lives, Dances With Wolves, Hamlet, In the Heat of the Night,
Marty, Midnight Cowboy, Platoon, Rain Man, Rocky, Silence of the Lambs, Tom
Jones and West Side Story.
 
  The Library also includes over 8,900 episodes from television series
previously broadcast on prime-time network television or in first-run
syndication, including episodes of The Addams Family, American Gladiators, Bat
Masterson, Cagney & Lacey, Fame, Green Acres, Highway Patrol, In the Heat of
the Night, Mr. Ed, The Patty Duke Show, Pink Panther, Sea Hunt and
thirtysomething. The television series in the Library have won, among others,
59 Emmy awards and nine Golden Globe awards.
 
  The Library includes titles from a wide range of genres, including dramas,
comedies, action-adventure movies, westerns and suspense thrillers. Management
believes that the Library's diversity, quality and extensive size provides the
Company with substantial competitive advantages. The Company seeks to continue
to build upon these advantages by producing and acquiring new motion pictures
across a variety of genres and budget ranges to update and enhance the
Library. See "--Production--Motion Picture Production."
 
  The Company will continue to implement its strategy of developing new
projects from existing Library assets. The Library represents a readily-
available, "market tested" source of development ideas. For example, the
Company had success with the film The Birdcage, a remake of La Cage aux
Folles, and plans to release a remake of another of its Library titles, The
Thomas Crown Affair, in June 1999. Furthermore, the Company has successfully
expanded the valuable film franchises within its Library, most notably the
James Bond franchise, with the commercial success of GoldenEye in 1995 and the
release of the latest James Bond film, Tomorrow Never Dies, in December 1997.
Tomorrow Never Dies has earned greater domestic box office receipts than any
other film in the James Bond film franchise. Additionally, the Company has
successfully developed television series based on Library motion pictures such
as: The Magnificent Seven based on the movie of the same name; Poltergeist:
The Legacy based on Poltergeist; Stargate SG-1 based on Stargate; and All Dogs
Go to Heaven, based on the movie of the same name. The Company also produced a
remake of Twelve Angry Men as a made-for-television movie for Showtime
Networks Inc. ("Showtime").
 
  The Company, together with Danjaq LLC (collectively with its predecessors,
"Danjaq"), is the sole owner of all of the James Bond motion pictures.
Eighteen James Bond motion pictures in the Library, in addition to the
upcoming release The World Is Not Enough, are produced and distributed
pursuant to a series of agreements with Danjaq. The motion pictures are
produced by Danjaq, and the Company has the right to approve all key elements
of the pictures, such as the selection of the director and the leading actors.
The copyright in each of the motion pictures is owned jointly by the Company
and Danjaq. Generally, the Company has the right to distribute each of the
pictures in all media worldwide in perpetuity or for a term of 15 years. Where
the Company's distribution rights are not perpetual, the rights revert to
joint control by the Company and Danjaq after expiration of the distribution
term. Danjaq owns any television series created that is based on the James
Bond motion pictures, and the Company has the distribution rights to such
series. Danjaq controls the merchandising rights with respect to the pictures,
with the Company being entitled to receive a portion of the revenues from all
merchandising licenses. Additionally, the Company controls all the marketing
rights and the music from The Living Daylights (1987) and all subsequent
pictures. All other rights relating to the pictures are controlled jointly by
the Company and Danjaq. The agreements contain certain restrictions on the
sale or licensing by the Company of any of its rights in the pictures.
 
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  Additionally, two James Bond motion pictures had previously been produced by
other parties. In 1967 Columbia Pictures Industries, Inc. ("Columbia") and
Famous Artists Productions Ltd. (a subsidiary of the Company) produced Casino
Royale pursuant to an earlier license from Ian Fleming and in 1983, Warner and
Taliafilm, Inc. produced Never Say Never Again. In 1998 the Company acquired
the rights to Never Say Never Again and, as more fully set forth below, the
Company and Danjaq recently acquired the rights to Casino Royale. With these
two acquisitions the Library now contains every James Bond motion picture ever
made and the Company is the only studio to hold such rights.
 
  On October 13, 1997, Sony Pictures issued a press release announcing plans
by its Columbia Pictures division to produce a series of new James Bond
feature films based on works created by Ian Fleming, Kevin McClory and John
Whittingham. On November 17, 1997, the Company and Danjaq filed an action in
federal court in Los Angeles against Sony Corporation, Sony Pictures,
Columbia, John Calley, Kevin McClory and Spectre Associates, Inc. ("Spectre")
seeking declaratory and injunctive relief and/or damages for copyright
infringement, trademark dilution, slander of title, unfair competition,
inducing breach of contract and breach of fiduciary duties, and
misappropriation of trade secrets. On January 23, 1998, the Company and Danjaq
filed an amended complaint adding claims for trademark infringement, federal
unfair competition and California trademark dilution. Among other things, the
Company and Danjaq contend not only that Mr. McClory's rights were limited to
remaking Thunderball but that even those rights have expired under U.S. law
pursuant to the doctrine of Stewart v. Abend, 495 U.S. 207 (1990), and that
the rights during the current term of the copyright to make films using the
James Bond character and other aspects of Ian Fleming's James Bond novels were
acquired by Danjaq. The Company and Danjaq now co-own most of these rights. On
May 19, 1998, the Company and Danjaq filed a motion for preliminary injunction
on the copyright and trademark issues to preclude Sony Pictures from
preparation, production, distribution, advertising or other exploitation of a
James Bond motion picture. On July 29, 1998, that motion was granted and Sony
Pictures, Columbia and the other defendants were preliminarily enjoined from
the production, preparation, distribution, advertising or other exploitation
in the United States of a James Bond motion picture in any medium and from
using the "James Bond" and the "James Bond 007" trademarks in the United
States. The defendants appealed the District Court's order granting the
preliminary injunction to the United States Court of Appeals for the Ninth
Circuit. On December 2, 1998, the Ninth Circuit affirmed the District Court's
order granting the preliminary injunction. Thereafter, defendants filed a
petition for rehearing en banc, which was denied by a three-judge panel of the
Ninth Circuit on December 28, 1998. On March 29, 1999, the Company and Danjaq
entered into a settlement agreement with Sony Pictures, Columbia and Mr.
Calley (the "Sony Parties") that provided for a payment by the Sony Parties
and pursuant to which the Sony Parties entered into an agreement which
effectively makes permanent the court's July 1998 preliminary injunction.
Specifically, the Sony Parties agreed (i) not to make or distribute any James
Bond motion pictures in the United States based on Thunderball or any other
purported rights deriving from Mr. McClory, and (ii) not to utilize the "James
Bond" and the "James Bond 007" trademarks in the United States. Mr. McClory
and Spectre did not participate in this settlement agreement. The Sony Parties
have reassigned their counterclaims for copyright infringement to Mr. McClory,
and the court has set a status conference for May 3, 1999 to allow Mr. McClory
time to inform the court whether or not he wishes to pursue that claim. See
"Item 3. Legal Proceedings."
 
  Under the terms of a separate agreement entered into on March 29, 1999, the
Company and Danjaq acquired from Columbia all of Columbia's rights to the 1967
James Bond film entitled Casino Royale and the Sony Parties agreed to broaden
the contractual prohibition regarding making or distributing James Bond films
and the James Bond trademarks, as described in the prior paragraph, throughout
the world.
 
  The Company seeks aggressively to market and distribute titles in the
Library in existing pay and free television, home video and other markets
worldwide. The Company believes that the size of the Library allows the
Company to minimize the over-exploitation of any title and therefore better
preserve the ongoing value of the Library by actively managing the rotation of
titles through such markets. During the most recent three-year period, the
Company exploited approximately 80 percent of the theatrical motion picture
titles and approximately 45 percent of the television title episodes in the
Library (excluding the titles in the PFE Libraries, which could
 
                                       8
<PAGE>
 
not yet be reflected in such calculation because of the recent nature of their
acquisition by the Company). Rather than selling its titles on a single or
multi-picture basis, the Company strives to strategically pool its motion
picture and television titles into cohesive programming packages directed at
specific markets, including purchasers of large quantity programming and
services in emerging markets which may not have their own programming
capabilities.
 
  The Company also seeks aggressively to market and distribute its titles
through developing technology. The Company believes that the development and
growth of direct broadcast satellite ("DBS") and other new distribution
systems may generate significant incremental profits for the industry as the
number of channels requiring content grows. The Company believes that, with
its extensive Library, including the recent addition of the PFE Libraries, and
its branded programming strategy, the Company is well positioned to benefit
from such growth and development.
 
  The Company has differing types of rights to the various titles in the
Library. In some cases, the Company owns the title outright, with the right to
exploit the title in all media and territories for an unlimited time. In other
cases, the title may be owned by a third party and the Company may have
obtained the right to distribute the title in certain media and territories
for a limited term. Even if a title is owned by the Company, the Company may
have granted rights to exploit the title in certain media and territories to
others. As of December 31, 1998, the Company owned outright, or had been
granted rights in perpetuity to, approximately 60 percent of the titles in the
Library (excluding the titles in the PFE Libraries, which could not yet be
reflected in such calculation because of the recent nature of their
acquisition by the Company). The Company's rights in the other Library titles
(excluding the titles in the PFE Libraries) are limited in time and, pursuant
to the terms of the existing arrangements, the rights granted to the Company
expire with respect to approximately six percent of the Library over the next
two years (i.e. through the end of 2000), with respect to another
approximately 13 percent over the six years thereafter (from 2001 to 2007),
and with respect to another approximately 18 percent thereafter (from 2008
on). The Company has generally been able to renew such rights on acceptable
terms; however no assurances can be made that it will continue to be able to
do so in the future. In accordance with industry practice, for purposes of
calculating the size of the Library, the Company includes any title that the
Company has the right to distribute in any territory in any media for any
term.
 
  Due to certain long-term pre-paid licenses entered into by prior management,
the Company does not expect to receive significant revenue with respect to
substantial portions of its Library from domestic free and certain major
international television markets for the next several years. As of December
31, 1998, the titles included in these licenses represent a cross-section of
the titles in the Library, including approximately 50 percent of the pre-1990
MGM and UA titles, which have been licensed in one or more of the U.S.,
France, Spain and Germany, and approximately 25 percent of the Orion titles,
which have been licensed in one or more of France, Spain, Germany and the
United Kingdom. See "--Distribution--Pay and Free Television Distribution."
The Company expects to benefit as certain rights to the Library that have been
previously licensed to others revert to the Company over time. See "--
Distribution."
 
  In recent years the Company has derived approximately 40 percent of its
revenues from non-U.S. sources due to its distribution of motion picture and
television productions in foreign countries. As a result, the Company's
business is subject to certain risks inherent in international trade, many of
which are beyond its control, such as changes in laws and policies affecting
trade, investment and taxes (including laws and policies relating to the
repatriation of funds and to withholding taxes), differing degrees of
protection for intellectual property and the instability of foreign economies
and governments. In addition, fluctuations in foreign exchange rates can
adversely affect the Company's business, results of operations and cash flows.
See "--Regulation," "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Item 7A. Quantitative and
Qualitative Disclosures about Market Risk."
 
                                       9
<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 pursue independently the best new
projects on the creative side of the business. At the same time, the Company
supports the units with the benefits of centralized marketing, sales, legal,
physical production and distribution functions. Direct access to senior
management also expedites major decision-making. By utilizing its two separate
production units, management believes that the Company benefits from the
distinct creative talents and perspectives of each of its chief production
executives, resulting in greater diversity within its overall release slate.
 
  Through these production units, the Company intends under its current
business plan to produce or co-produce and distribute six to ten motion
pictures annually across a variety of genres and budget ranges and may also
release additional pictures each year that are produced by other producers.
Both production units employ a development staff of creative executives who
work to refine concepts and scripts so that projects are developed to the
point that production decisions can be made. The creative staffs of both MGM
Pictures and UA Pictures currently have approximately 108 ongoing projects in
the aggregate, which are in various phases of development and pre-production.
The Company's current strategy is to have fewer projects in development at any
one time than the other major studios in order to concentrate its efforts and
assets on the projects that management believes could be the most commercially
successful. The Company believes that this strategy results in lower
development related write-offs and abandonment costs. Historically, the
Company's development related write-offs and abandonment costs amounted to
$24.1 million, $21.2 million, and $11.6 million in the years ended December
31, 1998, 1997 and 1996, respectively.
 
  Additionally, the Company plans to release approximately two to four
specialty motion pictures each year through G2 Films. These motion pictures
will be produced or co-produced by G2 Films or acquired through negative
pickups or other distribution arrangements and will include motion pictures in
a variety of genres generally involving producers and directors, writers or
other talent who typically work outside of the studio system. The Company's
investment in such pictures is expected to be significantly less than the
Company's investment for pictures produced through MGM Pictures or UA
Pictures. The Company believes that this strategy of releasing independent
motion pictures will add greater diversity to the Company's release slate and
enhance the Library both through the addition of new film product and the
building of relationships with up-and-coming producers and directors, writers
and other talent.
 
  In order to manage the financial risks inherent in motion picture
production, management has developed a rigorous budgeting and approval process
and strictly controls the cost of each motion picture through active
management involvement in all phases of the production process. When a project
is considered to have commercial potential, budgets are developed
independently by the physical production department to determine the below-
the-line cost of a motion picture. At a point early in this process, a
preliminary below-the-line estimate is combined with potential above-the-line
costs, such as talent costs and participations, to form a model of the total
cost of the motion picture. The Company then performs sensitivity analyses to
determine the motion picture's potential ROI. The ROI range is developed using
a preliminary cost model together with a revenue model based on the picture's
budget, genre, cast, international appeal and other factors. The Company
believes that, as a result of its focus on budgeting and controlling
production expenditures, it is able to avoid unnecessary cost-overruns and
excess expenditures.
 
  The Company believes that it pursues fewer producer or talent "overhead"
arrangements, in which a studio pays a portion of the overhead of creative
talent (i.e., producer, director or actor) for the right to receive a "first
look" at that party's projects, than other major studios. In general, the
Company believes that its capital resources are better allocated to acquire
literary properties or the services of talent for a specific project than to
fund overhead. The Company's current business plan also calls for the
Company's annual release slates to be comprised of proportionately fewer large
budget "event" motion pictures than the current release slates of the other
major studios.
 
                                      10
<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 competing
films released into the marketplace at or near the same time, the availability
of alternative forms of entertainment and leisure time activities, general
economic conditions and other tangible and intangible factors, all of which
can change and cannot be predicted with certainty. Further, the theatrical
success of a motion picture is generally a key factor in generating revenues
from other distribution channels. There is a substantial risk that some or all
of the Company's motion pictures will not be commercially successful,
resulting in costs not being recouped or anticipated profits not being
realized. In that connection, although Tomorrow Never Dies and The Man In The
Iron Mask performed better than anticipated, the Company's other major
theatrical releases in 1998 performed below expectations. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
 
  The following table details the Company's current 1999 release schedule.
 
                               Release Schedule
 
<TABLE>
<CAPTION>
                         Approximate
          Title          Release Date         Summary              Principal Actors
          -----          ------------         -------              ----------------
<S>                      <C>          <C>                      <C>
At First Sight(2).......   Released   Based on the true story  Val Kilmer, Mira
                                      by Oliver Sacks          Sorvino, Kelly McGillis,
                                      (Awakenings) of a blind  Nathan Lane, Steven
                                      man whose sight is       Weber
                                      restored and the effects
                                      it has on him, his
                                      sister and the woman he
                                      loves.
 
Just the Ticket.........   Released   A story of love,         Andy Garcia, Andie
                                      redemption and faith     MacDowell
                                      centering on a ticket
                                      scalper who must
                                      confront his past in
                                      order to hold onto the
                                      girl he loves.
 
The Rage: Carrie 2(1)...   Released   A sequel to the 1976     Amy Irving, Emily Bergl,
                                      horror thriller, The     Jason
                                      Rage: Carrie 2 is a      London
                                      supernatural thriller
                                      about a teenage loner
                                      whose telekinetic powers
                                      awaken when she becomes
                                      the focus of a cruel
                                      high school joke.
 
The Mod Squad(2)........   Released   A trio of juvenile       Claire Danes, Giovanni
                                      delinquents become       Ribisi, Omar Epps, Josh
                                      undercover cops to       Brolin
                                      infiltrate a drug ring
                                      in the ultra-hip LA club
                                      scene.
 
Molly(2)................  April 1999  A mentally challenged    Elizabeth Shue, Aaron
                                      young woman's genius is  Eckhart
                                      unleashed after
                                      experimental surgery,
                                      while her brother's
                                      carefree lifestyle is
                                      turned on its side when
                                      he must care for her.
 
Tea With Mussolini......   May 1999   A coming-of-age tale     Cher, Judi Dench, Joan
                                      about an illegitimate    Plowright, Maggie Smith,
                                      child who struggles to   Lily Tomlin
                                      assert his independence
                                      and find his way into a
                                      life of art, taken from
                                      the autobiography of
                                      Franco Zeffirelli.
 
</TABLE>
 
 
                                      11
<PAGE>
 
<TABLE>
<CAPTION>
                           Approximate
          Title           Release Date          Summary              Principal Actors
          -----           ------------          -------              ----------------
<S>                       <C>           <C>                      <C>
One Man's Hero...........   May 1999    An adventure about the   Tom Berenger
                                        legendary Saint Patrick
                                        Battalion, who fought
                                        for Mexico alongside
                                        Pancho Villa in the
                                        Mexican-American War.
 
The Thomas Crown            June 1999   An adventure of a        Pierce Brosnan, Rene
 Affair(1)...............               millionaire playboy who  Russo
                                        steals a priceless work
                                        of art and then strikes
                                        up a fiery romance with
                                        the brilliant female
                                        insurance investigator
                                        who is on to his game.
 
Stigmata(2)..............   July 1999   When a young woman       Patricia Arquette,
                                        becomes the focus of     Gabriel Byrne
                                        brutal assaults by an
                                        unseen attacker, a
                                        priest becomes more
                                        concerned with saving
                                        her life than denouncing
                                        her claims.
 
Mr. Accident(3)..........  August 1999  The janitor of a free-   Yahoo Serious, Helen
                                        range chicken farm meets Dallimore
                                        the woman of his dreams
                                        and joins her in trying
                                        to thwart the tobacco
                                        industry's nefarious
                                        plans to addict new
                                        customers through
                                        nicotine-injected eggs.
Supernova(1)............. October 1999  Science-fiction thriller James Spader, Angela
                                        about a medical          Bassett, Lou Diamond
                                        spaceship that responds  Phillips, Robert Forster
                                        to a distress signal and
                                        takes on a mysterious
                                        passenger.
 
The World Is Not          November 1999 Michael Apted directs    Pierce Brosnan, Denise
 Enough(1)...............               the Company's 19th       Richards, Sophie Marceau
                                        installment of the James
                                        Bond series.
 
Flawless(2).............. December 1999 A tough, conservative    Robert De Niro, Philip
                                        security guard suffers a Seymour Hoffman
                                        stroke and is assigned a
                                        rehabilitative program
                                        that includes singing
                                        lessons with the drag
                                        queen next door.
</TABLE>
--------
(1) Developed and produced by UA Pictures.
(2) Developed and produced by MGM Pictures.
(3) Developed and produced by G2 Films.
 
  The Company may revise the release date of a motion picture as the
production schedule changes or in such a manner as the Company believes is
likely to maximize revenues. Additionally, there can be no assurance that any
of the motion pictures scheduled for release will be completed, that
completion will occur in accordance with the anticipated schedule or budget,
or that the motion pictures will necessarily involve all of the creative
talent listed above. See the discussion above.
 
 Television Production
 
  The Company is engaged in the development and production of episodic
television series, mini-series and movies for distribution on domestic and
international television networks, local independent and network-affiliated
television stations, pay television networks, basic cable networks and home
video. Since the re-establishment of its television series production
operations in 1994, the Company has obtained commitments for approximately
1,030 hours of television programming, of which approximately 40 percent
remained to be aired as of December 31, 1998. Historically, the Company's
television activities were focused on the traditional network production
business and made-for-television movies, and many of the television programs
in the Library were produced as network series. However, since the networks
have substantially lowered the license fees as a
 
                                      12
<PAGE>
 
percentage of the budget for network television programming in recent years,
resulting in significantly larger production investment risks for the
producers of such programming, the Company altered its television strategy in
1994 when the Company's management re-established the Company's television
series production operations. See "--The Motion Picture and Television
Industry."
 
  Since 1994 the Company has focused primarily on the development and
production of series for the first-run syndication business, which involves a
lower production investment risk for the Company, and movies and mini-series
for both network and off-network broadcasters. The Company's strategy is
designed to (i) minimize up-front capital investment through the production of
series for the first-run syndication business and through co-production
arrangements, (ii) minimize risks associated with large deficit financing by
developing product such as two-hour movies or mini-series that generally offer
stable, predictable cash flows, (iii) use valuable Library assets such as The
Magnificent Seven, The Outer Limits, Poltergeist, Stargate and All Dogs Go to
Heaven to develop recognizable products with enhanced marketability at a
reduced cost and (iv) develop alternative types of programming, such as
animated cartoon strips, talk shows, variety/magazine shows such as National
Enquirer and reality-based programming such as LAPD--Life on the Beat.
 
  As part of its strategy, the Company has entered into a programming
arrangement with Showtime whereby the Company provides television series and
movies for premiere on Showtime. Showtime has agreed to license from the
Company exclusive U.S. pay television rights to the following television
series: (i) 122 hours (six seasons) of The Outer Limits (winner of the Cable
Ace award for Best Dramatic Series in 1995 and 1996) of which 32 hours
remained to be aired as of December 31, 1998; (ii) 66 episodes (three seasons)
of Poltergeist: The Legacy of which no episodes remained to be aired as of
December 31, 1998; (iii) 88 episodes (four seasons) of Stargate SG-1 of which
52 episodes remained to be aired as of December 31 1998; and (iv) two new
series (for a minimum commitment of 21 and 43 episodes each, respectively,
including a two-hour episode) to be produced by the Company for Showtime, with
one new series to commence broadcast in 2000 and one to commence in 2001.
Showtime has also committed to a two-hour pilot for Species, a possible
television series based on the theatrical motion picture of the same name. The
Company has also acquired worldwide (excluding Canada) distribution rights to
the Showtime series Dead Man's Gun (a Cable Ace nominee for Best Dramatic
Series in 1997). Twenty-two new episodes of such series will be produced,
giving the Company a minimum of 44 episodes that have not previously been
distributed outside North America. Following their initial exhibition cycle on
Showtime, the Company intends to exploit these programs further in other
markets. In this respect, the Company has recently entered into a license
agreement with Sci-Fi Channel for the exclusive domestic basic cable
exhibition rights of The Outer Limits, Poltergeist: The Legacy and Stargate
SG-I.
 
  The programming agreement with Showtime also includes a commitment by
Showtime to license seven made-for-television movies from the Company, five of
which remained to be produced and all of which remained to be aired as of
December 31, 1998.
 
  Additionally, the Company has obtained a commitment from Paxson
Communications ("Paxson") to license 88 episodes of Flipper, a one-hour
series, which commitment includes a production order for 44 episodes. The
series began airing in fall 1998 on Paxson's PAX NET network, comprised
principally of owned and operated stations which cover in excess of 65 percent
of U.S. television households.
 
  The Company also has obtained a commitment from Fox Family Worldwide to
license 40 episodes (of which 14 episodes are newly commissioned) of All Dogs
Go to Heaven, a half-hour animated series that began airing in fall 1998. The
Company has also entered into agreements to produce for U.S. broadcast
syndication (i.e. licenses to individual television stations) 40 half-hour
episodes of Robocop: Alpha Commando, an animated series based on the feature
motion picture Robocop, and 13 half-hour episodes of The Lionhearts, an
animated series based on Leo, the familiar MGM lion, and his cartoon "family."
 
  In addition to National Enquirer, which will premiere in first-run
syndication in fall 1999, the Company intends to develop additional series for
first-run syndication for which production, if the Company elects to produce
such series, would begin no earlier than 2000.
 
                                      13
<PAGE>
 
  From time to time, the Company may produce series for network television on
a selective basis, which typically require deficit financing but generally
offer the potential for greater financial return. In its first sale of a
series to network television since 1994, the Company produced a two-hour pilot
and 21 episodes of The Magnificent Seven for CBS during the 1997/98 and
1998/99 broadcast seasons.
 
  The Company may consider joint ventures, co-productions and other partnering
arrangements for certain of its existing or future series in order to minimize
the up-front capital investment and limit the financial risk to the Company
with respect to the production of such series.
 
  Since the Company's ability to recover production costs and realize profits
on its television programs depends on various factors, including but not
limited to the programs' acceptance by the public, fluctuation in prevailing
advertising rates, and the ability to distribute the programs into licenses
subsequent to their first-run license, there can be no assurance that the
Company can recover the production costs or realize profits on any television
series. Thus, there is a substantial risk that some or all of the Company's
television projects will not be commercially successful, resulting in costs
not being recouped or anticipated profits not being realized. See "--
Distribution" and "--Competition."
 
Distribution
 
 Theatrical Distribution
 
  General. The initial step in the release of a motion picture is the booking
of engagements with theatrical exhibitors. The exhibitors retain a portion of
the admissions paid at the box office, which generally includes a fixed amount
per week, as well as a percentage of the admissions that escalates over time.
A studio's or other producer's (or third party distributor's) share is
approximately 50 percent of gross box office admissions, although such
percentage, which has generally decreased in recent years, varies depending
upon factors such as the number and box office performance of such studio's or
other producer's recent releases.
 
  The Company intends to release a slate of films appealing to a wide variety
of audiences. By strategically timing the release of its motion pictures
throughout the year, the Company intends to avoid some of the risks posed when
a motion picture is inappropriately released during the most crowded and
competitive box office seasons. The Company believes that this strategy is
unlikely to have a negative impact on its ability to generate home video
rentals.
 
  All motion pictures that are released theatrically by the Company in the
U.S. and Canada, whether produced by MGM Pictures, UA Pictures, G2 Films or
third parties, are marketed and distributed by Metro-Goldwyn-Mayer
Distribution Co. Additionally, the Company generally distributes its motion
pictures in theatrical markets outside of the U.S. and Canada through United
International Pictures B.V. ("UIP"), a partnership owned equally by the
Company, Paramount and Universal. UIP is the world's largest theatrical motion
picture distribution company outside the U.S., with distribution activities in
over 50 countries. UIP has a cost sharing arrangement that requires each
partner to be responsible for one-third of UIP's annual operating overhead.
UIP charges each partner a distribution fee of 35 percent of gross theatrical
receipts until the fee equals one-third of the annual operating costs of the
partnership, and thereafter a negotiated percentage of any additional gross
receipts as a fee for incremental use of the organization. Each partner bears
all of its own releasing costs and retains all cash flow from its pictures
after payment of fees.
 
  The Company can elect to withdraw from UIP on November 1 of any year with at
least one year's prior notice (although the Company has no current intention
to withdraw). If the Company, or either other partner, withdraws, that partner
is entitled to one-third of the book value of UIP less one-third of the
estimated winding down costs of the partnership. Both Universal and Paramount
have agreed not to withdraw from the partnership until after 2001; however,
the Company believes that either party's exit from UIP would not have a
material adverse effect on the Company's financial condition or results of
operations, as the Company would expect to distribute its motion pictures in
these territories by either modifying and downsizing the UIP structure or
finding or developing satisfactory alternative methods for international
distribution. There can be no assurance, however,
 
                                      14
<PAGE>
 
that such alternatives would not result in decreased revenues or
profitability. The partners are prohibited from transferring their respective
partnership interests. UIP received a "Statement of Objections" from the
Competition Directorate of the Commission of European Communities in January
1998. A hearing was held before the European Commission in September 1998. See
"--Regulation."
 
  Co-Production and Distribution Agreements. In addition to producing feature
motion pictures independently, the Company occasionally enters into co-
production agreements, split rights deals and similar arrangements under which
the Company retains certain distribution rights with respect to a picture and
shares the cost of production with a partner that obtains other rights
(generally outside of the U.S. and Canada). While such agreements limit the
Company's risk relating to a motion picture's performance as they reduce the
Company's production costs, such agreements also limit profitability. The
Company also acquires rights to distribute films through negative pickup
arrangements under which the Company acquires a completed motion picture, or
certain rights therein, from a third party. Under co-production agreements,
split rights deals or negative pickup arrangements, the Company may be
committed to spend specified amounts for prints and advertising. Additionally,
the Company occasionally enters into "rent-a-system" arrangements under which
the Company provides distribution services to an independent film company for
a percentage distribution fee. Under rent-a-system arrangements the
independent film company generally is responsible for all print and
advertising costs. These types of arrangements may be entered into before,
during or after production of a particular motion picture.
 
  Theatrical Marketing. The Company's theatrical marketing department consists
of five functional groups: research, media planning, advertising, promotion
and publicity. The objective of the marketing department is to maximize each
motion picture's commercial potential by designing and implementing a
marketing campaign tailored to appeal to the picture's most receptive
audience. The marketing process begins with research before a motion picture
is completed. The research department determines, through audience screenings
and focus groups, a motion picture's appeal to its most likely target
audience. The marketing group begins to develop media plans and marketing
materials well in advance of a motion picture's scheduled theatrical release.
The media campaign generally begins six months before release with the
circulation of teaser trailers, posters and exhibitor advertising materials.
The campaign becomes more aggressive two to three months before release as
full-length trailers are released in theaters and more significant materials
are sent to exhibitors. Finally, a national campaign is launched four to five
weeks before opening day. This media campaign generally involves advertising a
picture's release on national television, including network prime time and
syndication markets, national cable and radio and in magazines, newspapers and
specific target markets, such as colleges. In addition, public appearances,
such as television talk shows, are arranged for a picture's stars in order to
promote the film. The entire process is managed by the Company's in-house
staff, although outside agencies are frequently retained to provide creative
input.
 
 Home Video Distribution
 
  The Company's marketing and distribution strategy in the home video market
domestically and internationally is to (i) market its motion picture and
television titles in cohesive packages, (ii) create branded product lines,
(iii) adapt to a maturing home video market and (iv) release new motion
pictures into the home entertainment market at the time of the year that it
believes will generate the most sales without diminishing revenues from other
markets. Under current management, the Company has repackaged and repriced a
number of Library titles through the creation of various branded lines.
Examples of these branded lines include MGM's Movie Time, Contemporary
Classics, Screen Epics, Vintage Classics and Musicals. The Company believes
this strategy has resulted in increased shelf space in video retail stores and
that this increased visibility has led to increased sales of Library titles.
This strategy has also been used to expand the sales and distribution of the
Orion catalog titles. The addition of the PFE Libraries in January 1999 is
expected to enhance the longevity and sales potential of the existing branded
lines and to contribute to the creation of new branded lines. Additionally, in
connection with new films which it releases into the market, the Company often
releases related Library films, or groups of Library films in order to
increase sales of both the Library films and new releases. An example is the
upcoming worldwide re-release of the James Bond video catalog in connection
with the fall 1999 theatrical
 
                                      15
<PAGE>
 
release of the Company's nineteenth installment of the James Bond series, The
World Is Not Enough. The Company intends to continue this strategy of
packaging groups of films or film franchises and releasing them in connection
with the releases of its most highly visible new films.
 
  MGM Home Entertainment Inc. ("Home Entertainment") manages the marketing and
distribution of both current feature motion pictures and Library product of
MGM Studios and its subsidiaries in the home video and other home
entertainment markets.
 
  In 1990, as part of the acquisition of MGM/UA by Pathe, MGM-Pathe (the
predecessor in interest to MGM Studios), MGM/UA and UA Pictures (collectively,
the "Parties") entered into an agreement (as amended, the "WHV Agreement")
with the predecessor to WHV. Under the WHV Agreement, the Parties granted to
WHV certain home video distribution rights with respect to new motion pictures
and the motion picture library of MGM/UA, UA Pictures and their respective
affiliates, subject to certain limited exceptions, throughout the world for a
distribution fee expressed as a percentage of worldwide home video revenues
(as determined under the WHV Agreement) and reimbursement of certain
distribution expenses. The WHV Agreement was originally scheduled to expire in
May 2003, with the home video rights of each of the films still covered by the
WHV Agreement at that time reverting to MGM Studios or its affiliates five
years after the film's initial availability in the U.S. home video market. On
March 12, 1999 the Company, WHV and Turner entered into an agreement to
accelerate the expiration of the WHV Agreement. The Parties restructured the
terms of the WHV Agreement, which will function as an interim distribution
agreement (the "Transitional Video Agreement"), under which WHV will
distribute certain of the Company's product in the home video marketplace
while the Company establishes its own home video distribution network. The
Transitional Video Agreement expires on January 31, 2000. In addition to
accelerating the expiration of the WHV Agreement, (i) the Company agreed to
pay WHV $225 million, $112.5 million of which was paid on March 12, 1999 and
the additional $112.5 million (plus interest at a rate of eight percent per
annum from March 1999) of which is payable in September 1999, (ii) the Company
reconveyed as of January 1, 1999 to WHV the right that the Company had to
distribute in the home video markets worldwide until June 2001, approximately
2,950 titles from the Old MGM Library, the Turner library and all pre-1949
Warner titles, which titles had been serviced under the WHV Agreement, and
(iii) the Company, WHV and Turner released any claims against each other
arising out of the WHV Agreement and the Turner video distribution agreements
including claims previously advanced by WHV with respect to the Orion library.
Under the Transitional Video Agreement, all security interests in favor of WHV
over the assets of the Company have been released and the restrictive
provisions previously contained in the WHV Agreement have been terminated,
including restrictions on the acquisition and disposition of film rights and
the requirement that the product of future affiliates of the Company be
distributed under the WHV Agreement. WHV will distribute on home video the
motion pictures that the Company elects to make available in the home video
market throughout the world for a distribution fee determined under the
Transitional Video Agreement and reimbursement of certain distribution
expenses. In general, the percentage varies from 10 percent to 15 percent
based upon the amount of worldwide home video revenues during the term and
other factors. MGM Studios and its affiliates maintain direct control of all
significant elements of distribution such as the determination of release
dates, marketing, return policies and pricing for these home video releases.
Laser disc and digital video disc ("DVD") distribution rights are also covered
by the Transitional Video Agreement.
 
  Even with the WHV Agreement in effect, the Company's home video sales have
increased since 1993. From 1993 to 1998, the Company increased its annual
worldwide home video gross revenue from feature films by 102 percent, from
$243.0 million to $491.2 million. The Company believes that this increase is a
result of more effective and efficient marketing by the Company, the
distribution of more current product, the distribution of more titles due to
the Orion Acquisition, the renegotiation by the Company of key vendor
relationships and a reorganization of the Company's distribution
infrastructure. Management believes that the agreement reached with WHV to
accelerate the expiration of the WHV Agreement is an important step in
enabling the Company to manage home video distribution in a more cost-
effective manner and further increase sales and profitability.
 
  The Company has recently begun entering into revenue sharing agreements for
certain of its rental titles, pursuant to which the Company leases titles to
rental establishments and receives a percentage of the consumer rental
revenues generated from such titles. The Company anticipates that it will
continue to enter into more of
 
                                      16
<PAGE>
 
such agreements in the future. Although no assurance can be given, in part
because of the recent introduction of these arrangements in the industry, the
Company believes that such arrangements may increase its revenues from the
home video rental market, by allowing the Company to participate in increased
revenues from successful titles, although such revenues will be received over
a longer period.
 
  The Company had licensed to Hallmark Entertainment Distribution Company,
Inc. ("Hallmark") the right to distribute in the U.S. home video market
substantially all of the library of G2 Films and Goldwyn. In February 1999,
Hallmark's rights under such license reverted to the Company.
 
  During 1998, the Company has released 15 Orion films to the rental market,
including features Ulee's Gold, Fall, The Locusts and Retroactive, as well as
the Company's television productions, Twelve Angry Men and the two-hour pilot
of Stargate SG-1. The Company has also released under the Orion banner certain
titles produced by Playboy Entertainment, the distribution rights to which
were obtained as part of the Orion Acquisition.
 
  The Company intends to capitalize on developing technologies such as DVD, a
high-quality mass-produced delivery system for video and audio data. The
Company believes that DVD is a promising technology that could generate
significant incremental profits for the industry because, among other things,
the format may be more attractive to retail purchasers than videocassettes.
The Company was among the first major studios to make titles available on DVD
and, as of December 31, 1998, ranked fourth in total DVD market share behind
Warner, Sony Pictures and Universal. Tomorrow Never Dies has become the
largest selling DVD title yet released. The Company believes that it is well
positioned to benefit if DVD is successful, since the high quality of DVD is
expected to create additional demand for the many classic or familiar
"collectible" titles in the Library. As DVD is a developing technology, it is
uncertain when and if DVD will become a substantial revenue source; however
the Company was encouraged by the progress of the format in 1998 and believes
that DVD may increasingly provide incremental profits to the Company in the
future.
 
 Pay and Free Television Distribution
 
  General. The Company generally licenses its current theatrical motion
pictures for pay television through output agreements pursuant to which films
not yet produced are pre-licensed for a specified fee paid on delivery. The
Company believes that output agreements with international distributors with
recognized expertise are beneficial as they assure that a significant advance
will be received for a given territory and that a prominent distributor with
recognized distribution and marketing capabilities will distribute the picture
in such territory.
 
  The Company intends to enter into relatively short-term licenses of its
Library motion pictures for pay and free television in packages that are
strategically designed for the relevant marketplace. The Company has created a
proprietary database for use by its salesforce which contains detailed
information on each of the Company's films, including dates of availability,
media controlled by the Company, sales history, genre, format, length, stars,
soundtrack, etc. This information can be utilized by the sales force in order
to create strategically designed packages of motion pictures based on one or
more various criteria. The Company believes that this system is one of the
most advanced in the entertainment business and provides its sales force with
an advantage in a competitive marketplace that requires large amounts of
diverse content and is becoming more receptive to packaged programming.
 
  Domestic Pay Television. The Company and Showtime have entered into a
theatrical motion picture output agreement requiring the Company's future
theatrical motion pictures to air on Showtime's pay television network. The
first output period expires upon the first to occur of August 31, 2001 or the
delivery of 150 pictures (other than specialty pictures) under the agreement.
As of December, 1998, the Company had delivered 36 pictures to Showtime. The
second output period commences on September 1, 2001 and expires upon the first
to occur of December 31, 2003 or the delivery of 65 additional pictures (other
than specialty pictures). Additionally, the agreement requires the Company's
future specialty motion pictures (i.e., pictures released under the G2 Films
logo) to air on Showtime's pay television network. The output period for
specialty motion pictures expires upon the first to occur of December 31, 2003
or the delivery of 50 specialty motion pictures. The license fees for each
picture are determined according to a formula based on U.S. theatrical rentals
of such picture, with special provisions applicable to the specialty motion
pictures.
 
                                      17
<PAGE>
 
  Orion and Home Box Office ("HBO") have entered into a theatrical motion
picture output agreement requiring future theatrical motion pictures produced
and distributed by Orion (excluding pictures produced by G2 Films and
distributed under both the prior and current G2 Films and Goldwyn logo) to air
on HBO's pay television network. The license fees for each picture are
determined according to a formula based on U.S. theatrical rentals of such
picture. The agreement expires on December 31, 2001, but HBO has the right to
extend the agreement through December 31, 2006.
 
  Domestic Free Television. The Company distributes its feature motion
pictures to U.S. and Canadian networks, local television stations in the U.S.
and Canada and basic cable networks. The Company also generates revenue by
granting syndication licenses on a barter basis. Barter syndication allows the
television stations to license the Company's product in exchange for a portion
of the local commercial air time. The Company, in turn, sells the inventory of
commercial air time to advertisers on a national basis, while the television
stations retain a portion of the commercial air time for local advertisers.
The Company has used outside barter companies to sell television spots to
advertisers in the past, but the Company commenced its own barter sales
business in 1996.
 
  In connection with the acquisition of MGM/UA by Pathe in November 1990, MGM-
Pathe licensed the domestic free television rights to a substantial portion of
its library (the UA library and the post-1986 MGM/UA titles in theatrical
release at the time) and selected television programs to Turner for a period
of ten years beginning from the availability of each such product in that
market. The license excludes motion pictures released theatrically after 1987.
With respect to most of the motion pictures and television programming covered
by the license, the domestic free television rights revert to the Company
between 2000 and 2003. The Company expects to receive relatively little
revenue from the licensing of the product covered by the agreement with Turner
in the domestic free television market until such product reverts to the
Company. The Company believes that, due to the significant increases in
licensing fees for domestic television since 1990, the expiration of the
Turner license and the subsequent ability of the Company to freely license the
Library in this market will generate incremental revenue for the Company. See
"--Film and Television Library."
 
  International Pay and Free Television. The Company currently distributes its
motion pictures and television product through pay television licenses in over
90 territories. The Company has output agreements with licensees in major
territories, including Germany, France, the United Kingdom, Spain, Italy,
Japan and Brazil. In 1998, the Company received $52.1 million in revenue from
international pay television distribution, accounting for four percent of the
Company's total revenue for the year.
 
  The Company currently distributes its motion pictures and television product
through free television licenses in over 100 territories. In 1998 the Company
received $147.4 in revenues under these agreements, accounting for 12 percent
of the Company's total revenues for the year. These license arrangements
typically provide licensees with the right to exhibit the licensed motion
pictures on television for a specific number of airings over a period of three
to seven years.
 
  However, in connection with the acquisition of MGM/UA by Pathe in November
1990, MGM-Pathe entered into long-term licenses of pay and free television
rights for theatrical and television movies and, in some cases, television
series in its Library at that time with United Communications (France) and
F.O.R.T.A. (Spain). A similar agreement had been entered into in 1984 with
Degeto Film (Germany). Substantially all of the license fees under these long-
term licenses have already been paid to the Company, and therefore, the
Company does not expect to receive significant revenue from these licenses in
future periods. With respect to most of the motion pictures licensed to United
Communications, the rights granted revert to the Company between 2000 and
2003. The James Bond features were excluded from such license. With respect to
most of the motion pictures licensed to F.O.R.T.A., the free television rights
revert to the Company between 1997 and 2000. With respect to most of the
motion pictures and television series licensed to Degeto Film, the
distribution rights granted revert to the Company between 1999 and 2010. See
"--Film and Television Library."
 
  Additionally, Orion has entered into certain long-term licenses covering a
significant number of its library motion pictures in the international free
and pay television markets. Orion has already received substantially all
 
                                      18
<PAGE>
 
of the license fees under these licenses, and therefore, the Company does not
expect significant revenue from these licenses in future periods. Orion has
licensed titles to Capitol Film and TV International (Germany), Compagnie
Luxembourgeoise de Telediffusion (France), British Sky Broadcasting (the
United Kingdom), Film Finance Group, Inc. and Principal Network Limited
(Italy) and Televisio de Catalunya, S.A. (Spain). The distribution rights
granted to Capitol Film and TV International revert to Orion in 2025. The
distribution rights granted to Compagnie Luxembourgeoise de Telediffusion
revert to Orion between 2003 and 2013. The distribution rights granted to
British Sky Broadcasting currently are reverting to Orion, with such reversion
being complete in 2002. The distribution rights granted to Film Finance Group,
Inc. and Principal Network Limited revert to Orion between 1999 and 2012. The
distribution rights granted to Televisio de Catalunya, S.A. currently are
reverting to Orion, with such reversion being complete in 2010. The Company
believes that, due to the importance of France, Spain, Germany, the United
Kingdom and Italy and the significant increases in licensing fees for
television in these markets since 1990, the expiration of these licenses and
subsequent ability of the Company to freely license its Library in these
markets could create substantial incremental revenue for the Company.
 
  The MGM/UA and Orion licenses discussed above (in "--Domestic Free
Television" and "--International Pay and Free Television") cover a cross-
section of the motion pictures in the Library. Although the Company exploits
the remaining titles in the Library in these markets, they do not generate
significant revenues.
 
  In addition to licensing packages of films, the Company holds equity
positions ranging from approximately five percent to 25 percent in joint
ventures such as LAPTV, Telecine, Star Channel and MovieVision, which are
emerging international premium film satellite television networks broadcasting
in different territories around the world. The Company has entered into
license agreements with respect to each of LAPTV, Telecine, Star Channel and
MovieVision, licensing theatrical and television motion pictures and, in some
cases, television series to each of the ventures.
 
  The Company believes its strategy of providing strategically pooled, branded
MGM programming through the licensing of programming packages to cable
networks and television broadcasters, as well as through the development of
new channels of distribution that deliver the Company's programming, will
provide opportunities in the international marketplace as foreign countries
continue to develop cable television infrastructures and satellite television
becomes more available.
 
  In April 1998, the Company and its 50 percent equity partner, an indirect
subsidiary of Tele-Communications, Inc., decided to terminate their joint
venture in MGM Gold (Asia). MGM Gold (Asia) was a 24-hour satellite and cable
delivered service based and distributed in Asia that featured programming from
the Library. The recent economic deterioration in Southeast Asia, which has
resulted in diminished growth in multi-channel television households, and
slower than anticipated penetration in India and China were the primary
factors influencing the decision to cease the operations of the joint venture.
As of December 31, 1998, the Company had invested $13.2 million in the
venture. The Company anticipates that the formal dissolution of the venture
will be concluded shortly and that the Company will not incur any additional
costs with respect to the venture.
 
  In May 1998 the Company and an indirect subsidiary of United International
Holdings ("UIH") combined their Latin American cable programming businesses
into a joint venture to form MGM Networks Latin America. Under the terms of
the joint venture, the Company acquired a 50 percent equity interest in the
venture by contributing its branded Brazilian channel MGM Gold Brazil, which
began operations in December 1997. In turn, UIH contributed its 100 percent
interest in United Family Communications, which produces and distributes The
Family Channel Latin America and Casa Club TV to satellite and cable
television distributors throughout Latin America and Brazil, for a 50 percent
interest in the joint venture. The Company shares equally in the profits of
the venture and is obligated to fund 50 percent of the joint venture's
expenses up to a maximum of approximately $24.0 million, of which the Company
had funded approximately $12.4 million as of December 31, 1998. The Company
has entered into license agreements with MGM Networks Latin America, licensing
certain motion pictures and trademarks to the venture. The joint venture is
based in Coral Gables, Florida.
 
                                      19
<PAGE>
 
  Over the next 12 months, The Family Channel Latin America will be re-branded
and reintroduced as MGM Latin America and MGM Brazil. MGM Latin America and
MGM Brazil are general entertainment channels programmed primarily with MGM
theatrical and television product. Casa Club TV is a women's and children's
channel offering home and garden, cooking and children's programming. As of
December 31, 1998, MGM Networks Latin America distributed its signal to
approximately 3.4 million homes in 15 countries throughout Latin America.
 
Trademarks and Consumer Products
 
  The Company owns the registered trademarks Metro-Goldwyn-Mayer, MGM, United
Artists, UA, Orion and variations thereof, as well as trademarks, logos and
other representations of characters, such as The Pink Panther, from motion
pictures and television series produced or distributed by the Company. In 1998
the Company received $10.7 million in revenue from the licensing of these
trademarks, logos and other representations.
 
  The Company believes that the MGM name and its lion logo are among the most
recognized in the world, evoking images of classic Hollywood. The Company
believes that the name and logo represent assets the value of which has been
substantially unrealized in the past. The Company plans to pursue a focused
branded strategy that will capitalize upon the Company's name and logo and
seek licensing opportunities for such name and logo, as well as other
trademarks of the Company, in a range of high quality product categories
(including gifts and apparel), distribution channels and venues.
 
  In February 1980 Old MGM granted to a predecessor-in-interest to MGM Grand,
Inc. an exclusive open-ended royalty-free license, which was amended in 1992
and further amended in 1998. Pursuant to the license, as amended, MGM Grand,
Inc. has the right to use certain trademarks that include the letters "MGM,"
as well as logos and names consisting of or related to stylized depictions of
a lion, in its resort hotel and/or gaming businesses and other businesses that
are not related to filmed entertainment. In 1986 MGM/UA granted MGM Grand Air,
Inc. ("Grand Air") an exclusive open-ended royalty-free license to use one of
its logos consisting of a stylized depiction of a lion in Grand Air's airline
business. See "Item 13. Certain Relationships and Related Transactions."
 
  In June 1985 Old MGM granted to Walt Disney Productions ("Disney
Productions") an exclusive long-term worldwide license (the "Disney License")
to use all trademarks, trade names and logos and names of or related to MGM
Studios that do not include "United Artists" or "UA" and materials from
certain MGM and UA motion pictures and television programming in movie theme
parks of Disney Productions that include a working movie production studio, as
long as Disney Productions makes the annual license payments. The Disney
License becomes non-exclusive with respect to the licensed trademarks, trade
names and logos on May 1, 2004 and is subject to early termination under
certain circumstances. Additionally, if Disney Productions did not develop a
movie theme park in any given territory by June 27, 1994, the Disney License
requires that Disney Productions reconvey all the licensed rights in that
territory to MGM Studios. MGM Studios requested the reconveyance of the
licensed rights in all territories except the U.S., and Disney Productions
reconveyed those rights in 1995 for all territories except the U.S. and
Western European territories in 1995. The Company filed a lawsuit against
Disney Enterprises, Inc. ("Disney") to compel the reconveyance of the licensed
rights in Western Europe and for termination of the Disney License and
received a jury verdict in its favor with respect to the rights in Western
Europe in November 1997. The court granted summary adjudication in favor of
Disney denying the Company the right to terminate Disney's U.S. rights under
the Disney License. The Company appealed this aspect of the decision. In an
unpublished opinion filed February 16, 1999, the Court of Appeal affirmed the
trial court's summary adjudication in favor of Disney on this issue. The
Company filed a petition for rehearing on March 3, 1999, which was denied on
March 11, 1999. On March 26, 1999, the Company filed a Petition for Review of
the Appellate Court's decision with the Supreme Court of the State of
California.
 
  For additional information regarding the Company's operating segments, see
the Company's Consolidated Financial Statements and the Notes thereto.
 
                                      20
<PAGE>
 
Competition
 
  Motion picture production and distribution are highly competitive
businesses. The Company faces competition from companies within the
entertainment business, as well as alternative forms of leisure entertainment.
The Company competes with the other major studios, numerous independent motion
picture and television production companies, television networks and pay
television systems for the acquisition of literary properties, the services of
performing artists, directors, producers and other creative and technical
personnel and production financing. Numerous organizations with which the
Company competes in the motion picture industry have significantly greater
financial and other resources than does the Company, while the independent
production companies may have less overhead than the Company. Most of the
other major studios are part of large diversified corporate groups with a
variety of other operations, including television networks and cable channels,
which can provide both means of distributing their products and stable sources
of earnings that offset the fluctuations in the financial performance of their
motion picture and television operations. See "--Distribution--Pay and Free
Television Distribution."
 
  In addition, the Company's motion pictures compete for audience acceptance
and exhibition outlets with motion pictures produced and distributed by other
companies. As a result, the success of any of the Company's motion pictures is
dependent not only on the quality and acceptance of a particular picture, but
also on the quality and acceptance of other competing motion pictures released
into the marketplace at or near the same time. The number of films released by
the Company's competitors, particularly the other major film studios, in any
given period may create an oversupply of product in the market, thereby
potentially reducing the Company's share of gross box office admissions and
may make it more difficult for the Company's films to succeed.
 
  Competition is also intense within the television industry. There are
numerous suppliers of television programming, including the networks, the
television production divisions of the major studios and independent
producers, all of which compete actively for the limited number of available
broadcast hours. The Company's programming competes with first-run
programming, network reruns and programs produced by local television
stations. Competition is also intense in supplying motion pictures and other
programming for the pay television and home video markets. Numerous
organizations with which the Company competes in the television industry have
significantly greater financial and other resources than does the Company.
 
  The entertainment industry in general, and the motion picture and television
industry in particular, are continuing to undergo significant changes,
primarily due to technological developments. Due to this rapid growth of
technology, shifting consumer tastes and the popularity and availability of
other forms of entertainment, it is impossible to predict the overall effect
these factors will have on the potential revenue from and profitability of
feature-length motion pictures and television programming.
 
Employees
 
  As of December 31, 1998, the Company had approximately 870 full-time and
part-time regular employees in its worldwide operations. Of that total,
approximately 130 were primarily engaged in production and development,
approximately 310 were primarily engaged in sales, marketing and distribution
and approximately 430 were primarily engaged in management and administration.
Approximately 160 of the Company's employees are currently covered by
employment contracts. The Company also hires additional employees on a
picture-by-picture basis in connection with the production of the Company's
motion pictures and television programming. The salaries of these additional
employees, as well as portions of the salaries of certain full-time employees
of the Company who provide direct production services, are typically allocated
to the capitalized cost of the related motion pictures or television
programming. The Company believes that its employee and labor relations are
good.
 
  Approximately 30 of the Company's current employees (and many of the
employees that the Company hires on a project-by-project basis) are
represented under industry-wide collective bargaining agreements with various
unions, including the Writers Guild of America (the "WGA"), the Directors
Guild of America (the "DGA")
 
                                      21
<PAGE>
 
the Screen Actors Guild ("SAG"), and the International Alliance of Theatrical
Stage Employees. A strike, job action or labor disturbance by the members of
any of these organizations may have a material adverse effect on the
production of a motion picture or television program within the United States.
 
Regulation
 
  In 1994 the U.S. was unable to reach agreement with its major international
trading partners to include audiovisual works, such as television programs and
motion pictures, under the terms of the General Agreement on Trade and Tariffs
Treaty ("GATT"). The failure to include audiovisual works under GATT allows
many countries (including members of the European Union, which consists of
Austria, Belgium, Denmark, Germany, Greece, Finland, France, Ireland, Italy,
Luxembourg, The Netherlands, Portugal, Spain, Sweden and the United Kingdom)
to continue enforcing quotas that restrict the amount of U.S. produced
television programming which may be aired on television in such countries. The
European Union Council of Ministers has adopted a directive requiring all
member states of the European Union to enact laws specifying that broadcasters
must reserve, where practicable, a majority of their transmission time
(exclusive of news, sports, game shows and advertising) for European works.
The directive must be implemented by appropriate legislation in each member
country. Under the directive, member states remain free to require
broadcasters under their jurisdiction to comply with stricter rules. For
example, France requires that original French programming constitute a
required portion of all programming aired on French television. These quotas
generally apply only to television programming and not to theatrical
exhibition of motion pictures, but quotas on the theatrical exhibition of
motion pictures could also be enacted in the future. There can be no assurance
that additional or more restrictive theatrical or television quotas will not
be enacted or that countries with existing quotas will not more strictly
enforce such quotas. Additional or more restrictive quotas or more stringent
enforcement of existing quotas could materially and adversely affect the
business of the Company by limiting the ability of the Company to exploit
fully its motion pictures internationally.
 
  Distribution rights to motion pictures are granted legal protection under
the copyright laws of the U.S. and most foreign countries, which laws provide
substantial civil and criminal sanctions for unauthorized duplication and
exhibition of motion pictures. The Company seeks to take appropriate and
reasonable measures to secure, protect and maintain or obtain agreements to
secure, protect and maintain copyright protection for all of its motion
pictures or television programming under the laws of applicable jurisdictions.
Motion picture piracy is an international as well as a domestic problem.
Motion picture piracy is extensive in many parts of the world, including South
America, Asia (including Korea, China and Taiwan), the countries of the former
Soviet Union and other former Eastern bloc countries. In addition to the MPAA,
the Motion Picture Association, the American Film Marketing Association and
the American Film Export Association monitor the progress and efforts made by
various countries to limit or prevent piracy. In the past, these various trade
associations have enacted voluntary embargoes of motion picture exports to
certain countries in order to pressure the governments of those countries to
become more aggressive in preventing motion picture piracy. In addition, the
U.S. government has publicly considered trade sanctions against specific
countries which do not take steps to prevent copyright infringement of U.S.
produced motion pictures. There can be no assurance that voluntary industry
embargoes or U.S. government trade sanctions will be enacted. If enacted, such
actions could impact the amount of revenue that the Company realizes from the
international exploitation of its motion pictures depending upon the countries
subject to such action and the duration of such action. If not enacted or if
other measures are not taken, the motion picture industry (including the
Company) may continue to lose an indeterminate amount of revenues as a result
of motion picture piracy.
 
  Article 85(1) of the Treaty of Rome prohibits certain agreements and
concerted practices which prevent, restrict or distort trade within the
European Union. In 1989 after several years of proceedings before the European
Commission, UIP received an exemption from Article 85(1) with respect to its
theatrical distribution activities in the European Union. In connection with
this exemption, UIP gave certain undertakings to the European Commission. The
1989 exemption expired in 1993, and although UIP has filed an application
seeking renewal of such exemption, such renewal has not yet been granted. In
July 1996 the European Commission conducted unannounced visits of four of
UIP's offices in Europe, interviewing officers and copying documents.
 
                                      22
<PAGE>
 
These visits were based on complaints submitted to the European Commission by
third parties, to the effect that UIP was acting in an anti-competitive manner
and was not complying with certain of the undertakings given by it in
connection with receiving the 1989 exemption. In addition, on January 16,
1998, the Competition Directorate of the Commission of the European
Communities issued a Statement of Objections in response to UIP's renewal
application. The Statement of Objections indicates that, although a final
decision has not been taken, the Commission is of the opinion that the
exemption granted to UIP in 1989 should not be extended and that UIP should be
required to cease operations in the European Union. UIP responded to the
Statement of Objections on May 15, 1998 and a hearing was held before the
European Commission in late September 1998. There can be no assurances that
the 1989 exemption will be renewed or renewed on terms acceptable to UIP. If
the 1989 exemption is not renewed at all or not renewed on terms satisfactory
to UIP and UIP ceases or reduces operations, the Company believes that it will
be able to find or develop satisfactory alternative methods for international
distribution, although such alternatives may result in decreased revenues and
profitability from such distribution.
 
  On February 2, 1999, the United States Department of Justice (Antitrust
Division), in the course of an antitrust investigation, issued a Civil
Investigative Demand ("CID") to the Company, requiring it to produce certain
documents and answer certain interrogatories concerning conduct, activities or
proposed action in the motion picture exhibition industry. The Company
believes that similar demands were issued to other major studios. The Company
is in the process of complying with the CID. While the Company has
communicated with the Department of Justice regarding the investigation, the
Company believes it is too early to determine the Department of Justice's
intentions and whether the Company is a target of the investigation.
 
  The Code and Ratings Administration of the MPAA assigns ratings indicating
age-group suitability for theatrical distribution of motion pictures. The
Company has followed and will continue to follow the practice of submitting
its pictures for such ratings. As a substantial number of the Company's films
are rated "R," under rules enforced by theatrical exhibitors, children under
certain ages may attend the applicable motion picture only if accompanied by
an adult.
 
  United States television stations and networks as well as foreign
governments impose content restrictions on motion pictures which may restrict
in whole or in part exhibition on television or in a particular territory.
There can be no assurance that such restrictions will not limit or alter the
Company's ability to exhibit certain motion pictures in such media or markets.
 
Item 2. Properties
 
  The Company leases approximately 375,000 square feet of office space, as
well as related parking facilities, for its corporate headquarters in Santa
Monica, California under several leases which generally expire in May 2003.
The Company also leases approximately 27,000 square feet in New York City for
its East Coast publicity, marketing and theatrical and television distribution
offices under a lease that expires in June 2004. Additionally, the Company
leases approximately 40,000 square feet of office space in Los Angeles,
California, which has been used by Orion, under a lease that expires in
January 2004. The current monthly rent for the above properties is
approximately $1.1 million in the aggregate (in addition to taxes, insurance
and certain expenses paid by the Company). The Company has subleased the
office space used by Orion prior to its acquisition by the Company. In
addition, the Company maintains relatively small domestic theatrical and
television distribution branches in Boca Raton, Chicago, Montreal, San Juan
and Toronto and has small international television distribution offices in
London and Sydney. In 1998 the Company closed its Paris office and
consolidated its European distribution operations to its London office. The
Company also leases studio facilities and stages from unaffiliated parties on
an as-needed basis in connection with the production of specific motion
picture and television projects.
 
  The Company believes that its current facilities are adequate to conduct its
business operations for the foreseeable future.
 
                                      23
<PAGE>
 
Item 3. Legal Proceedings
 
  In the matter entitled Estate of Jim Garrison, et al. v. Warner Bros., Inc.,
et al., which was filed as a putative class action in Los Angeles County
Superior Court in November 1995 against, among others, MGM Pictures and UA
Pictures and the other major studios, the court denied class certification in
August 1996 with respect to the plaintiffs' claims for breach of contract,
breach of implied covenant, unjust enrichment, imposition of constructive
trust and declaratory relief and, initially, granted class certification with
respect to plaintiffs' claims for price fixing under the Sherman Antitrust
Act, price fixing under state law, boycott/concerted refusal to deal under the
Sherman Antitrust Act and boycott/concerted refusal to deal under state law.
The court subsequently announced that its grant of the plaintiffs' class
certification motion might have been "inadvertent" and issued an order on its
own motion requesting briefing on the issue whether the class should be
decertified. After such briefing and by Order dated May 26, 1998, the court
decertified the plaintiff class with respect to plaintiffs' remaining claims
for price fixing under the Sherman Antitrust Act, price fixing under state
law, boycott/concerted refusal to deal under the Sherman Antitrust Act and
boycott/concerted refusal to deal under state law. The plaintiffs have
announced their intention to proceed against all defendants, including MGM
Pictures and UA Pictures, on their legal theories but solely as to the Warner
Bros. motion picture "JFK." Trial has been set for October 18, 1999. The
defendants filed motions for summary judgment. By Order entered January 28,
1999, the court denied defendants' motions in part and continued defendants'
motions in part, reopening discovery limited to certain issues related to one
motion and ordering supplemental briefing regarding those issues. In March
1999, the parties lodged with the court a stipulation and proposed order
dismissing the case with prejudice. The Company anticipates that the court
will order the case dismissed shortly.
 
  In May 1996 MGM Studios initiated an action in Los Angeles County Superior
Court against Disney to compel the reconveyance of rights granted to Disney
Productions with respect to Western European territories under the Disney
License. See "Item 1. Business--Trademarks and Consumer Products." MGM Studios
also claims that Disney Productions' breach of the reconveyance obligation
entitles MGM Studios under the terms of the Disney License to terminate the
Disney License altogether. The Company believes that if the Disney License is
terminated, the loss of revenue to the Company will be minimal, and the
Company may be able to relicense or otherwise exploit these rights on more
favorable terms. Trial proceedings with respect to such action began in
October 1997, and the Company has received a jury verdict in its favor with
respect to the Western European rights on November 5, 1997. The court granted
summary adjudication in favor of Disney denying the Company the right to
terminate Disney's U.S. rights under the Disney License. The Company appealed
this aspect of the decision. In an unpublished opinion filed February 16,
1999, the Court of Appeal affirmed the trial court's summary adjudication in
favor of Disney. The Company filed a petition for rehearing on March 3, 1999,
which was denied on March 11, 1999. On March 26, 1999, the Company filed a
Petition for Review of the Appellate Court's decision with the Supreme Court
of the State of California.
 
  In the two consolidated litigations entitled Turner Broadcasting System,
Inc. et al. vs. Tracinda Corporation and Turner Broadcasting System, Inc., et
al. vs. Metro-Goldwyn-Mayer Inc., (Base File CV-S-97-415), in April 1998 the
Company moved to dismiss the Amended Complaint against it on jurisdictional
grounds. In such litigation, MGM Studios, as successor-in-interest to UA, and
Tracinda are defendants in consolidated actions in the United States District
Court for the District of Nevada. Turner alleges that, as a result of Turner's
1986 acquisition of a predecessor-in-interest to MGM Studios and related
transactions, there was a $260 million tax loss and that the defendants are
contractually obligated to pay over to Turner any resulting tax benefits
attributable to that loss that Tracinda has received or will be allowed. The
Company has not claimed and will not receive any such tax benefits. The
Internal Revenue Service has disallowed both Turner's and Tracinda's tax
claims, which are now subject to appeal from the United States Tax Court.
Based upon information to date, the Company's management believes that it is
unlikely that the Turner litigation will have a material adverse effect on the
Company's financial condition or results of operations. The Nevada court has
stayed the action against MGM Studios pending a final decision in the tax
court proceedings.
 
  Orion is a defendant in a matter entitled Sidney Sapsowitz et al. v. John W.
Kluge, Metromedia International Group, Inc., and Orion Pictures Corp., et al.,
which was filed in June 1997. The plaintiffs claim a "finder's
 
                                      24
<PAGE>
 
fee" of $28.5 million in connection with the Orion Acquisition. Pursuant to
the terms of agreements executed in connection with the Orion Acquisition, the
Company has indemnification from Metromedia International Group, Inc. with
respect to the payment of any finder's fee. As a result, management believes
that the Sapsowitz litigation will not have any material adverse effect on the
Company's financial condition or results of operations.
 
  In December 1998, the action entitled Samuel Goldwyn, Jr., et al. v. Metro-
Goldwyn-Mayer Studios Inc., et al., which had been pending in the Los Angeles
County Superior Court and in which the Company had been a defendant, was
dismissed by agreement between the parties. The plaintiff's complaint,
originally served in October 1997, had alleged, among other things, fraud and
deceit, breach of various agreements, breach of fiduciary duty, trademark
infringement and unfair competition. The complaint had sought, among other
relief, damages in excess of $5 million, an injunction against the defendants'
use of the trademarks covered by the trademark license, injunctive relief
preventing the Company from using the "Goldwyn" name in connection with the
licensing or exhibition of any new film that had not been acquired by G2
Films, termination of a distribution agreement and unspecified punitive
damages.
 
  On November 17, 1997, the Company and Danjaq filed an action in federal
court in Los Angeles against Sony, Sony Pictures, Columbia, John Calley, Kevin
McClory and Spectre seeking declaratory and injunctive relief and/or damages
for copyright infringement, trademark dilution, slander of title, unfair
competition, inducing breach of contract and breach of fiduciary duties, and
misappropriation of trade secrets, based on Sony Pictures' publicized
assertion on October 13, 1997 that it had the right (together with Mr.
McClory) to create its own James Bond film franchise.
 
  Prior to 1959, Ian Fleming authored a number of novels depicting the
adventures of James Bond, and commencing in 1959, Mr. Fleming and Kevin
McClory collaborated on the development of certain plot lines and treatments
and a script entitled Thunderball, featuring the James Bond character. In that
connection, Mr. McClory ultimately acquired from Mr. Fleming certain rights to
make a feature film using the James Bond character in these plot lines. Mr.
Fleming thereafter wrote a novel of the same name. In 1961, Mr. McClory
commenced litigation against Mr. Fleming with regard to the script, the novel
and certain related rights.
 
  In 1962, prior to the settlement of the Fleming-McClory litigation, Mr.
Fleming effectively granted to a predecessor-in-interest of Danjaq the
exclusive worldwide rights to, among other things, make films based on Mr.
Fleming's existing or future James Bond novels (other than Thunderball or
Casino Royale) and to create original screenplays about the adventures of
James Bond not based on Mr. Flemings's James Bond novels. This agreement
further provides that the film rights to the Thunderball novel that were the
subject of the Fleming-McClory litigation would also be transferred to
Danjaq's predecessor to the extent Mr. Fleming was permitted to transfer such
rights following completion of the litigation.
 
  The Fleming-McClory litigation was resolved in 1963 by a settlement among
Mr. Fleming, Mr. McClory and the other parties to the litigation in which Mr.
McClory acknowledged that Mr. Fleming was the creator and proprietor of the
James Bond character. Pursuant to that settlement, Mr. McClory was, in effect,
given the film rights in the Thunderball documents and scripts attached to the
settlement agreement, the rights to reproduce any part of Mr. Flemings's
Thunderball novel in a film and to exhibit any such film in any manner
whatsoever and the rights to use the James Bond character in the film
Thunderball. The Company believes these rights, at most, give Mr. McClory the
right to make films of the story in the novel Thunderball (i.e. a "remake" of
Thunderball). Mr. McClory produced the film Thunderball (with UA and Danjaq)
in 1965. Mr. McClory has at various times since 1963 taken the position that
he has broader rights to use the James Bond character than simply remake
Thunderball, but since 1965 he has only made the 1983 film Never Say Never
Again, which Mr. McClory claimed was a remake of the film Thunderball.
 
  The complaint filed in November 1997 by the Company and Danjaq seeks various
forms of legal relief based on the Company's position that the defendants do
not have any legal right to produce or distribute a franchise of James Bond
films, or any James Bond films, in the United States. On January 23, 1998, the
Company and Danjaq filed an amended complaint adding claims for trademark
infringement, federal unfair competition
 
                                      25
<PAGE>
 
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 the rights during the current term of
the copyright to make films using the James Bond character and other aspects
of Ian Fleming's James Bond novels were acquired by Danjaq. The Company and
Danjaq now co-own most of these rights. They also contend that Mr. Calley
misappropriated trade secret information about the James Bond franchise when
he left UA Pictures for Sony Pictures. On February 12, 1998, Sony Pictures 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 Pictures 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.
Mr. McClory answered the complaint on March 19, 1998, asserting contentions
similar to Sony Pictures'. On April 10, 1998, the Company and Danjaq filed a
motion to dismiss a portion of one of Sony Pictures' claims for relief, the
Third Claim For Relief seeking an accounting of the Company's and Danjaq's
profits in exploiting the James Bond franchise. While that motion was pending,
but before it was heard, Sony Pictures and Columbia on May 1, 1998 filed a
First Amended Counterclaim making certain modifications to their claims,
including a modification to the Third Claim For Relief so that it no longer
seeks an accounting but instead seeks damages for copyright infringement. On
May 19, 1998, the Company and Danjaq filed a motion for preliminary injunction
on the copyright and trademark issues to preclude Sony Pictures from
preparation, production, distribution, advertising or other exploitation of a
James Bond motion picture. On July 29, 1998, that motion was granted and
Sony Pictures, Columbia and the other defendants were preliminarily enjoined
from the production, preparation, distribution, advertising or other
exploitation in the United States of a James Bond motion picture in any medium
and from using the "James Bond" and the "James Bond 007" trademarks in the
United States. The defendants appealed the District Court's order granting the
preliminary injunction to the United States Court of Appeals for the Ninth
Circuit. On December 2, 1998, the Ninth Circuit affirmed the District Court's
order granting the preliminary injunction. Thereafter, defendants filed a
petition for rehearing en banc, which was denied by a three-judge panel of the
Ninth Circuit on December 28, 1998. On March 29, 1999, the Company and Danjaq
entered into a settlement agreement with the Sony Parties that provided for a
payment by the Sony Parties and pursuant to which the Sony Parties entered
into an agreement which effectively makes permanent the court's July 1998
preliminary injunction. Specifically, the Sony Parties agreed (i) not to make
or distribute any James Bond motion pictures in the United States based on
Thunderball or any other purported rights deriving from Mr. McClory, and (ii)
not to utilize the "James Bond" and the "James Bond 007" trademarks in the
United States. Mr. McClory and Spectre did not participate in this settlement
agreement. The Sony Parties have reassigned their counterclaims for copyright
infringement to Mr. McClory, and the court has set a status conference for May
3, 1999 to allow Mr. McClory time to inform the court whether or not he wishes
to pursue that claim.
 
  Under the terms of a separate agreement entered into on March 29, 1999, the
Company and Danjaq acquired from Columbia all of Columbia's rights to the 1967
James Bond film entitled Casino Royale and the Sony Parties agreed to broaden
the contractual prohibition regarding making or distributing James Bond films
and the James Bond trademarks, as described in the prior paragraph, throughout
the world. See "Item 1. Business--Film and Television Library."
 
  The Company believes that a remake of Thunderball by Mr. McClory would not
have a material adverse effect on the Company's business or results of
operations. However, a determination that Mr. McClory has 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 he
has 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
 
                                      26
<PAGE>
 
in an unstated amount. In response to the plaintiffs' complaint, the Company
has denied all of plaintiffs' allegations, including their claims for breach
of both oral and written contract. On December 31, 1997 and March 2, 1998, the
Company filed consecutive motions to dismiss. The motions were granted in
part, leaving only plaintiffs' claims for breach of oral contract, fraud,
negligent misrepresentation and interference with prospective economic
advantage. Discovery is ongoing. Based upon information to date, the Company's
management believes that it is unlikely that the plaintiffs' claims will have
a material adverse effect on the Company's financial condition or results of
operations. The Company plans vigorously to defend itself against such claims.
 
  On February 2, 1999, the United States Department of Justice (Antitrust
Division), in the course of an antitrust investigation, issued a CID to the
Company, requiring it to produce certain documents and answer certain
interrogatories concerning conduct, activities or proposed action in the
motion picture exhibition industry. The Company believes that similar demands
were issued to other major studios. The Company is in the process of complying
with the CID. While the Company has communicated with the Department of
Justice regarding the investigation, the Company believes it is too early to
determine the Department of Justice's intentions and whether the Company is a
target of the investigation.
 
  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
 
  In connection with the Rights Offering, the Company amended its Amended and
Restated Certificate of Incorporation (the "Amendment") in order to increase
the number of shares of the Common Stock authorized thereunder from
125,000,000 to 250,000,000. The Amendment ensured that the Company had enough
authorized shares to effect the Rights Offering and to allow for other future
issuances by the Company. The Amendment was approved by the Board of Directors
of the Company and the Tracinda Group, which represents a majority of the
outstanding Common Stock. Pursuant to Section 228 of the Delaware General
Corporation Law, the Company notified all holders of Common Stock of this
action by way of the prospectus issued in connection with the Rights Offering
(which also served as an Information Statement pursuant to Rule 14c-2 under
the Exchange Act). The approval by the Tracinda Group (in the form of a
written consent) was sufficient to satisfy the applicable requirements under
Delaware law that the Amendment be approved by the stockholders of the
Company. No further approval by or meeting of holders of the Common Stock was
required in connection with the Amendment. Thus, the Company did not solicit
any proxies or consents in connection with the Amendment. The Amendment took
effect upon the completion of the Rights Offering.
 
Item 4(a). Executive Officers of the Company
 
  Frank G. Mancuso, age 65, 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.
 
  A. Robert Pisano, age 56, was appointed as a director and Vice Chairman of
the Board of Directors of the Company immediately following the IPO. 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.
 
                                      27
<PAGE>
 
  William A. Jones, age 57, 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.
 
  Daniel J. Taylor, age 42, has been Senior Executive Vice President and Chief
Financial Officer of the Company and MGM Studios since June 1998 and, prior
thereto, was Executive Vice President--Corporate Finance since August 1997.
From May 1991 to July 1997, Mr. Taylor served as an executive of Tracinda.
Prior thereto, Mr. Taylor served as Vice President--Taxes and in various other
capacities at the predecessor of the Company, from 1985 to May 1991.
 
  Robert Brada, age 33, has been Executive Vice President and General Counsel
of the Company and MGM Studios since August 1998 and, prior thereto, served as
Executive Vice President of the Company and MGM Studios from June 1998 through
August 1998 and was Senior Vice President and Deputy General Counsel since
June 1995. Prior to joining MGM Studios, Mr. Brada was with the law firm of
White & Case LLP in its Los Angeles and Paris offices from 1990 to June 1995.
 
                                      28
<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 19, 1999 the closing sale
price per share of the Common Stock on the NYSE, as reported by the Dow Jones
News Retrieval, was $11.31. 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, 1998.
 
<TABLE>
<CAPTION>
                                                                 High     Low
                                                               -------- -------
   <S>                                                         <C>      <C>
   1997
     Fourth Quarter (November 13-December 31, 1997)........... $21 7/8  $19 3/8
   1998
     First Quarter............................................  24 1/2   17 1/2
     Second Quarter...........................................  27       21 1/2
     Third Quarter............................................  22 3/16  13 7/8
     Fourth Quarter...........................................  13 3/16   7 1/8
</TABLE>
 
  As of March 19, 1999, there were 150,873,728 shares issued and outstanding
and in excess of 2000 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 facility
contains 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.
 
Recent Sales of Unregistered Securities
 
  Pursuant to Mr. Mancuso's employment agreement, Mr. Mancuso receives an
annual stock purchase payment of $3 million (payable annually in advance in
November of each year), out of the after tax proceeds of which he is required
to purchase shares of the Common Stock. For the year ended December 31, 1998,
Mr. Mancuso purchased 159,082 shares of the Common Stock for aggregate
consideration of approximately $3.0 million. Registration was not required
because the transactions did not involve a public offering under Section 4(2)
under the Securities Act of 1933, as amended (the "Securities Act"). See "Item
11. Executive Compensation--Employment Agreements--Frank G. Mancuso."
 
  For the year ended December 31, 1998, the Company contributed an aggregate
of 42,116 shares of unregistered Common Stock valued at approximately $891,000
as its matching contribution to the MGM Savings Plan (the "Savings Plan"). In
addition, in connection with the Rights Offering and as required by the
Savings Plan, the trustee of the Savings Plan purchased 8,189 shares of
unregistered Common Stock from the Company for an aggregate of $91,107,
representing the proceeds from the sale of the subscription rights received by
the Savings Plan in the Rights Offering. Registration for such shares was not
required because the transactions did not constitute "sales" under Section
2(3) of the Securities Act. On August 7, 1998, the Company filed a
registration statement on Form S-8 with the Commission with respect to up to
one million shares of Common Stock authorized to be issued pursuant to the
Savings Plan.
 
                                      29
<PAGE>
 
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 1994 and
1995, the period from January 1 to October 10, 1996, the period from October
11 to December 31, 1996 and the years ended December 31, 1997 and 1998 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 years ended December 31, 1997 and
1998, 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
PricewaterhouseCoopers LLP, independent public accountants.
 
  The selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Consolidated Financial Statements and the
related Notes thereto included elsewhere in this Form 10-K.
 
                                      30
<PAGE>
 
<TABLE>
<CAPTION>
                          Predecessor                            Successor
                          -----------                            ---------
                               Year Ended         January 1 to   October 11 to       Year Ended
                              December 31,        October 10,    December 31,       December 31,
                             1994        1995         1996          1996(2)     1997(2)(4)  1998(2)(4)
                          ----------  ----------  ------------   ------------- -----------  ----------
                          (in thousands, except share data)
<S>                       <C>         <C>         <C>            <C>           <C>          <C>
Statements of Operations
 Data
Revenues................  $  597,121  $  860,971   $ 912,706      $   228,686  $   831,302  $1,240,723
Expenses:
 Films and television
  production and
  distribution..........     668,516     894,280     953,820          195,076      799,539   1,191,848
 General and
  administration
  expenses..............      49,314      64,175      60,056           18,319       87,644      92,244
 Severance and related
  costs.................         --          --          --               --           --       13,182
 Goodwill amortization..      14,876      14,876      11,570            1,717       11,230      14,289
 Provision for
  impairment............         --          --      563,829(3)           --           --          --
                          ----------  ----------   ---------      -----------  -----------  ----------
                             732,706     973,331   1,589,275          215,112      898,413   1,311,563
Operating income (loss).    (135,585)   (112,360)   (676,569)          13,574      (67,111)    (70,840)
Interest expense, net of
 amounts capitalized....     (33,860)    (66,386)    (71,375)          (9,875)     (53,105)    (80,611)
Interest and other
 income, net............       2,070      10,372       3,179              813        2,447       3,984
                          ----------  ----------   ---------      -----------  -----------  ----------
Income (loss) before
 provision for income
 taxes..................    (167,375)   (168,374)   (744,765)           4,512     (117,769)   (147,467)
Income tax provision ...      (3,877)       (935)       (273)          (4,346)     (10,345)    (10,181)
                          ----------  ----------   ---------      -----------  -----------  ----------
Net income (loss).......  $ (171,252) $ (169,309)  $(745,038)     $       166  $  (128,114) $ (157,648)
                          ==========  ==========   =========      ===========  ===========  ==========
Earnings (loss) per
 share:
 Basic..................                                          $      0.01  $     (4.47) $    (2.08)
                                                                  ===========  ===========  ==========
 Diluted................                                          $      0.00  $     (4.47) $    (2.08)
                                                                  ===========  ===========  ==========
Weighted average number
 of common shares
 outstanding
 Basic..................                                           16,692,217   28,634,362  75,816,326
                                                                  ===========  ===========  ==========
 Diluted................                                           37,796,672   28,634,362  75,816,326
                                                                  ===========  ===========  ==========
Other Operating Data
 (unaudited)
Cash flow from operating
 activities.............  $  216,289  $  371,657   $ 343,137      $    61,328  $   245,318  $  433,543
Cash flow from investing
 activities.............    (464,031)   (710,812)   (380,142)      (1,390,861)  (1,285,674)   (903,922)
Cash flow from financing
 activities.............     239,965     328,029      44,852        1,345,394    1,028,784     521,566
EBITDA(1)...............    (103,499)    (81,588)    (87,289)          16,709      (49,098)    (47,987)
Capital expenditures....       9,099       9,376       6,901            2,079        9,555      14,005
Depreciation expense....       5,335       4,021       4,645            1,418        6,783       8,564
Balance Sheet Data
Cash and cash
 equivalents............  $   28,797  $   17,128   $  24,717      $    16,381  $     3,978  $   54,839
Film and television
 costs, net.............   1,412,607   1,565,438   1,006,402        1,099,201    1,867,126   2,076,663
Total assets............   2,235,622   2,440,254   1,744,234        1,774,668    2,822,654   3,158,978
Bank and other debt.....     876,866   1,217,316   1,229,499          444,427      890,508     715,574
Stockholders' equity....     829,059     659,499         --           903,122    1,378,555   1,919,657
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 "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.
 
                                      31
<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 these forward-looking statements.
 
  The following discussion and analysis should be read in conjunction with the
"Item 6. Selected Consolidated Financial Data" and the Company's 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. 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, results of operations and cash flows. 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 any of the periods presented herein. Deferred
gains and losses on foreign exchange contracts as of December 31, 1998 were
not material. See "Item 7A. Quantitative and Qualitative Disclosures about
Market Risk."
 
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
 
                                      32
<PAGE>
 
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.
 
  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 the WGA, the DGA and the SAG. 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 (when CDR announced its intention
to sell MGM Studios) through the sale of MGM Studios on October 10, 1996, no
new production was approved, and accordingly, production expenditures on new
films decreased significantly during 1996. Following the MGM Acquisition in
October 1996, production activity increased as the Company resumed a
normalized production and distribution 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 at least
through the end of 1999.
 
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 (assuming it has been shipped) 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 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
 
                                      33
<PAGE>
 
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 film or television
program recognizes a substantial portion of its ultimate revenues within the
first two years of release. By then, a film has been exploited in the domestic
and international theatrical markets and the domestic and international home
video markets, as well as the domestic and international pay television and
pay-per-view markets, and a television program has been exploited on network
television or in first-run syndication. A similar portion of the film's or
television program's capitalized costs should be expected to be amortized
accordingly, assuming the film or television program 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 at
least through the end of 1999, and thus the fluctuations caused by this
accounting method may have a greater impact, than otherwise might be the case.
 
  In October 1998, the Financial Accounting Standards Board issued an Exposure
Draft on a proposed Statement of Position (the "Proposed SOP") for "Accounting
By Producers and Distributors of Films." If adopted, the Proposed SOP would
establish new accounting and reporting standards for all producers and
distributors that own or hold the rights to distribute or exploit films. The
Proposed SOP provides that the cumulative effect of changes in accounting
principles caused by adoption of the provisions of the SOP should be included
in the determination of net income in conformity with Accounting Principles
Board Opinion No. 20, "Accounting Changes." If adopted, the Proposed SOP, as
currently drafted, would be effective for financial statements for fiscal
years beginning after December 15, 1999, with earlier adoption encouraged.
 
                                      34
<PAGE>
 
Results of Operations
 
 Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
 
  The following table sets forth the Company's operating results for the year
ended December 31, 1998 and 1997. The 1997 results are not comparable to
results in 1998 due to the acquisition of Orion on July 10, 1997.
 
<TABLE>
<CAPTION>
                                                         Year Ended December
                                                                 31,
                                                            1998       1997
                                                         ----------  ---------
                                                            (in thousands)
<S>                                                      <C>         <C>
Revenues:
  Feature films......................................... $1,005,747  $ 699,219
  Television programs...................................    197,759    114,200
  Other.................................................     37,217     17,883
                                                         ----------  ---------
    Total revenues...................................... $1,240,723  $ 831,302
                                                         ==========  =========
Operating income (loss):
  Feature films......................................... $   39,748  $  65,509
  Television programs...................................     12,885     (7,201)
  Other.................................................     (3,758)   (26,545)
  General and administration expenses...................    (92,244)   (87,644)
  Severance and related costs...........................    (13,182)       --
  Goodwill amortization.................................    (14,289)   (11,230)
                                                         ----------  ---------
Operating loss..........................................    (70,840)   (67,111)
Interest expense, net of amounts capitalized............    (80,611)   (53,105)
Interest and other income (expense), net................      3,984      2,447
                                                         ----------  ---------
Loss before provision for income taxes..................   (147,467)  (117,769)
Income tax provision....................................    (10,181)   (10,345)
                                                         ----------  ---------
Net loss................................................ $ (157,648) $(128,114)
                                                         ==========  =========
</TABLE>
 
  Feature Films. Feature film revenues increased by $306.5 million, or 44
percent, to $1,005.7 million in the year ended December 31, 1998 compared to
the year ended December 31, 1997. Explanations for the changes in revenues are
discussed in the following paragraphs.
 
  Worldwide theatrical revenues increased by $139.3 million, or 135 percent,
to $242.2 million in 1998 due to significant worldwide theatrical revenues
earned by Tomorrow Never Dies, The Man In The Iron Mask and Ronin, as well as
the release in the domestic theatrical marketplace of Disturbing Behavior and
Dirty Work, among others. In 1997 the Company initially released Tomorrow
Never Dies in worldwide theatrical markets (in December 1997), and in the
domestic theatrical marketplace released Hoodlum and Red Corner, among others.
Overall, in 1998 the Company released 12 new feature films domestically and
four new films internationally, as compared to 15 films released domestically
and two new films internationally in 1997. Of the films released in 1997,
seven films were produced by Orion and six of these were released in limited
distribution only, as compared to three films produced by Orion and released
in limited distribution only in 1998.
 
  Worldwide home video revenues increased by $140.8 million, or 40 percent, to
$491.2 million in 1998, which included the release in the domestic rental
market of Tomorrow Never Dies, The Man In The Iron Mask, Red Corner, Species 2
and Hoodlum, among others, as compared to the release of Kingpin and Fled in
the domestic rental market in 1997. In 1998 the Company also re-released in
the sell-through market Gone With The Wind, as compared to the sell-through
releases of Larger Than Life, The Birdcage and Warriors of Virtue in 1997.
Significant international home video releases in 1998 included Tomorrow Never
Dies and The Man In The Iron Mask, as compared to GoldenEye, Get Shorty, The
Birdcage and Fled, in 1997. Additionally, in 1998 the Company distributed the
Orion library for the entire year as compared to a shorter period in 1997
(from the acquisition date of July 10, 1997).
 
                                      35
<PAGE>
 
  Worldwide pay television revenues from feature films decreased by $11.1
million, or 10 percent, to $96.5 million in 1998, primarily due to a lack of
significant new releases in international pay television markets in 1998 as
compared to 1997, which included GoldenEye, Get Shorty, Species and The
Birdcage. In the domestic pay television market, in 1998 the Company released
Tomorrow Never Dies, Red Corner and Hoodlum, as compared to The Birdcage and
Kingpin, among others, in 1997. Network television revenues from feature films
increased by $30.6 million, or 208 percent, to $45.3 million in 1998,
principally due to the delivery of eight new films to network television in
1998, including The Birdcage and GoldenEye, as compared to seven new films
delivered in 1997. Worldwide syndicated television revenues from feature films
decreased by $2.4 million, or two percent, to $121.2 million in 1998
principally due to lower international sales from library films, partially
offset by the distribution of the Orion film library for the entire year in
1998 as compared to the shorter period from acquisition in 1997.
 
  Other feature film revenues increased $9.3 million in 1998 due to certain
audit recoveries, miscellaneous rebates and other income collected in the
period.
 
  Operating income from feature films decreased by $25.8 million, or 39
percent, to $39.7 million in 1998 as compared to 1997. The decrease in
operating results in 1998 reflects increased amortization expense, in addition
to feature film write-downs which aggregated $80.0 million on certain
releases, partially offset by profit realized from the films Tomorrow Never
Dies and The Man In The Iron Mask. Feature film write-downs were $38.1 million
in 1997.
 
  Television Programming. Television programming revenues increased by $83.6
million, or 73 percent, to $197.8 million in 1998 as compared to 1997. Network
television revenues were $31.3 million in 1998, consisting of the deliveries
of the new series The Magnificent Seven, the television miniseries Creature
and one made-for-television movie. There were no series, mini-series or
television movies on network television in 1997. Worldwide pay television
revenues decreased by $2.0 million, or six percent, to $30.3 million in 1998.
Pay television revenues in both years included three series in broadcast on
domestic pay television, The Outer Limits, Poltergeist and Stargate SG-1, and
three made-for-television movies delivered in each year. The decrease in
worldwide pay television revenues in 1998 was due to lower international
library sales. Worldwide syndicated television revenues increased by $41.1
million, or 67 percent, to $101.9 million in 1998, primarily due to the
addition of the new series Stargate SG-1 and Fame LA in worldwide syndication,
as well as additional years of the ongoing series The Outer Limits and
Poltergeist, the delivery of the new series Flipper in domestic syndication,
and the licensing of the international rights to the television mini-series
Creature. Worldwide home video revenues with respect to television programming
increased by $5.7 million, or 34 percent, to $22.7 million in 1998 due to the
domestic home video releases of An All Dogs Christmas Carol, Secret of NIMH 2,
Garth Brooks Live In Concert and the television movie Twelve Angry Men, as
compared to the home video release of Babes In Toyland in 1997. The remaining
television programming revenue increase of $7.5 million was principally
related to a payment received from a third party for the rights to create new
episodes of Hollywood Squares.
 
  Operating income from television programming increased by $20.1 million to
$12.9 million in 1998 as compared to a loss of $7.2 million in 1997. The
increase in operating results in 1998 was principally a result of the
aforementioned increase in revenues and the receipt of the Hollywood Squares
remake rights payment.
 
  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, as well
as music soundtrack and royalty income. The Company recognized an operating
loss from other businesses of $3.8 million in 1998 as compared to an operating
loss of $26.5 million in 1997. Operating results in 1998 include interactive
revenue of $7.6 million, consumer products revenue of $10.3 million and music
soundtrack and royalty revenue of $6.6 million, as compared to interactive
revenue of $3.0 million, consumer products revenue of $8.7 million and music
soundtrack and royalty revenue of $4.1 million in 1997. Interactive revenues
in 1998 were principally derived from the release of the interactive game
Wargames. There were no significant new interactive games released in 1997.
Additionally, operating
 
                                      36
<PAGE>
 
results in 1998 include the receipt of a $10.0 million payment associated with
the Company's sale of a portion of its investment in a Japanese pay television
channel to a new partner. Expenses for other businesses in 1998 include
interactive product and development costs of $16.5 million, as compared to
similar costs of $16.8 million in 1997. In addition, operating results for
other businesses in 1998 include aggregate losses of $12.5 million on the
Company's equity investments, including its interest in MGM Gold (Asia), a
satellite and cable delivered channel based in Asia whose operations were
terminated in April 1998, and the Company's newly launched cable programming
joint venture, MGM Networks Latin America, as compared to $14.2 million for
such start-up losses in 1997.
 
  General and Administration Expenses. General and administration expenses
increased by $4.6 million, or five percent, to $92.2 million in 1998 as
compared to 1997, primarily due to increased legal and professional fees of
$2.4 million, executive severance charges (incurred prior to implementation of
the restructuring program noted below) of $2.6 million, and increased rent and
depreciation expense of $4.3 million. Additionally, in 1997 the Company
benefited from certain insurance recoveries of $5.7 million. There were no
such recoveries in 1998. In 1997, long-term incentive and other bonuses were
$15.5 million as compared to $3.2 million in 1998. The Company also achieved
certain cost savings in 1998 from a restructuring program initiated in the
period (see "--Severance and Related Costs").
 
  Severance and Related Costs. The Company incurred severance and related
costs of $13.2 million in 1998, due to an overhead restructuring program
initiated by management in the third quarter of 1998. The Company expects to
receive certain cost savings in future periods due to the implementation of
this program.
 
  Goodwill Amortization. Goodwill amortization increased by $3.1 million, or
27 percent, to $14.3 million in 1998 as compared to 1997 as a result of higher
goodwill due to the Orion Acquisition.
 
  Interest Expense, Net of Amounts Capitalized. Net interest expense increased
by $27.5 million, or 52 percent, to $80.6 million in 1998 as compared to 1997,
primarily due to higher debt levels associated with the financing of the Orion
Acquisition, as well as borrowings for increased operating and production
activities.
 
  Income Tax Provision. The income tax provision of $10.2 million in 1998 and
$10.3 million in 1997 primarily reflect foreign remittance taxes attributable
to international distribution revenues.
 
 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
  In connection with the MGM Acquisition, all of the assets and liabilities of
MGM Studios, including the Library as it then existed, 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.
 
                                      37
<PAGE>
 
  The following table sets forth the Company's operating results 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.
 
<TABLE>
<CAPTION>
                             Successor     Successor   Predecessor    Combined
                            ------------ ------------- ------------ ------------
                             Year Ended  October 11 to January 1 to  Year Ended
                            December 31, December 31,  October 10,  December 31,
                                1997         1996          1996         1996
                            ------------ ------------- ------------ ------------
                                               (in thousands)       (unaudited)
<S>                         <C>          <C>           <C>          <C>
Revenues:
  Feature films...........   $ 699,219     $209,354     $ 815,460    $1,024,814
  Television programs.....     114,200       14,413        82,315        96,728
  Other...................      17,883        4,919        14,931        19,850
                             ---------     --------     ---------    ----------
    Total revenues........   $ 831,302     $228,686     $ 912,706    $1,141,392
                             =========     ========     =========    ==========
Operating income (loss):
  Feature films...........   $  65,509     $ 37,140     $ (54,268)   $  (17,128)
  Television programs.....      (7,201)      (4,062)       11,412         7,350
  Other...................     (26,545)         532         1,742         2,274
  General and
   administration
   expenses...............     (87,644)     (18,319)      (60,056)      (78,375)
  Goodwill amortization...     (11,230)      (1,717)      (11,570)      (13,287)
  Provision for
   impairment.............         --           --       (563,829)     (563,829)
                             ---------     --------     ---------    ----------
Operating income (loss)...     (67,111)      13,574      (676,569)     (662,995)
Interest expense, net of
 amounts capitalized......     (53,105)      (9,875)      (71,375)      (81,250)
Interest and other income,
 net......................       2,447          813         3,179         3,992
                             ---------     --------     ---------    ----------
Income (loss) before
 provision for income
 taxes....................    (117,769)       4,512      (744,765)     (740,253)
Income tax provision......     (10,345)      (4,346)         (273)       (4,619)
                             ---------     --------     ---------    ----------
Net income (loss).........   $(128,114)    $    166     $(745,038)   $ (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. Tomorrow Never Dies was initially released in December
1997 and earned 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 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,
 
                                      38
<PAGE>
 
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. 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.
 
  Operating income from feature films was $65.5 million in 1997 as compared to
a loss of $17.1 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: The Legacy 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.
 
  The Company recognized an operating loss from television programming of $7.2
million in 1997 as compared to operating income 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 canceled, 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, as well
as music soundtrack and royalty income. The Company recognized an operating
loss from other businesses of $26.5 million in 1997 as compared to operating
income of $2.3 million in 1996. Operating results in 1997 include interactive
revenues of $3.0 million, consumer products revenue of $8.7 million and music
soundtrack and royalty revenue of $4.1 million, as compared to interactive
revenue of $1.8 million, consumer products revenue of $8.3 million and music
soundtrack and royalty revenue of $5.6 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 whose operations were terminated in April 1998, and $2.4 million of
start-up costs associated with the Company's newly launched cable programming
joint venture, MGM Networks Latin America. There were no such start-up losses
or costs in 1996.
 
  General and Administration Expenses. General and administration expenses
increased by $9.3 million, or 12 percent, to $87.6 million in 1997 as compared
to 1996, primarily as a result of the Orion Acquisition, 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.
 
  Goodwill Amortization. Goodwill amortization decreased by $2.1 million, or
15 percent, to $11.2 million in 1997 compared to 1996 due to the revaluation
of the Company's assets and liabilities pursuant to purchase
 
                                      39
<PAGE>
 
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 IPO and the Tracinda
Purchase, 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.
 
EBITDA
 
  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 generally accepted accounting principles. EBITDA does not
reflect cash 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.
 
                                      40
<PAGE>
 
  The following table sets forth EBITDA for the years ended December 31, 1998
and 1997, the period from October 11, 1996 to December 31, 1996, and the
period from January 1, 1996 to October 10, 1996:
 
<TABLE>
<CAPTION>
                                                                           Successor                             Predecessor
                                                                           ----------                            ------------
                                                                           Year Ended December     October 11 to January 1 to
                                                                                   31,             December 31,  October 10,
                                                                              1998       1997          1996          1996
                                                                           ----------  ---------  -------------- ------------
                                                                                            (in thousands)
<S>                                                                        <C>         <C>        <C>            <C>
Revenues:
  Feature films........................................................... $1,005,747  $ 699,219     $209,354     $ 815,460
  Television programs.....................................................    197,759    114,200       14,413        82,315
  Other...................................................................     37,217     17,883        4,919        14,931
                                                                           ----------  ---------     --------     ---------
    Total revenues........................................................ $1,240,723  $ 831,302     $228,686     $ 912,706
                                                                           ==========  =========     ========     =========
EBITDA:
  Feature films........................................................... $   39,748  $  65,509     $ 37,140     $ (45,032)
  Television programs.....................................................     12,885     (7,201)      (4,062)       11,412
  Other...................................................................     (3,758)   (26,545)         532         1,742
  General and administration expenses.....................................    (83,680)   (80,861)     (16,901)      (55,411)
  Severance and related costs.............................................    (13,182)       --           --            --
                                                                           ----------  ---------     --------     ---------
  EBITDA..................................................................    (47,987)   (49,098)      16,709       (87,289)
Depreciation and non-film amortization....................................    (22,853)   (18,013)      (3,135)      (25,451)
Provision for impairment..................................................        --         --           --       (563,829)
                                                                           ----------  ---------     --------     ---------
Operating income (loss)...................................................    (70,840)   (67,111)      13,574      (676,569)
Interest expense, net of amounts capitalized..............................    (80,611)   (53,105)     (9,875)       (71,375)
Interest and other income (expense), net..................................      3,984      2,447          813         3,179
                                                                           ----------  ---------     --------     ---------
Income (loss) before provision for income taxes...........................   (147,467)  (117,769)       4,512      (744,765)
Income tax provision......................................................    (10,181)   (10,345)      (4,346)         (273)
                                                                           ----------  ---------     --------     ---------
Net income (loss)......................................................... $ (157,648) $(128,114)    $    166     $(745,038)
--------------------------------------------------
                                                                           ==========  =========     ========     =========
</TABLE>
 
Liquidity and Capital Resources
 
  General. The Company's operations are capital intensive. In recent years the
Company has funded its operations primarily from proceeds from (i) the sale of
equity securities, (ii) bank borrowings and (iii) internally generated funds.
Sales of equity securities include proceeds from the IPO and the Tracinda
Purchase, which were completed in November 1997, and the 1998 Rights Offering,
which was completed in November 1998. During the year ended December 31, 1998,
the net cash provided by operating activities was $433.5 million, the net cash
used in investing activities (primarily additions to film and television
costs) was $903.9 million, and the net cash provided by financing activities
(equity proceeds reduced by net bank repayments) was $521.6 million.
 
  Amended Credit Facility. The Company anticipates substantial continued
borrowing under its principal credit facility (the "Amended Credit Facility").
This $1.3 billion syndicated facility consists of (i) a six year $600 million
revolving credit facility (the "Revolving Facility"), (ii) a $400 million
seven and one-half year term loan ("Tranche A Loan") and (iii) a $300 million
eight and one-half year term loan ("Tranche B Loan" and, collectively with the
Tranche A Loan, the "Term Loans"). As of March 15, 1999, $203 million was
available under the Amended Credit Facility. The Amended Credit Facility also
contains provisions allowing, under certain circumstances, for an additional
$200 million tranche ("Tranche C Loan").
 
  Currently, the Revolving Facility and Tranche A Loan bear interest at 2.50
percent over the Adjusted LIBOR rate, as defined therein, and the Tranche B
Loan bears interest at 2.75 percent over the Adjusted LIBOR rate. As of
December 31, 1998, Adjusted LIBOR was approximately 5.44 percent. The Company
has entered into three-year fixed interest rate swap contracts in relation to
a portion of the Amended Credit Facility for a
 
                                      41
<PAGE>
 
notional value of $800 million at an average rate of approximately 7.5
percent, which expire at various times no later than December 2001. 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 at
maturity. The Revolving Facility was entered into in October 1997 and 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. The Amended Credit Facility was
amended, effective March 30, 1998 and September 9, 1998, to modify certain of
these financial covenants. The Company is currently in compliance with all
such covenants. However, no assurances can be given that the Company will
remain in compliance with such covenants or other conditions under the Amended
Credit Facility in the future.
 
  Factors Affecting Cash Flow in 1998; The 1998 Rights Offering. The Company's
cash flow in 1998 was adversely affected by, and the Company determined to
undertake the 1998 Rights Offering as a result of, several factors. First,
during 1998 the Company made and committed to make substantial investments
that are more extensive than previously anticipated in connection with
commitments entered into for new television programming. This new television
production includes an aggregate of approximately 100 additional episodes for
the Company's non-network programs. Such production also included 13 new
episodes of The Magnificent Seven (which was a network program and thus
produced at a greater deficit than the Company's non-network programs) for the
1998/99 television season. See "Item 1. Business--Production--Television
Production."
 
  Second, although Tomorrow Never Dies and The Man In The Iron Mask performed
better than anticipated, the Company's other major theatrical releases in 1998
performed below expectations. The Company's short-term cash flow has been and
will continue to be negatively affected by the unsuccessful releases,
particularly during the ten to 15 months after the release of such films.
Although the Company anticipates that the reduction in receipts due to the
performance of such underperforming films will ultimately be offset in part by
the increased ancillary cash receipts from the two successful releases, such
ancillary cash receipts will be realized over several years.
 
  Third, the Company's 1998 sales experience in the television syndication and
home video markets has indicated that the cash that the Company will collect
from these sources will be realized over a longer period than originally
anticipated. Fourth, during the first half of 1998, the Company accelerated
certain theatrical motion picture production in order to avoid the impact of
an industry strike that had been threatened in the second quarter of 1998.
Other factors include increases in marketing and distribution expenses that
were higher than anticipated.
 
  The Company consummated the 1998 Rights Offering in November 1998, issuing a
total of 84,848,485 shares of the Common Stock for $8.25 per share. The total
net proceeds to the Company were approximately $696.5 million (gross proceeds
of $700.0 million less applicable fees and expenses of approximately $3.5
million). A portion of the net proceeds from the 1998 Rights Offering was used
to repay in full the amounts outstanding under a $100 million bridge loan,
which had been accessed by the Company in September 1998 in order to enhance
the Company's liquidity prior to the completion of the 1998 Rights Offering.
The remainder of the net proceeds was used to reduce borrowings then
outstanding under the Revolving Facility.
 
  Current Capital Requirements. The Company's current strategy and business
plan call for substantial on-going investments, at levels comparable to 1998,
in the production of new feature films and television programs. Furthermore,
the Company may wish to continue to make investments in new distribution
channels to further exploit the Library. The Company plans to continue to
evaluate the level of such investments in the context of the capital available
to the Company and changing market conditions.
 
  In January 1999, the Company acquired the PFE Libraries, containing over
1,300 feature films that were previously owned by PolyGram, for $235 million.
The purchase was funded by borrowings under the Revolving Facility and
utilization of cash on hand.
 
                                      42
<PAGE>
 
  In March 1999, in consideration for the early expiration of the WHV
Agreement, the Company agreed to pay WHV $225 million, of which $112.5 million
was paid in March 1999 and the remaining $112.5 million installment is payable
in September 1999. Additionally, the Company reconveyed to WHV the rights that
the Company had to distribute in the home video markets worldwide until June
1, 2001, approximately 2,950 titles in the Turner library that had been
serviced under the WHV Agreement. This reconveyance to WHV was made effective
as of January 1, 1999. The Company intends to record a one-time pre-tax
contract termination charge in the first quarter of 1999 of approximately $225
million for costs in connection with terminating the WHV Agreement. The
Company anticipates that the reconveyance of the Turner rights will result in
decreased cash flow to the Company of approximately $10 million per year
through June 2001.
 
  The remaining $112.5 million installment (plus interest at the rate of eight
percent per year from March 1999) payable to WHV in September 1999 is secured
by a standby letter of credit issued by one of the Company's principal lenders
(the "Letter of Credit"). If the Letter of Credit is drawn upon, the Company
will be deemed to have accessed a seven and one-half year term loan from such
lender with a principal amount equal to the amount drawn. Such term loan would
bear interest at 3.5 percent over Adjusted LIBOR rate. Interest would be
payable quarterly in arrears and principal of such loan would be due on the
earlier of maturity or upon any equity or debt issuance by the Company.
 
  The Company is obligated to fund 50 percent of the expenses of MGM Networks
Latin America up to a maximum of approximately $24 million. The Company has
funded approximately $12.4 million under such obligation as of December 31,
1998. See "Item 1. Business--Distribution--International Pay and Free
Television."
 
  The Company expects to incur approximately $10 million of additional costs
in 1999 in connection with the integration of the PFE library and the
Company's transition to home video self-distribution. The Company's obligation
to pay other capital requirements, including the purchase of certain computer
systems and equipment and other improvements, are currently not expected to
exceed $15.0 million per year.
 
  In addition, the slate of films released by the Company in 1999 to date have
performed below expectations. As a result of these various factors (including,
in particular, the short-term costs associated with the accelerated
termination of the WHV Agreement), cash flow from operations and the amounts
available under the existing tranches of the Amended Credit Facility are not
expected to be adequate to meet the Company's obligations and commitments and
to enable the Company to continue to conduct is operations in accordance with
its current business plan through the end of 1999. Therefore, the Company is
currently considering various alternatives to increase the Company's capital
resources.
 
  The Company believes that several different sources of increased liquidity
may be available. The Company is currently considering various film financing
alternatives. Additionally, the Company may seek to access the $200 million
Tranche C Loan. Accessing the Tranche C Loan would require the consent of
lenders holding at least two-thirds of the amounts outstanding or available
under the Amended Credit Facility and the commitment by such (or other)
lenders of the requisite funds. The Company may also seek additional equity
financing, including through another rights offering. While management of the
Company believes that it will be able to obtain the requisite funds, no
assurance can be given that the Company will be able to obtain any such debt
or equity financing, or otherwise obtain the requisite funds, or that it will
be able to do so on a timely basis and on terms acceptable to the Company.
 
  If necessary in order to manage its cash needs, the Company may also seek to
reduce or delay its production or release schedules and to further increase
its use of co-production, split-rights or other partnering arrangements. There
can be no assurance that any such steps by the Company to reduce its cash
needs would be adequate or timely, or that acceptable arrangements could be
reached with third parties if necessary. In addition, although changes in the
Company's production or release schedule or the increased use of partnering
would diminish the Company's short-term cash needs and (in the case of
partnering) reduce the Company's risk relating to the performance of the
relevant films, such steps could adversely affect long term cash flow and
results of operations in subsequent periods.
 
                                      43
<PAGE>
 
  The Company intends to continue to pursue its goal of becoming an integrated
global entertainment company. In connection with its pursuit of this goal, the
Company may consider various strategic alternatives, such as business
combinations with companies with strengths complementary to those of the
Company and other acquisitions, as opportunities arise. The nature, size and
structure of any such acquisition could require the Company to seek additional
financing.
 
Year 2000 Data Conversion
 
  Impact of the Year 2000 Issue Introduction. The term "Year 2000 issue" is a
general term used to describe the various problems that may result from the
improper processing of dates and date-sensitive calculations by computers and
other machinery as the Year 2000 is approached and reached. These problems
generally arise from the fact that most of the world's computer hardware and
software have historically used only two digits to identify the year in a
date, often meaning that the computer will fail to distinguish dates in the
"2000's" from dates in the "1900's." These problems may also arise from other
sources as well, such as the use of special codes and conventions in software
that make use of the date field.
 
  State of Readiness. The Company's primary focus has been on its own internal
systems. To date, the Company has completed the Year 2000 conversion with
respect to all of its most critical computer systems and applications, which
constitute approximately 70 percent of the Company's Year 2000 sensitive
systems (together with those systems containing embedded microprocessors or
other technology, "Systems"). The Company is in the testing or remediation
phase with respect to the remainder of its Systems, which include most of the
Company's computer hardware and other equipment containing embedded
microprocessors or other technology. The Company expects to complete its Year
2000 conversion by June 30, 1999.
 
  Because of the substantial progress made by the Company towards its Year
2000 conversion, the Company does not anticipate that any additional
significant changes will be required or that the Year 2000 issue will pose
significant operational problems for the Company. However, if any necessary
changes are not made or completed in a timely fashion or unanticipated
problems arise, the Year 2000 issue may take longer for the Company to address
and may have a material impact on the Company's financial condition and
results of operations.
 
  In addition, the Company has had communications with certain of its
significant suppliers, distributors, financial institutions, lessors and
others with which it does business to evaluate their Year 2000 compliance
plans and state of readiness and to determine the extent to which the
Company's Systems may be affected by the failure of others to remediate their
own Year 2000 issues. The Company is also distributing a Year 2000 assessment
form to other parties, in order to provide the Company with further
information as to their Year 2000 conversion progress. To date, the Company
has received feedback from certain but not all of such parties, and has not
independently confirmed any information received with respect to the Year 2000
issues. As such, there can be no assurance that parties will complete their
Year 2000 conversion in a timely fashion or will not suffer a Year 2000
business disruption that may adversely affect the Company's financial
condition and results of operations.
 
  Costs to Address the Year 2000 Issue. To date, the Company estimates that it
has spent approximately $0.4 million to address the Year 2000 issue, with the
majority of the work being performed by Company employees. The aggregate cost
to achieve Year 2000 conversion is estimated to be approximately $1.3 million.
The Company intends to fund such costs from its operations and funds borrowed
under the Amended Credit Facility. The Company believes such costs will not
have a material adverse effect on its liquidity or financial condition.
However, as the Company progresses with its Year 2000 conversion and
implements any necessary changes to its Systems, certain additional costs may
be identified. There can be no assurance that such additional costs will not
have a material adverse effect on the Company's financial condition and
results of operations.
 
  Risks of Year 2000 Issues. To date, the Company has not identified any
System which presents a material risk of not being Year 2000 ready in a timely
fashion or for which a suitable alternative cannot be implemented. However, as
the Company progresses with its Year 2000 conversion, the Company may identify
Systems which
 
                                      44
<PAGE>
 
do present a material risk of Year 2000 disruption. Such disruption may
include, among other things, the inability to process transactions or
information, record and access data relating to the availability of titles in
the Company's library for licensing and distribution, send invoices or engage
in similar normal business activities. The failure of the Company to identify
Systems which require Year 2000 conversion that are critical to the Company's
operations or the failure of the Company or others with which the Company does
business to become Year 2000 ready in a timely manner could have a material
adverse effect on the Company's financial condition and results of operations.
 
  Contingency Plans. While the Company's Year 2000 conversion is expected to
be completed prior to any potential disruption to the Company's business, the
Company acknowledges the uncertainties involved in preparing its Systems for
the Year 2000. As such, the Company is developing a comprehensive Year 2000
specific contingency plan. As part of its Year 2000 contingency effort,
information received from external sources is examined for date integrity
before being brought into the Company's internal systems. If the Company
determines that its business or a segment thereof is at material risk of
disruption due to the Year 2000 issue or anticipates that its Year 2000
conversion will not be completed in a timely fashion, the Company will work to
further enhance its contingency plan.
 
  The discussion above contains certain forward-looking statements. The costs
of the Year 2000 conversion, the date which the Company has set to complete
such conversion and possible risks associated with the Year 2000 issue are
based on the Company's current estimates and are subject to various
uncertainties that could cause the actual results to differ materially from
the Company's expectations. Such uncertainties include, among others, the
success of the Company in identifying Systems that are not Year 2000
compliant, the nature and amount of programming required to upgrade or replace
each of the affected Systems, the availability of qualified personnel,
consultants and other resources, and the success of the Year 2000 conversion
efforts of others.
 
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
 
Impact of Interest Rate Changes
 
  The Company has only limited involvement in derivative financial instruments
and does not use them for trading purposes. Certain amounts borrowed under the
Company's Amended Credit Facility are at variable interest rates and the
Company is thus subject to market risk resulting from interest rate
fluctuations. The Company enters into interest rate swaps in part to alter
interest rate exposures. 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 amounts calculated by reference to an agreed notional
principal amount.
 
  The following table provides information about the Company's interest rate
swaps and foreign currency forward exchange contracts at December 31, 1998:
 
<TABLE>
<CAPTION>
                                   Amounts scheduled for
                                          maturity
                                    for the year ending
                                        December 31,               Estimated
                                 ----------------------------    fair value at
                                   1999      2000      2001    December 31, l998
                                 --------  --------  --------  -----------------
                                       (in thousands)
   <S>                           <C>       <C>       <C>       <C>
   Interest rate swaps
   Variable to fixed:
     Notional value............. $150,000  $225,000  $575,000       $(6,978)
     Average pay rate...........    6.164%    6.127%    5.237%
     Average receive rate.......    5.407%    5.404%    5.244%
</TABLE>
 
                                      45
<PAGE>
 
Impact of Foreign Currency Rate Changes
 
  Because approximately 25 percent of the Company's revenues are denominated
and the Company incurs certain operating and production costs in foreign
currencies, the Company is subject to market risks resulting from fluctuations
in foreign currency exchange rates. In certain instances, the Company 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.
 
  The following table provides information about the Company's sensitivity to
foreign currency exchange contracts into which the Company enters. The
contracts generally mature within one year. The Company currently intends to
continue to enter into such contracts to hedge against future material foreign
currency exchange rate risks.
 
<TABLE>
<CAPTION>
                                           Amounts scheduled
                                             for maturity         Estimated
                                          for the year ending   fair value at
                                           December 31, 1999  December 31, 1998
                                          ------------------- -----------------
                                                     (in thousands)
   <S>                                    <C>                 <C>
   $US Functional Currency
   Forward exchange agreements (receive
    $US / pay CAD )......................
     Contract amount.....................        $5,000             $205
     Average contractual exchange rate...      0.693481
</TABLE>
 
Item 8. Financial Statements and Supplementary Data
 
  The Report of Independent Public Accountants, the Company's Consolidated
Financial Statements and Notes thereto appear in a separate section of this
Form 10-K (beginning on page 51) 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
 
                                      46
<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.
 
                                      47
<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 51 to
    85.
 
     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 86 to
    93.
 
    3. Exhibits.
 
      The exhibits listed in the accompanying Exhibit Index on pages 94 to
    95 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, 1998.
 
                                      48
<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.
 
March 30, l999
                                          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 30, 1999
____________________________________  Directors, Chief Executive
          Frank G. Mancuso            Officer and Director
 
      /s/ A. Robert Pisano           Vice Chairman and Director    March 30, 1999
____________________________________
          A. Robert Pisano
 
        /s/ James Aljian             Director                      March 30, 1999
____________________________________
            James Aljian
 
    /s/ Francis Ford Coppola         Director                      March 30, 1999
____________________________________
        Francis Ford Coppola
 
      /s/ Willie D. Davis            Director                      March 30, 1999
____________________________________
          Willie D. Davis
 
   /s/ Alexander M. Haig, Jr.        Director                      March 30, 1999
____________________________________
       Alexander M. Haig, Jr.
 
       /s/ Kirk Kerkorian            Director                      March 30, 1999
____________________________________
           Kirk Kerkorian
 
      /s/ Alex Yemenidjian           Director                      March 30, 1999
____________________________________
          Alex Yemenidjian
 
       /s/ Jerome B. York            Director                      March 30, 1999
____________________________________
           Jerome B. York
 
      /s/ Daniel J. Taylor           Senior Executive Vice         March 30, 1999
____________________________________  President and Chief
          Daniel J. Taylor            Financial Officer
</TABLE>
 
                                      49
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Metro-Goldwyn-Mayer Inc.
 
Successor Consolidated Financial Statements:
  Report of Independent Public Accountants................................  51
  Consolidated Balance Sheets as of December 31, 1998 and 1997............  52
  Consolidated Statements of Operations and Comprehensive Income (Loss)
   for the Years Ended December 31, 1998, 1997 and the Period from October
   11, 1996 to December 31, 1996..........................................  53
  Consolidated Statements of Stockholders' Equity for the Years Ended
   December 31, 1998, 1997 and the Period from October 11, 1996 to
   December 31, 1996......................................................  54
  Consolidated Statements of Cash Flows for the Years Ended December 31,
   1998, 1997 and the Period from October 11, 1996 to December 31, 1996...  55
  Notes to Consolidated Financial Statements..............................  56
 
Metro-Goldwyn-Mayer Studios Inc.
 
Predecessor Consolidated Financial Statements:
  Report of Independent Public Accountants................................  76
  Consolidated Statement of Operations and Comprehensive Income (Loss) for
   the Period from January 1, 1996 to October 10, 1996....................  77
  Consolidated Statement of Stockholder's Equity for the Period from
   January 1, 1996 to October 10, 1996....................................  78
  Consolidated Statement of Cash Flows for the Period from January 1, 1996
   to October 10, 1996....................................................  79
  Notes to Consolidated Financial Statements..............................  80
 
Financial Statement Schedules
 
  Report of Independent Public Accountants................................  86
  Schedule I: Condensed Financial Information of Registrant...............  87
  Report of Independent Public Accountants................................  92
  Schedule II: Valuation and Qualifying Accounts..........................  93
</TABLE>
 
                                       50
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Metro-Goldwyn-Mayer Inc.:
 
  We have audited the accompanying consolidated balance sheets of Metro-
Goldwyn-Mayer Inc. (a Delaware corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity and cash flows for the years
then ended 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, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended 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 23, 1999 (except with respect to
the matter discussed in Note 15,
as to which date is March 12, 1999)
 
                                      51
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                                                      December 31, December 31,
                                                          1998         1997
                                                      ------------ ------------
<S>                                                   <C>          <C>
                       ASSETS
 
Cash and cash equivalents............................  $   54,839   $    3,978
Accounts and contracts receivable (net of allowance
 for doubtful accounts of $23,220 and $27,603,
 respectively).......................................     365,067      285,283
Film and television costs, net.......................   2,076,663    1,867,126
Investments and advances to affiliates...............      17,674        9,917
Property and equipment, net..........................      38,636       32,785
Excess of cost over net assets of acquired
 businesses, net.....................................     561,026      574,795
Other assets.........................................      45,073       48,770
                                                       ----------   ----------
                                                       $3,158,978   $2,822,654
                                                       ==========   ==========
 
        LIABILITIES AND STOCKHOLDERS' EQUITY
 
Liabilities:
  Bank and other debt................................  $  715,574   $  890,508
  Accounts payable and accrued liabilities...........     100,377      147,476
  Accrued participants' share........................     232,515      216,530
  Income taxes payable...............................      34,869       31,579
  Advances and deferred revenues.....................     130,664      130,329
  Other liabilities..................................      25,322       27,677
                                                       ----------   ----------
    Total liabilities................................   1,239,321    1,444,099
                                                       ----------   ----------
 
Commitments and contingencies
 
Stockholders' equity:
  Common stock, $.01 par value, 250,000,000 shares
   authorized, 150,856,424 and 65,765,655 shares
   issued and outstanding............................       1,509          658
  Additional paid-in capital.........................   2,203,490    1,504,850
  Deficit............................................    (285,596)    (127,948)
  Accumulated other comprehensive income.............         254          995
                                                       ----------   ----------
    Stockholders' equity.............................   1,919,657    1,378,555
                                                       ----------   ----------
                                                       $3,158,978   $2,822,654
                                                       ==========   ==========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       52
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
     CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                                           Year Ended December    October 11 to
                                                   31,            December 31,
                                             1998        1997         1996
                                          ----------  ----------  -------------
<S>                                       <C>         <C>         <C>
Revenues................................. $1,240,723  $  831,302   $  228,686
Expenses:
  Film and television production and
   distribution..........................  1,191,848     799,539      195,076
  General and administrative expenses....     92,244      87,644       18,319
  Severance and related costs............     13,182         --           --
  Goodwill amortization..................     14,289      11,230        1,717
                                          ----------  ----------   ----------
    Total expenses.......................  1,311,563     898,413      215,112
                                          ----------  ----------   ----------
Operating income (loss)..................    (70,840)    (67,111)      13,574
Other income (expense):
  Interest expense, net of amounts
   capitalized...........................    (80,611)    (53,105)      (9,875)
  Interest and other income, net.........      3,984       2,447          813
                                          ----------  ----------   ----------
    Total other expense..................    (76,627)    (50,658)      (9,062)
                                          ----------  ----------   ----------
Income (loss) from operations before
 provision for income taxes..............   (147,467)   (117,769)       4,512
Income tax provision.....................    (10,181)    (10,345)      (4,346)
                                          ----------  ----------   ----------
Net income (loss)........................   (157,648)   (128,114)         166
Foreign currency translation adjustment..       (741)       (150)       1,145
                                          ----------  ----------   ----------
Comprehensive income (loss).............. $ (158,389) $ (128,264)  $    1,311
                                          ==========  ==========   ==========
Earnings (loss) per share:
  Basic.................................. $    (2.08) $    (4.47)  $     0.01
                                          ==========  ==========   ==========
  Diluted................................ $    (2.08) $    (4.47)  $     0.00
                                          ==========  ==========   ==========
Weighted average number of common shares
 outstanding:
  Basic.................................. 75,816,326  28,634,362   16,692,217
                                          ==========  ==========   ==========
  Diluted................................ 75,816,326  28,634,362   37,796,672
                                          ==========  ==========   ==========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       53
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                            Preferred
                              Stock           Common Stock
                          ---------------  ------------------   Add'l     Retained   Accum. Other      Total
                           No. of    Par     No. of     Par    Paid-in     Earnings  Comprehensive Stockholders'
                           Shares   Value    Shares    Value   Capital    (Deficit)     Income        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
Issuance of common
 stock..................       --     --    85,090,769    851    697,084        --         --          697,935
Amortization of deferred
 stock compensation.....       --     --           --     --       1,556        --         --            1,556
Foreign currency
 translation adjustment.       --     --           --     --         --         --        (741)           (741)
Net loss................       --     --           --     --         --    (157,648)       --         (157,648)
                          --------  -----  ----------- ------ ----------  ---------     ------      ----------
Balance December 31,
 1998...................       --   $ --   150,856,424 $1,509 $2,203,490  $(285,596)    $  254      $1,919,657
                          ========  =====  =========== ====== ==========  =========     ======      ==========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       54
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
 
<TABLE>
<CAPTION>
                                                                   October 11 to
                                         Year Ended December 31,   December 31,
                                            1998         1997          1996
                                         ----------- ------------  -------------
<S>                                      <C>         <C>           <C>
Operating activities:
  Net income (loss)....................  $ (157,648) $   (128,114)  $       166
  Adjustments to reconcile net income
   (loss) to net cash provided by
   operating activities:
   Amortization of film and television
    costs and participants' share......     751,807       429,003        83,508
   Depreciation and amortization of
    property and equipment.............       8,564         6,783         1,418
   Amortization of goodwill and
    deferred financing costs...........      19,985        16,323         2,761
   Reduction in goodwill due to
    realization of tax benefits........         --            --          1,206
   Amortization of deferred executive
    compensation.......................       1,556           --            --
   Stock contributions to employee
    savings plan.......................       1,435           --            --
   Increase in bad debt and other
    reserves...........................         467         6,382           --
   Losses (gains) on equity
    investments, net...................      10,887        17,620        (2,592)
   (Increase) decrease in accounts and
    contracts receivable and other
    assets.............................     (81,436)       35,054        12,895
   Decrease in accounts payable,
    accrued and other liabilities,
    accrued participants' share and
    domestic and foreign taxes.........    (121,264)      (99,455)      (31,542)
   Increase (decrease) in advances and
    deferred revenues..................         335       (40,468)       (6,258)
   Foreign currency exchange (gain)
    loss...............................      (1,145)        2,190          (234)
                                         ----------  ------------   -----------
   Net cash provided by operating
    activities.........................     433,543       245,318        61,328
                                         ----------  ------------   -----------
Investing activities:
  Acquisition of Metro-Goldwyn-Mayer
   Studios Inc.........................         --            --     (1,331,430)
  Acquisition of Orion Pictures
   Corporation.........................         --       (561,617)          --
  Additions to film costs, net.........    (871,271)     (703,222)      (55,814)
  Additions to property and equipment..     (14,005)       (9,555)       (2,079)
  Other investing activities...........     (18,646)      (11,280)       (1,538)
                                         ----------  ------------   -----------
  Net cash used in investing
   activities..........................    (903,922)   (1,285,674)   (1,390,861)
                                         ----------  ------------   -----------
Financing activities:
  Proceeds from issuance of equity
   securities to outside parties.......      73,185       165,000           --
  Proceeds from issuance of equity
   securities to related parties.......     623,315       438,697       901,811
  Proceeds from debt issuance..........         --        200,000       475,000
  Additions to borrowed funds..........     472,478       452,600         4,036
  Repayments of borrowed funds.........    (647,412)     (217,473)      (35,453)
  Financing costs and other............         --        (10,040)          --
                                         ----------  ------------   -----------
  Net cash provided by financing
   activities..........................     521,566     1,028,784     1,345,394
                                         ----------  ------------   -----------
Net change in cash and cash equivalents
 from operating, investing and
 financing activities..................      51,187       (11,572)       15,861
Net increase (decrease) in cash due to
 foreign currency fluctuations.........        (326)         (831)          520
                                         ----------  ------------   -----------
Net change in cash and cash
 equivalents...........................      50,861       (12,403)       16,381
Cash and cash equivalents at beginning
 of period.............................       3,978        16,381           --
                                         ----------  ------------   -----------
Cash and cash equivalents at end of the
 period................................  $   54,839  $      3,978   $    16,381
                                         ==========  ============   ===========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       55
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               December 31, 1998
 
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, and is majority owned by an investor group comprised of Tracinda
Corporation and a corporation that is principally owned by Tracinda
(collectively, "Tracinda") and certain executive officers of the Company.
Until September 1, 1998 the investor group included Seven Network Limited
("Seven"), whose interest was wholly acquired by Tracinda pursuant to the
Seven Sale (as defined in Note 7). The acquisition of MGM Studios by MGM was
completed on October 10, 1996, at which time MGM commenced principal
operations (see Note 2). 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. Certain
reclassifications have been made to amounts reported in prior periods to
conform with the current presentation.
 
  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. The Company's business units have been aggregated
into three reportable operating segments: feature films, television
programming and other operating activities (see Note 11). Operating units
included in the other operating segment include licensing and merchandising,
interactive media and music, as well as the Company's equity investments (see
Note 4).
 
  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 their 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, Orion and all of their 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.
 
 
                                      56
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  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, 1998 and 1997 is
approximately $4,333,000 and $4,905,000, 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. 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. The Company has
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. 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 $26,716,000 and $12,947,000 as of December 31, 1998 and 1997,
respectively.
 
                                      57
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  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 accumulated other
comprehensive income 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.
 
  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 7.57 percent and 8.31 percent at December 31, 1998 and
1997, 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, 1998, accounts and
contracts receivable aggregated $388,287,000 (before allowance for doubtful
accounts), of which approximately $338,000,000 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, 1998 and 1997, there were no significant customers accounting
for greater than 10 percent of the Company's accounts and contracts
receivable.
 
  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 disclosures 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 75,816,326 and 28,634,362 in the years ended
December 31, 1998 and 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
 
                                      58
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
1 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 1,642,556 and 18,291,004
shares are not included in the calculation of diluted EPS in the years ending
December 31, 1998 and 1997 because they are antidilutive.
 
  Comprehensive Income. The Company has adopted SFAS No. 130, "Reporting
Comprehensive Income", effective for the year ending December 31, 1998. This
statement establishes standards for the reporting and display of comprehensive
income and its components in financial statements and thereby reports a
measure of all changes in equity of an enterprise that result from
transactions and other economic events other than transactions with owners.
 
  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 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which is
effective for all quarters of fiscal years beginning after June 15, 1999. This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities.
 
  In October 1998, the FASB issued an Exposure Draft on a proposed Statement
of Position (the "Proposed SOP") for "Accounting By Producers and Distributors
of Films". If adopted, the Proposed SOP would establish new accounting and
reporting standards for all producers and distributors that own or hold the
rights to distribute or exploit films. The Proposed SOP provides that the
cumulative effect of changes in accounting principles caused by adoption of
the provisions of the SOP should be included in the determination of net
income in conformity with Accounting Principles Board Opinion No. 20,
"Accounting Changes". If adopted, the Proposed SOP, as currently drafted,
would be effective for financial statements for fiscal years beginning after
December 15, 1999, with earlier adoption encouraged.
 
  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 and Restructuring Charges
 
  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") among
Mr. Frank Mancuso, an investor group comprised of Tracinda and 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 former 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.
 
 
                                      59
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  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 and 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 on hand......................................................    (4,348)
                                                                      ---------
   Cash purchase price............................................... $ 561,617
                                                                      =========
</TABLE>
 
  The results of operations of MGM Studios have been included in the
consolidated financial statements from October 11, 1996, date of commencement
of principal operations. The results of operations of Orion have been included
in the consolidated financial statements from July 10, 1997, date of
acquisition. The Company has made severance and other payments associated with
the Orion Acquisition aggregating $36,000,000 from the date of acquisition to
December 31, 1998. 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
                                                            December 31,
                                                           1997        1996
                                                        ----------  ----------
   <S>                                                  <C>         <C>
   Revenues............................................ $  893,419  $1,315,128
   Operating income (loss)............................. $  (84,819) $ (598,742)
   Net income (loss)................................... $ (158,364) $ (669,251)
   Pro forma loss per share............................ $    (2.91) $   (12.73)
   Pro forma weighted average shares................... 54,458,427  52,567,754
</TABLE>
 
  In association with a restructuring program implemented by the Company in
September 1998, the Company recorded a charge of $13,782,000 representing
severance and other costs, of which $9,972,000 has been paid through December
31, 1998. This charge included the termination of 114 employees across all
divisions of the Company.
 
                                      60
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
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,
                                                           1998         1997
                                                       ------------ ------------
   <S>                                                 <C>          <C>
   Theatrical productions:
     Released.........................................  $2,116,007   $1,688,378
     Less: accumulated amortization...................    (750,008)    (269,932)
                                                        ----------   ----------
     Released, net....................................   1,365,999    1,418,446
     Completed not released                                 98,654        7,662
     In process and development.......................     283,242      174,386
                                                        ----------   ----------
       Subtotal: theatrical productions...............   1,747,895    1,600,494
                                                        ----------   ----------
   Television programming.............................     567,138      361,514
     Less:accumulated amortization....................    (238,370)     (94,882)
                                                        ----------   ----------
       Subtotal: television programming...............     328,768      266,632
                                                        ----------   ----------
                                                        $2,076,663   $1,867,126
                                                        ==========   ==========
</TABLE>
 
  Interest costs capitalized to theatrical productions were $16,775,000,
$15,242,000 and $524,000 during the years ended December 31, 1998 and 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, 1998, approximately 60% of unamortized film costs applicable to released
theatrical films and released television programs will be amortized during the
nine years ending December 31, 2007.
 
  On January 7, 1999, the Company acquired certain film libraries and film
related rights containing over 1,300 feature films that were previously owned
by PolyGram N.V. and its subsidiaries for $235 million. The purchase was
funded through an advance on the Revolving Facility (as defined in Note 6) and
utilization of cash on hand.
 
Note 4--Investments and Advances to Affiliates
 
  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 share of the net profits in UIP in the
years ended December 31, 1998 and 1997, and the period from October 11, 1996
to December 31, 1996, were $7,391,000, $6,227,000 and $2,592,000,
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 satellite and cable delivery
channel based in Asia whose operations were terminated in April 1998. In
addition, in May 1998, the Company acquired a 50 percent interest in a Latin
American cable programming joint venture, MGM Networks Latin America ("MGM
Latin America"), for certain assets contributed by the Company to the joint
venture. The Company shares equally in the profits of the venture and is
obligated to fund 50 percent of the
 
                                      61
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
joint venture's expenses up to a maximum of approximately $24,000,000, of
which the Company had funded approximately $12,400,000 as of December 31,
1998. The Company's share of MGM Gold's and MGM Latin America's start-up
losses in the years ended December 31, 1998 and 1997 were $9,296,000 and
$11,754,000, respectively.
 
  Investments are summarized as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                      December 31, December 31,
                                                          1998         1997
                                                      ------------ ------------
   <S>                                                <C>          <C>
   UIP...............................................   $  8,273     $  6,623
   MGM Latin America.................................      6,724          --
   Others............................................      2,677        3,294
                                                        --------     --------
                                                        $ 17,674     $  9,917
                                                        ========     ========
 
Note 5--Property and Equipment
 
  Property and equipment are summarized as follows (in thousands):
 
<CAPTION>
                                                      December 31, December 31,
                                                          1998         1997
                                                      ------------ ------------
   <S>                                                <C>          <C>
   Leasehold improvements............................   $ 20,921     $ 14,845
   Furniture, fixtures and equipment.................     34,056       26,141
                                                        --------     --------
                                                          54,977       40,986
   Less accumulated depreciation and amortization....    (16,341)      (8,201)
                                                        --------     --------
                                                        $ 38,636     $ 32,785
                                                        ========     ========
 
Note 6--Bank and Other Debt
 
  Bank and other debt is summarized as follows (in thousands):
 
<CAPTION>
                                                      December 31, December 31,
                                                          1998         1997
                                                      ------------ ------------
   <S>                                                <C>          <C>
   Revolving Facility................................   $    --      $175,000
   Term Loans........................................    700,000      700,000
   Capitalized lease obligations and other
    borrowings.......................................     15,574       15,508
                                                        --------     --------
                                                        $715,574     $890,508
                                                        ========     ========
</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 2.50
percent over the Adjusted LIBOR rate, as defined (7.94 percent at December 31,
1998). The Tranche B Loan bears interest at 2.75 percent over the Adjusted
LIBOR rate (8.19 percent at December 31, 1998). 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.
 
                                      62
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  The Company has entered into three year fixed interest rate swap contracts
in relation to a portion of the Amended Credit Facility for a notional value
of $800,000,000 at an average rate of approximately 7.5 percent, which expire
in various terms no later than December 2001. At December 31, 1998, the
Company would have to pay approximately $6,978,000 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. The Amended Credit Facility was amended, effective March 30, 1998 and
September 9, 1998, to modify certain of these financial covenants.
 
  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, 1998 are scheduled to mature as follows (in thousands):
 
<TABLE>
       <S>                                                              <C>
       1999............................................................ $  7,334
       2000............................................................    5,009
       2001............................................................   33,123
       2002............................................................   73,695
       2003............................................................  103,774
       Thereafter......................................................  492,639
                                                                        --------
                                                                        $715,574
                                                                        ========
</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 IPO 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 "IPO").
Concurrent with the consummation of the IPO, 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 IPO, for net proceeds of $75,000,000 (the "Tracinda Purchase").
Subsequently, $190,000,000 of the net proceeds of the IPO and the Tracinda
Purchase were used to repay existing bank debt and the remaining net proceeds
were retained and used for working capital purposes.
 
  Seven Sale. On September 1, 1998, Tracinda purchased from Seven 16,208,463
shares of the Common Stock, representing all of the capital stock of the
Company beneficially owned by Seven, for a price per share of
 
                                      63
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
$24 and an aggregate purchase price of $389,003,000 (the "Seven Sale"). With
the consummation of the Seven Sale, Tracinda and 250 Rodeo, Inc., an affiliate
of Tracinda ("250 Rodeo"), increased their beneficial ownership of the Company
to approximately 89.5 percent.
 
  Rights Offering. On October 26, 1998 (the "Record Date"), the Company issued
to the holders of record of the Common Stock, at no charge to such holders,
transferable subscription rights (the "Rights") to subscribe for 84,848,485
shares (the "Shares") of the Common Stock for $8.25 per share (the
"Subscription Price") (the "Rights Offering"). Holders of the Common Stock
received 1.289 Rights for each share of the Common Stock held as of the Record
Date. Rights holders were allowed to purchase one share of the Common Stock at
the Subscription Price for each whole Right held (the "Basic Subscription
Privilege"). Rights holders who exercised the Basic Subscription Privilege in
full also had the opportunity to purchase additional shares at the
Subscription Price pursuant to an Oversubscription Privilege, as defined.
Pursuant to the Rights Offering, Tracinda and 250 Rodeo each committed to
exercise the Basic Subscription Privilege with respect to all of the
Subscription Rights distributed to it (subject to certain conditions). The
Rights expired on November 16, 1998. The Rights Offering was fully subscribed
(including shares issued pursuant to the Oversubscription Privilege), and the
Company issued the Shares for total net proceeds of $696,500,000 (gross
proceeds of $700,000,000 less applicable fees and expenses of approximately
$3,500,000). The net proceeds from the Rights Offering were used to repay in
full the amounts outstanding under a bridge loan, and then to repay borrowings
outstanding under the Revolving Facility.
 
  In connection with the Rights Offering, the Company also amended its Amended
and Restated Certificate of Incorporation in order to increase the number of
shares of the Common Stock authorized from 125,000,000 to 250,000,000 (the
"Amendment"). The Amendment was approved by the Board of Directors of the
Company and Tracinda (which represents a majority of the outstanding Common
Stock) on October 22, 1998 and was effective prior to the closing of the
Rights Offering.
 
  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.
 
  In connection with the Rights Offering, the per share exercise price of the
stock options granted to certain executive officers and other key employees of
the Company (the "Executive Repricing Participants") aggregating 3,164,604
options were reduced from $24.00 to $14.90, and for approximately 400 other
employees the exercise price of 2,027,900 stock options was reduced from
$20.00 to $14.90, for 10,400 options from $22.00 to $14.90, for 103,800
options from $21.50 to $14.90 and for 19,800 options from $19.63 to $14.90
(the "Employee Options") (collectively, the "Options Repricing"). The options
which have had their exercise price adjusted pursuant to the Options Repricing
will not be exercisable until the later of (i) six months following the Rights
Offering, (ii) the date the Options Repricing is approved by the holders of 75
percent of the outstanding shares of the Common Stock and (iii) the applicable
date of exercise set forth in the respective option agreement. No changes will
be made to the vesting schedule or expiration date of the options subject to
the Options Repricing.
 
                                      64
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  Stock option transactions under the 1996 Incentive Plan were as follows:
 
<TABLE>
<CAPTION>
                                                                       October 11 to
                          December 31, 1998     December 31, 1997    December 31, 1996
                         -------------------- ---------------------- ------------------
                                     Weighted             Weighted             Weighted
                                     Average               Average             Average
                                     Exercise             Exercise             Exercise
                           Shares     Price    Shares       Price     Shares    Price
                         ----------  -------- ---------  ----------- --------- --------
<S>                      <C>         <C>      <C>        <C>         <C>       <C>
Options outstanding at
 beginning of year......  7,683,952   $22.71  1,745,680    $24.00          --      --
Granted.................  5,973,714   $14.73  5,948,672    $22.33    1,745,680  $24.00
Cancelled............... (5,945,055)  $22.16    (10,400)   $20.00          --      --
                         ----------   ------  ---------    ------    ---------  ------
Options outstanding at
 end of year............  7,712,611   $17.25  7,683,952    $22.71    1,745,680  $24.00
                         ==========   ======  =========    ======    =========  ======
Options exercisable at
 end of year............    765,662   $24.00        --        --           --      --
                         ==========   ======  =========    ======    =========  ======
 
  The following table summarizes information about the outstanding options at
December 31, 1998 under the 1996 Incentive Plan:
<CAPTION>
                                              Outstanding
                                     -------------------------------
                                                          Weighted
                                                           Average
                                                          remaining
                                                          years of
                                     Exercise Number of  contractual
                                      Price    Options      life
                                     -------- ---------  -----------
<S>                                  <C>      <C>        <C>
                                      $11.38    285,000      9.94
                                      $14.90  5,323,595      8.39
                                      $24.00  2,104,016      7.78
                                              ---------
                                              7,712,611
                                              =========
</TABLE>
 
  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 certain key employees. Subject to
certain vesting and other requirements, each Bonus Interest held by the
Executive Repricing Participants 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 plus, in certain circumstances, per share distributions on the
Common Stock (together, the "Price") preceding a Determination Date, as
defined, is greater than (b) $14.90 and less than $29.80 (adjusted for stock
splits, reverse stock splits and similar events). With respect to Bonus
Interests held by all others, each Bonus Interest entitles the holder to
receive a cash payment if the Price preceding a Determination Date, as
defined, is greater than $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 $29.80, with respect to Executive Repricing Participants, or
$48.00 with respect to all others, multiplied by (iii) 1.61, with respect to
the Executive Repricing Participants only (in each case, a maximum of $24.00
per Bonus Interest). Once a payment is made in respect of the vested portion
of a Bonus Interest, no further payment is due in respect of that portion. If
at any Determination Date the Price equals or exceeds $29.80, with respect to
Executive Repricing Participants, or $48.00, with respect to all others, no
payments will thereafter be due in respect of any then-vested portion of a
Bonus Interest. Bonus Interests vested 20 percent at October 1, 1997 and 1/60
each month thereafter. Bonus Interests vested at December 31, 1998 were
1,103,301.
 
                                      65
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  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,
                                               1998       1997         1996
                                             ---------  ---------  -------------
   <S>                                       <C>        <C>        <C>
   Net income (loss):
     As reported............................ $(157,648) $(128,114)    $  166
     Pro forma.............................. $(170,546) $(136,187)    $  (15)
     Pro forma loss per share............... $   (2.25) $   (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
stock options granted in the year ended December 31, 1998, 1997 and in the
period from October 11 to December 31, 1996 was $4.62, $5.41 and $6.94,
respectively. The dividend yield was 0 percent in all periods, and expected
volatility was 40.5 percent for the year ended December 31, 1998 and 0 percent
in all other periods. Also, the calculation uses a weighted average expected
life of 5.0 years, 5.0 years and 5.5 years, and a weighted average assumed
risk-free interest rate of 4.9 percent, 5.9 percent and 6.2 percent, for the
years ended December 31, 1998, 1997 and the period from October 11 to December
31, 1996, respectively.
 
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,
                                                           1998         1997
                                                       ------------ ------------
   <S>                                                 <C>          <C>
   Current............................................   $34,869      $30,879
   Deferred...........................................       --           700
                                                         -------      -------
                                                         $34,869      $31,579
                                                         =======      =======
</TABLE>
 
                                      66
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  For income tax purposes, the historical tax basis of the assets and
liabilities of MGM Studios and Orion have been retained following their
acquisitions by the Company. 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,
                                                           1998         1997
                                                       ------------ ------------
   <S>                                                 <C>          <C>
   Deferred tax assets:
     Film and television costs........................  $  32,078    $  21,143
     Participations and residuals payable.............     61,434       10,886
     Reserves and investments.........................     48,332       52,375
     Net miscellaneous tax assets.....................     26,595       34,780
     Operating loss carryforwards.....................    104,607       74,069
                                                        ---------    ---------
      Subtotal, gross deferred tax assets.............    273,046      193,253
     Valuation allowance..............................   (228,044)    (173,867)
                                                        ---------    ---------
       Total deferred tax assets......................     45,002       19,386
                                                        ---------    ---------
   Deferred tax liabilities:
     Film revenue.....................................    (41,556)     (18,709)
     Goodwill.........................................     (3,446)      (1,377)
                                                        ---------    ---------
       Total deferred tax liabilities.................    (45,002)     (20,086)
                                                        ---------    ---------
   Net deferred tax liability.........................  $     --     $    (700)
                                                        =========    =========
</TABLE>
 
  As of December 31, 1998, the Company and its subsidiaries for U.S. federal
income tax purposes had net operating loss carryforwards of $30,323,000,
$91,511,000 and $146,388,000, which expire in 2011, 2012 and 2018,
respectively. Under U.S. tax rules enacted in 1997, net operating losses
generated in tax years beginning before August 6, 1997 may be carried forward
for 15 years while losses generated in subsequent tax years may be carried
forward 20 years. Presently, there are no limitations on the use of these
carryforwards.
 
  At December 31, 1998, management has determined that $228,044,000 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>
                                                                   October 11 to
                                         Year Ended December 31,   December 31,
                                            1998         1997          1996
                                         -----------  -----------  -------------
   <S>                                   <C>          <C>          <C>
   Current taxes:
     Foreign taxes.....................     $ 10,181  $     9,645     $ 3,140
   Deferred taxes:
     Federal and state taxes (benefit).      (54,177)     (66,102)      6,055
     Adjustment for change in valuation
      allowance........................       54,177       66,802      (4,849)
                                         -----------  -----------     -------
   Total tax provision.................     $ 10,181  $    10,345     $ 4,346
                                         ===========  ===========     =======
</TABLE>
 
                                      67
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  The following is a summary reconciliation of the federal tax rate to the
effective tax rate:
 
<TABLE>
<CAPTION>
                                                 Year Ended         October 11 to
                                                 December 31,       December 31,
                                                 1998      1997         1996
                                                ------    ------    -------------
   <S>                                          <C>       <C>       <C>
   Federal tax rate on pre-tax book income
    (loss).....................................    (35)%     (35)%        35%
   Goodwill and other permanent differences....      3 %       3 %        14%
   Foreign taxes, net of available federal tax
    benefit....................................      7 %       8 %        45%
   Loss carryforward not benefitted............     32 %      32 %        --%
                                                ------    ------         ---
   Effective tax rate..........................      7 %       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. In 1998, the
Company adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits", which revised employers' disclosures about pension
and post-retirement benefit plans.
 
  Reconciliation of the funded status of the plans and the amounts included in
the Company's consolidated balance sheets are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                     December 31, December 31,
                                                         1998         1997
                                                     ------------ ------------
   <S>                                               <C>          <C>
   Projected benefit obligations:
     Beginning obligations..........................   $10,500      $ 9,913
     Service cost...................................     1,149        1,213
     Interest cost..................................       852          841
     Actuarial gains................................     1,506          381
     Benefits paid..................................      (355)      (1,848)
                                                       -------      -------
     Ending obligations.............................   $13,652      $10,500
                                                       =======      =======
   Fair value of plan assets (primarily debt
    securities):
     Beginning fair value...........................   $ 8,741      $ 8,403
     Actual return on plan assets...................     1,107          662
     Employer contributions.........................     1,712        1,524
     Benefits paid..................................      (355)      (1,848)
     Expenses.......................................       --           --
                                                       -------      -------
     Ending fair value..............................   $11,205      $ 8,741
                                                       =======      =======
</TABLE>
 
                                      68
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
<TABLE>
<CAPTION>
                                                      December 31, December 31,
                                                          1998         1997
                                                      ------------ ------------
   <S>                                                <C>          <C>
   Funded status of the plans:
     Projected benefit obligations...................   $13,652      $10,500
     Plan assets at fair value.......................    11,205        8,741
                                                        -------      -------
     Projected benefit obligations in excess of plan
      assets.........................................    (2,447)      (1,759)
     Unrecognized net asset as of beginning of year..      (140)        (160)
     Unrecognized net gain...........................     1,936          860
     Unrecognized prior service cost.................      (149)        (163)
                                                        -------      -------
     Net balance sheet liability.....................   $ (800)      $(1,222)
                                                        =======      =======
 
 
  Key assumptions used in the actuarial computations were as follows:
 
 
     Discount rate...................................      6.75%        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.
 
  Pension cost includes the following components (in thousands):
 
<TABLE>
<CAPTION>
                                                   Year ended     October 11 to
                                                  December 31,    December 31,
                                                   1998    1997       1996
                                                  ------  ------  -------------
   <S>                                            <C>     <C>     <C>
   Service cost.................................. $1,149  $1,213      $ 244
   Interest cost on projected benefit
    obligation...................................    852     841        163
   Actual (return) loss on plan assets...........   (676)   (636)       224
   Net amortization and deferral.................    (34)    (34)      (330)
                                                  ------  ------      -----
   Net periodic pension cost..................... $1,291  $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 $8,890,000, $12,366,000 and $2,824,000,
respectively, for such plans in years ended December 31, 1998 and 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 $1,435,000, $1,172,000 and $219,000, respectively,
to the Savings Plan in the years ended December 31, 1998 and 1997 and the
period from October 11, 1996 to December 31, 1996.
 
Note 10--Related Party Transactions
 
  In February 1980 a predecessor-in-interest to the Company granted to a
predecessor-in-interest to MGM Grand, Inc. an exclusive open-ended royalty-
free license, which was amended in 1992 and further amended in 1998. Pursuant
to the license, as amended, MGM Grand, Inc. has the right to use certain
trademarks that include the letters "MGM," as well as logos and names
consisting of or related to stylized depictions of a lion, in its resort hotel
and/or gaming businesses and other businesses that are not related to filmed
entertainment. In 1986
 
                                      69
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
MGM granted MGM Grand Air, Inc. ("Grand Air") an exclusive open-ended royalty-
free license to use one of its logos consisting of a stylized depiction of a
lion in Grand Air's airline business. The Company did not receive any monetary
compensation for these licenses. Tracinda owns a majority of the outstanding
common stock of MGM Grand, Inc., the parent of both MGM Grand Hotel ("Grand
Hotel") and Grand Air. Additionally, the Company and affiliates of Tracinda
occasionally conduct cross-promotional campaigns, in which the Company's
motion pictures and the affiliates' hotels are promoted together; however, the
Company believes that the amounts involved are immaterial.
 
  The Company and Grand Hotel have an ongoing relationship whereby Grand Hotel
can utilize key art, still photographs of artwork and one minute film clips
from certain of the Company's motion picture releases on an as-needed basis.
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 other 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 years ended December 31, 1998 and 1997 and the period from
October 11, 1996 to December 31, 1996, the Company recognized revenues of
$24,000, $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 the year ended December 31, 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 that could be
obtained from unrelated third parties. During the years ended December 31,
1998 and 1997 and the period from October 11, 1996 to December 31, 1996, the
aggregate of the payments made to Tracinda for such charters were
approximately $3,000, $308,000 and $10,000, respectively.
 
  In 1995 the Company licensed to a subsidiary of Seven, a former beneficial
owner of more than 5 percent of the Company's Common Stock, the right to
distribute certain motion picture and television product in the Australian
free television market. This agreement was amended on September 9, 1997. The
product licensed includes certain library pictures and theatrical motion
pictures and television series, miniseries and made-for-television movies
produced or distributed by the Company during the term of the agreement. The
license fees for the library product are at a rate which the Company believes
is arm's-length. The term of the output portion of the agreement is 15 years.
The license fees for output product television series, television movies and
television mini-series are on a "most favored nations" basis with prices paid
by the Seven subsidiary for comparable programming. During the years ended
December 31, 1998 and 1997 and the period from October 11, 1996 to December
31, 1996, the Company recognized revenues of $5,651,000, $4,454,000 and
$1,055,000, respectively, under this agreement. Management believes that the
terms of this agreement 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, as well as a number of its library 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
 
                                      70
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
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 such license fee revenues of
$3,678,000, $3,056,000 and $292,000 during the years ended December 31, 1998
and 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 an exclusive producer overhead arrangement with FGM
Entertainment for the services of Frank Mancuso, Jr., the son of the Company's
Chairman of the Board and Chief Executive Officer, which expires on July 31,
2002. FGM Entertainment, a company wholly owned by Mr. Mancuso, Jr., receives
$400,000 each year, subject to five to ten percent annual increases, for
overhead expenses, as well as a development fund and a production fund to pay
for the costs of developing and producing projects. FGM Entertainment must
submit all projects that it wishes to produce or develop to the Company and
receives a producing fee, as well as certain participations and royalties, for
each picture that is produced under the arrangement. The Company has the right
to acquire the domestic or worldwide rights to each picture produced under the
arrangement and controls all remake, sequel and television rights. Pursuant to
this arrangement, the Company paid Mr. Mancuso, Jr. approximately $2,429,000,
$1,916,000 and $39,000 during the years ended December 31, 1998 and 1997 and
the period from October 11, 1996 to December 31, 1996, respectively.
 
  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 were allocated 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.
 
                                      71
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 11--Segment Information
 
  The Company adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", for its fiscal year ended December 31,
1998, which changed the way the Company reports information about its
operating segments. The Company business units have been aggregated into three
reportable operating segments: feature films, television programming and other
(see Note 1). The factors for determining the reportable segments were based
on the distinct nature of their operations. They are managed as separate
business units because each requires and is responsible for executing a unique
business strategy. Earnings of industry segments and geographic areas exclude
interest income, interest expense, goodwill amortization, income taxes and
other unallocated corporate expenses. Identifiable assets are those assets
used in the operations of the segments. Corporate assets consist of cash,
certain corporate receivables and intangibles. Summarized financial
information concerning the Company's reportable segments is shown in the
following tables (in thousands):
 
<TABLE>
<CAPTION>
                                      Feature   Television
                                       Films     Programs   Other      Total
                                     ---------- ---------- --------  ----------
<S>                                  <C>        <C>        <C>       <C>
Year Ended December 31, 1998:
  Revenues.......................... $1,005,747  $197,759  $ 37,217  $1,240,723
  Segment income (loss)............. $   39,748  $ 12,885  $ (3,758) $   48,875
  Identifiable assets............... $2,096,092  $400,646  $ 19,718  $2,516,456
  Capital expenditures.............. $    9,293  $  1,776  $ 18,733  $   29,802
  Depreciation expense.............. $    5,683  $  1,086  $     53  $    6,822
Year Ended December 31, 1997:
  Revenues.......................... $  699,219  $114,200  $ 17,883  $  831,302
  Segment income (loss)............. $   65,509  $ (7,201) $(26,545) $   31,763
  Identifiable assets............... $1,874,683  $311,873  $  9,414  $2,195,970
  Capital expenditures.............. $    6,346  $  1,056  $ 11,312  $   18,714
  Depreciation expense.............. $    4,505  $    749  $     23  $    5,277
October 11 to December 31, 1996:
  Revenues.......................... $  209,354  $ 14,413  $  4,919  $  228,686
  Segment income (loss)............. $   37,140  $ (4,062) $    532  $   33,610
  Identifiable assets............... $1,255,389  $166,781  $  4,573  $1,426,743
  Capital expenditures.............. $    1,471  $    195  $  1,543  $    3,209
  Depreciation expense.............. $    1,003  $    133  $      4  $    1,140
</TABLE>
 
                                      72
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  The following table presents the details of other operating segment income
(loss):
 
<TABLE>
<CAPTION>
                                                                  October 11 to
                                        Year Ended December 31,   December 31,
                                           1998         1997          1996
                                        -----------  -----------  -------------
   <S>                                  <C>          <C>          <C>
   Licensing and merchandising......... $       484  $     2,526     $   801
   Interactive media...................      (9,930)     (16,828)     (1,878)
   Music...............................       4,787        2,140       1,149
   Losses on equity investments........     (12,536)     (14,225)        --
   Profit on sale of interest in joint
    venture............................      10,000          --          --
   Other...............................       3,437         (158)        460
                                        -----------  -----------     -------
                                        $    (3,758) $   (26,545)    $   532
                                        ===========  ===========     =======
</TABLE>
 
  The following is a reconciliation of reportable segment income to
consolidated income (loss) before taxes:
 
<TABLE>
<CAPTION>
                                                Year Ended        October 11 to
                                               December 31,       December 31,
                                              1998       1997         1996
                                            ---------  ---------  -------------
   <S>                                      <C>        <C>        <C>
   Segment income.......................... $  48,875  $  31,763    $ 33,610
   General and administrative expenses.....   (92,244)   (87,644)    (18,319)
   Severance and related costs.............   (13,182)       --          --
   Goodwill amortization...................   (14,289)   (11,230)     (1,717)
                                            ---------  ---------    --------
     Operating income (loss)...............   (70,840)   (67,111)     13,574
   Interest expense, net of amounts
    capitalized............................   (80,611)   (53,105)     (9,875)
   Interest and other income, net..........     3,984      2,447         813
                                            ---------  ---------    --------
     Consolidated income (loss) before
      taxes................................ $(147,467) $(117,769)   $  4,512
                                            =========  =========    ========
</TABLE>
 
  The following is a reconciliation of reportable segment assets to
consolidated total assets:
 
<TABLE>
<CAPTION>
                                                 Year Ended       October 11 to
                                                December 31,      December 31,
                                               1998       1997        1996
                                            ---------- ---------- -------------
   <S>                                      <C>        <C>        <C>
   Total assets for reportable segments.... $2,516,456 $2,195,970  $1,426,743
   Goodwill not allocated to segments......    561,026    574,795     302,741
   Other unallocated amounts...............     81,496     51,889      45,184
                                            ---------- ----------  ----------
     Consolidated total assets............. $3,158,978 $2,822,654  $1,774,668
                                            ========== ==========  ==========
</TABLE>
 
                                       73
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  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. Revenues
earned from motion picture and television films produced in the United States
by territory were as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                   Year Ended      October 11 to
                                                  December 31,     December 31,
                                                  1998      1997       1996
                                               ---------- -------- -------------
   <S>                                         <C>        <C>      <C>
   United States and Canada................... $  740,480 $458,977   $137,160
   Europe.....................................    276,673  255,396     62,298
   Asia and Australia.........................    158,615   86,695     15,052
   Other......................................     64,955   30,234     14,176
                                               ---------- --------   --------
                                               $1,240,723 $831,302   $228,686
                                               ========== ========   ========
</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 $15,011,000, $12,915,000 and $2,936,000 for the
years ended December 31, 1998 and 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 2002.
 
  Future minimum annual commitments under non-cancelable operating leases,
employment agreements, and creative talent agreements as of December 31, 1998
are as follows (in thousands):
 
<TABLE>
       <S>                                                              <C>
       1999............................................................ $ 78,746
       2000............................................................   45,923
       2001............................................................   27,246
       2002............................................................   13,013
       2003............................................................    8,075
       Thereafter......................................................    1,260
                                                                        --------
                                                                        $174,263
                                                                        ========
</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.
 
                                      74
<PAGE>
 
                           METRO-GOLDWYN-MAYER INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 13--Supplementary Cash Flow Information
 
  The Company paid interest, net of capitalized interest, of $66,887,000,
$45,394,000 and $7,103,000 during the years ended December 31, 1998 and 1997
and the period from October 11, 1996 to December 31, 1996, respectively.
 
  The Company paid income taxes of $7,137,000, $8,425,000 and $922,000 during
the years ended December 31, 1998 and 1997 and the period from October 11,
1996 to December 31, 1996, respectively. During the year ended December 31,
1997, the Company also received foreign remittance tax refunds of $12,296,000.
 
Note 14--Quarterly Financial Data (Unaudited)
 
  Certain quarterly information is presented below (in thousands):
 
<TABLE>
<CAPTION>
                                          First     Second    Third     Fourth
                                         Quarter   Quarter   Quarter   Quarter
                                         --------  --------  --------  --------
   <S>                                   <C>       <C>       <C>       <C>
   1998:
     Revenues..........................  $316,460  $281,201  $259,622  $383,440
     Operating income (loss)...........  $  1,929  $(33,621) $(17,402) $(21,746)
     Interest expense, net of amounts
      capitalized......................  $ 18,254  $ 20,174  $ 22,022  $ 20,161
     Net loss..........................  $(18,643) $(54,994) $(40,271) $(43,740)
     Basic and diluted loss per share..  $   (.28) $   (.84) $   (.61) $   (.30)
   1997:
     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..  $   (.85) $   (.88) $   (.55) $  (1.64)
</TABLE>
 
Note 15--Subsequent Events
 
  On March 12, 1999, the Company agreed to accelerate the expiration of the
right of Warner Home Video ("WHV") to distribute the Company's product in the
home video marketplace under the agreement executed in 1990 (the "WHV
Agreement"). In consideration for the early expiration of the WHV Agreement,
the Company has agreed to pay WHV $225 million, of which $112.5 million was
paid on March 12, 1999 and the remaining $112.5 million of which is payable in
September 1999. The parties restructured the terms of the WHV Agreement, which
will function as an interim distribution agreement (the "Transitional Video
Agreement"), under which WHV will distribute certain of the Company's product
in the home video marketplace while the Company establishes its own home video
distribution network. The Transitional Video Agreement expires on January 31,
2000. Additionally, the Company reconveyed as of January 1, 1999 to Turner
Entertainment, Co., Inc., an affiliate of WHV, the right that the Company had
to distribute in the home video markets worldwide until June 1, 2001, 2,950
titles that had been serviced under the WHV Agreement. The Company intends to
record a one-time pre-tax contract termination charge in the first quarter of
1999 for approximately $225 million for costs in connection with the early
expiration of WHV's rights under the WHV Agreement. The Company's obligation
to pay the remaining $112.5 million installment (plus interest at the rate of
eight percent per year from March 1999) in September 1999 is secured by a
standby letter of credit issued by one of the Company's principal lenders.
 
                                      75
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Metro-Goldwyn-Mayer Studios Inc.:
 
  We have audited the accompanying consolidated statements of operations and
comprehensive income (loss), stockholder's equity and cash flows for the
period from January 1, 1996 to October 10, 1996 of Metro-Goldwyn-Mayer Studios
Inc. (formerly known as Metro-Goldwyn-Mayer Inc.) and its subsidiaries. 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 results of operations and cash
flows of the Company 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
 
                                      76
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
     CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                                 (in thousands)
 
<TABLE>
<CAPTION>
                                                                    January 1
                                                                    to October
                                                                     10, 1996
                                                                    ----------
<S>                                                                 <C>
Revenues........................................................... $  912,706
Expenses:
 Film and television production and distribution...................    953,820
 General and administrative........................................     60,056
 Goodwill amortization.............................................     11,570
 Provision for impairment..........................................    563,829
                                                                    ----------
  Total expenses...................................................  1,589,275
                                                                    ----------
Operating loss.....................................................   (676,569)
Other income (expense):
 Interest expense, net of amounts capitalized......................    (71,375)
 Interest and other income, net....................................      3,179
                                                                    ----------
  Total other expense..............................................    (68,196)
                                                                    ----------
Loss from operations before provision for income taxes.............   (744,765)
Income tax provision...............................................       (273)
                                                                    ----------
Net loss...........................................................   (745,038)
Other comprehensive income, net of tax:
 Foreign currency translation adjustment...........................         95
                                                                    ----------
Comprehensive loss................................................. $ (744,943)
                                                                    ==========
</TABLE>
 
 
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       77
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                              Common Stock
                          -------------------- Additional              Accum. Other       Total
                          Number of    Par      Paid-in                Comprehensive  Stockholder's
                           Shares     Value     Capital     Deficit       Income         Equity
                          --------- ---------  ---------- -----------  -------------  -------------
<S>                       <C>       <C>        <C>        <C>          <C>            <C>
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.
 
                                       78
<PAGE>
 
                        METRO-GOLDWYN-MAYER STUDIOS INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                   January 1 to
                                                                   October 10,
                                                                       1996
                                                                   ------------
<S>                                                                <C>
Operating activities:
 Net loss.........................................................  $(745,038)
 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
  Depreciation and amortization of property and equipment.........      4,645
  Provision for impairment and amortization of intangibles........    575,399
  Increase in bad debt and other reserves.........................        430
  Gains on equity investments.....................................     (1,967)
  Increase in accounts and contracts receivable, advances to
   affiliates and other assets....................................    (28,192)
  Decrease in accounts payable, accrued and other liabilities,
   accrued participants' share and domestic and foreign taxes.....    (19,970)
  Decrease in advances and deferred revenues......................    (51,199)
  Foreign currency exchange loss and other........................        325
                                                                    ---------
   Net cash provided by operating activities......................    343,137
                                                                    ---------
Investing activities:
 Additions to film costs, net.....................................   (369,148)
 Additions to property and equipment..............................     (6,901)
 Other investing activities.......................................     (4,093)
                                                                    ---------
   Net cash used in investing activities..........................   (380,142)
                                                                    ---------
Financing activities:
 Additions to borrowed funds......................................    165,866
 Repayments of borrowed funds.....................................   (114,854)
 Dividends paid...................................................     (6,160)
                                                                    ---------
   Net cash provided by financing activities......................     44,852
                                                                    ---------
Net change in cash and cash equivalents from operating, investing
 and financing activities.........................................      7,847
Net decrease in cash due to foreign currency fluctuations.........       (258)
                                                                    ---------
Net change in cash and cash equivalents...........................      7,589
Cash and cash equivalents at beginning of period..................     17,128
                                                                    ---------
Cash and cash equivalents at end of the period....................  $  24,717
                                                                    =========
</TABLE>
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       79
<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 11). 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 2).
 
  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. All significant
intercompany balances and transactions have been eliminated.
 
  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 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 Note 2).
 
  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
 
                                      80
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
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 2).
 
  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 had been included in the
consolidated federal income tax return of MGM Group 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 Group 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.
 
  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--Impairment of Intangible Assets
 
  As discussed in Note 11, 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
 
                                      81
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Company on the date of the disposition, and were insufficient to repay the
bank debt and related accrued interest due to Credit Lyonnais. 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 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 3--Stockholder's Equity
 
  An affiliate of Credit Lyonnais has agreed to pay bonuses to certain
executives of the Company due upon the sale of the Company (see Note 11).
Accordingly, the Company has recorded compensation expense and a corresponding
contribution to capital of $9,641,000 during the period ended October 10,
1996, respectively.
 
Note 4--Income Taxes
 
  Pursuant to a 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.
 
  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>
                                                                    January 1 to
                                                                    October 10,
                                                                        1996
                                                                    ------------
   <S>                                                              <C>
   Current taxes:
     Foreign taxes.................................................  $     273
   Deferred taxes:
     Federal and state taxes (benefit).............................   (241,630)
     Adjustment for change in enacted tax rate.....................         --
     Adjustment for change in valuation allowance..................    241,630
                                                                     ---------
       Total tax provision.........................................  $     273
                                                                     =========
</TABLE>
 
  The following is a summary reconciliation of the effective tax rate to the
assumed federal tax rate:
 
<TABLE>
<CAPTION>
                                                                    January 1 to
                                                                    October 10,
                                                                        1996
                                                                    ------------
   <S>                                                              <C>
   Assumed federal tax rate on loss................................     (35)%
   Goodwill and other permanent differences........................       8 %
   Foreign taxes, net of available federal tax benefit.............       1 %
   Loss carryforward not benefited.................................      27 %
                                                                        ---
     Effective tax rate............................................       1 %
                                                                        ===
</TABLE>
 
 
                                      82
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  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 5--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.
 
 
  Pension costs includes the following components (in thousands):
 
<TABLE>
<CAPTION>
                                                                    January 1 to
                                                                    October 10,
                                                                        1996
                                                                    ------------
   <S>                                                              <C>
   Service cost....................................................    $   54
   Interest cost on projected benefit obligation...................       570
   Actual return on plan assets....................................      (521)
   Net amortization and deferral...................................       148
                                                                       ------
   Net periodic pension cost.......................................    $1,051
                                                                       ======
</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 in 1996 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 6--Related Party Transactions
 
  The Company has credit arrangements with CLBN and Credit Lyonnais
(collectively, the "'Bank"). Interest of approximately $45,000,000 was charged
by the Bank during the period ended October 10, 1996. 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.
 
  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. 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, the Company incurred legal fees of
approximately $1,735,000 to White & Case, one of whose partners is also a
director of the Company.
 
                                      83
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 7--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.
 
  Revenues earned from motion picture and television films produced in the
United States by territory were as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                      January 1
                                                                         to
                                                                     October 10,
                                                                        1996
                                                                     -----------
   <S>                                                               <C>
   United States and Canada.........................................   $570,586
   Europe...........................................................     215,588
   Asia and Australia...............................................      94,133
   Other............................................................      32,399
                                                                      ---------
                                                                        $912,706
                                                                      =========
</TABLE>
 
Note 8--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 for the period ended October 10, 1996.
 
  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 11, 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. 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.
 
  In the opinion of Company management, any liability under pending litigation
is not material in relation to the Company's results of operations.
 
Note 9--Supplementary Cash Flow Information
 
  Total interest paid, net of capitalized interest, was $29,490,000 in the
period ended October 10, 1996. Income taxes paid were $17,856,000 in the
period ended October 10, 1996.
 
  The Company recorded a non-cash contribution of capital of $9,641,000 during
the period ended October 10, 1996, respectively, from CDR due to the payment
of compensation expense (see Note 8).
 
                                      84
<PAGE>
 
                       METRO-GOLDWYN-MAYER STUDIOS INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 10--Quarterly Financial Data (Unaudited)
 
  Certain quarterly information is presented below (in thousands):
 
<TABLE>
<CAPTION>
                                                   First     Second     Third
                                                  Quarter   Quarter    Quarter
                                                 ---------  --------  ---------
   <S>                                           <C>        <C>       <C>
   1996:
     Revenues................................... $ 286,947  $308,185  $ 317,574
     Operating loss.............................   (24,724)  (25,086)  (626,759)
     Interest expense, net......................    22,361    22,725     26,289
     Net loss...................................   (53,678)  (49,874)  (641,486)
</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 2).
 
Note 11--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 was extinguished upon the closing of the transaction. The
acquisition will be accounted for as a purchase.
 
                                      85
<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 23, 1999. 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 23, 1999
 
                                      86
<PAGE>
 
           SCHEDULE I: CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
                                 BALANCE SHEETS
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                                                      December 31,  December
                                                          1998      31, 1997
                                                      ------------ -----------
<S>                                                   <C>          <C>
                       ASSETS
 
Investments and advances to affiliates...............  $1,919,657  $ 1,378,555
                                                       ==========  ===========
 
        LIABILITIES AND STOCKHOLDERS' EQUITY
 
Liabilities..........................................  $      --   $       --
 
Commitments and contingencies
 
Stockholders' equity:
  Common Stock, $.01 par value, 250,000,000 shares
   authorized, 150,856,424 and 65,765,655 shares
   issued and outstanding............................       1,509          658
  Additional paid-in capital.........................   2,203,490    1,504,850
  Deficit............................................    (285,596)    (127,948)
  Accumulated other comprehensive income.............         254          995
                                                       ----------  -----------
    Stockholders' equity.............................   1,919,657    1,378,555
                                                       ----------  -----------
                                                       $1,919,657  $ 1,378,555
                                                       ==========  ===========
</TABLE>
 
 
 
  The accompanying Notes to Financial Statements are an integral part of these
                                  statements.
 
                                       87
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
            STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                                               Year Ended         October 11 to
                                              December 31,        December 31,
                                             1998        1997         1996
                                          ----------  ----------  -------------
<S>                                       <C>         <C>         <C>
Revenues................................  $      --   $      --    $      --
Expenses:
  Equity in net (income) losses of
   subsidiaries.........................     157,648      94,760       (9,776)
  Interest expense, net.................         --       33,354        9,610
                                          ----------  ----------   ----------
    Total expenses......................     157,648     128,114         (166)
                                          ----------  ----------   ----------
Net income (loss).......................    (157,648)   (128,114)         166
Foreign currency translation adjustment.        (741)       (150)       1,145
                                          ----------  ----------   ----------
Comprehensive income (loss).............  $ (158,389) $ (128,264)  $    1,311
                                          ==========  ==========   ==========
Earnings (loss) per share:
  Basic.................................  $    (2.08) $    (4.47)  $     0.01
                                          ==========  ==========   ==========
  Diluted...............................  $    (2.08) $    (4.47)  $     0.00
                                          ==========  ==========   ==========
Weighted average number of common shares
 outstanding:
  Basic.................................  75,816,326  28,634,362   16,692,217
                                          ==========  ==========   ==========
  Diluted...............................  75,816,326  28,634,362   37,796,672
                                          ==========  ==========   ==========
</TABLE>
 
 
 
  The accompanying Notes to Financial Statements are an integral part of these
                                   statements
 
                                       88
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                            Preferred
                              Stock           Common Stock
                          ---------------  ------------------   Add'l     Retained   Accum. Other      Total
                           No. of    Par     No. of     Par    Paid-in    Earnings   Comprehensive Stockholders'
                           Shares   Value    Shares    Value   Capital    (Deficit)     Income        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
Issuance of common
 stock..................       --     --    85,090,769    851    697,084        --         --          697,935
Amortization of deferred
 stock compensation.....       --     --           --     --       1,556        --         --            1,556
Foreign currency
 translation adjustment.       --     --           --     --         --         --        (741)           (741)
Net loss................       --     --           --     --         --    (157,648)       --         (157,648)
                          --------  -----  ----------- ------ ----------  ---------      -----      ----------
Balance December 31,
 1998...................       --   $ --   150,856,424 $1,509 $2,203,490  $(285,596)     $ 254      $1,919,657
                          ========  =====  =========== ====== ==========  =========      =====      ==========
</TABLE>
 
 
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                           part of these statements.
 
                                       89
<PAGE>
 
                            METRO-GOLDWYN-MAYER INC.
                                 (PARENT ONLY)
 
                            STATEMENTS OF CASH FLOWS
                                 (in thousands)
 
<TABLE>
<CAPTION>
                                                                    October 11
                                             Year Ended December        to
                                                     31,           December 31,
                                               1998       1997         1996
                                             ---------  ---------  ------------
<S>                                          <C>        <C>        <C>
Operating activities:
  Net income (loss)......................... $(157,648) $(128,114) $       166
  Adjustments to reconcile net income from
   operations to net cash used by operating
   activities:
    Losses (gains) on equity investments,
     net....................................   157,648     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.       --    (561,617)         --
                                             ---------  ---------  -----------
  Net cash used in investing activities.....       --    (561,617)  (1,331,430)
                                             ---------  ---------  -----------
Financing activities:
  Proceeds from issuance of equity
   securities to outside parties............    73,185    165,000          --
  Proceeds from issuance of equity
   securities to related parties............   623,315    438,697      901,811
  Proceeds from debt issuance...............       --         --       475,000
  Net bank repayments.......................       --    (443,750)     (31,417)
  Net intercompany advances (repayments)....  (696,500)   432,543       (6,875)
                                             ---------  ---------  -----------
  Net cash provided by financing activities.       --     592,490    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.
 
                                       90
<PAGE>
 
                    METRO-GOLDWYN-MAYER INC. (PARENT ONLY)
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               December 31, 1998
 
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 Note
2), at which time MGM commenced principal operations. MGM acquired Orion
Pictures Corporation and its majority owned subsidiaries on July 10, 1997.
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.
 
                                      91
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Metro-Goldwyn-Mayer Studios Inc.:
 
  We have audited in accordance with generally accepted auditing standards,
the financial statements of Metro-Goldwyn-Mayer Studios Inc. for the period
from January 1, 1996 to October 10, 1996 included in this Report on Form 10-K
and have issued our report thereon dated December 16, 1996. Our audit was made
for the purpose of forming an opinion on the basic financial statements taken
as a whole. The accompanying schedule is the responsibility of the Company's
management and are presented for the purposes of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. This schedule has 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
December 16, 1996
 
                                      92
<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>
Year Ended December 31,
 1998:
Reserve for allowances and
 doubtful accounts..........  $27,603   $    467  $    --   $ (4,850)  $23,220
                              =======   ========  ========  ========   =======
Reserve for termination
 costs under acquisitions...  $16,380   $    --   $    --   $(16,380)  $   --
                              =======   ========  ========  ========   =======
Reserve for severance under
 corporate restructuring
 program....................  $   --    $ 13,182  $    --   $ (9,372)  $ 3,810
                              =======   ========  ========  ========   =======
Year Ended December 31,
 1997:
Reserve for allowances and
 doubtful accounts..........  $11,730   $  3,166  $ 13,600  $   (893)  $27,603
                              =======   ========  ========  ========   =======
Reserve for termination
 costs under acquisitions...  $ 9,547   $    --   $ 36,000  $(29,167)  $16,380
                              =======   ========  ========  ========   =======
For the Period from October
 11, 1996 to December 31,
 1996:
Reserve for allowances and
 doubtful accounts..........  $12,718   $    (21) $    --   $   (967)  $11,730
                              =======   ========  ========  ========   =======
Reserve for termination
 costs under acquisitions...  $   --    $    --   $ 45,384  $(35,837)  $ 9,547
                              =======   ========  ========  ========   =======
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)  $   --
                              =======   ========  ========  ========   =======
</TABLE>
 
                                       93
<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, SAC 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)  Form of Amended and Restated Certificate of Incorporation of the
           Company
 
  3.2(2)  Form of 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 Guaranty Trust Company of
           New York ("Morgan"), as agent*
 
 10.2(2)  Credit Agreement, dated as of July 10, 1997, among Orion, certain
           lenders and 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 ("B of A"), as syndication agent*
 
 10.4(5)  Amendment I to Amended and Restated Credit Agreement, dated as of
           March 30, 1998, among the Company, MGM Studios, Orion, certain
           lenders, Morgan, as agent and B of A, as syndication agent
 
 10.5(5)  Amendment II and Waiver I to Amended and Restated Credit Agreement;
           Amendment I to Amended and Restated Holdings Agreement dated as of
           September 9, 1998, among the Company, MGM Studios, Orion, certain
           lenders, Morgan, as agent and B of A, as syndication agent
 
 10.6(2)  Form of Modification and Cancellation Agreement, dated as of November
           5, 1997
 
 10.7(2)  Amended and Restated 1996 Stock Incentive Plan dated as of November
           11, 1997 and form of related Stock Option Agreement
 
 10.8(1)  Form of Executive Option Exchange Agreement
 
 10.9(2)  Senior Management Bonus Plan dated as of November 11, 1997 and form
           of related Bonus Interest Agreement
 
 10.10(1) Form of Bonus Interest Amendment
 
 10.11(2) Form of Amended and Restated Employment Agreement of Frank G. Mancuso
           dated as of August 4, 1997
 
 10.12(2) Employment Agreement of A. Robert Pisano dated as of October 10, 1996
 
 10.13(2) Employment Agreement of William A. Jones dated as of October 10, 1996
 
 10.14(5) Employment Agreement of Daniel J. Taylor dated as of August 1, 1997
 
 10.15(5) Amendment to Employment Agreement of Daniel J. Taylor dated as of
           June 15, 1998
 
 10.16(1) Employment Agreement of Robert Brada dated as of March 3, 1995
 
 10.17(1) Amendment to Employment Agreement of Robert Brada dated as of June 1,
           1998
 
 10.18(1) Amendment to Employment Agreement of Robert Brada dated as of October
           30, 1998
 
 10.19(2) Indemnification Agreement dated as of October 10, 1996--Frank G.
           Mancuso
</TABLE>
 
                                       94
<PAGE>
 
                          EXHIBIT INDEX--(Continued)
 
<TABLE>
<CAPTION>
 Exhibit
  Number                           Document Description
 -------                           --------------------
 <C>      <S>
 10.20(2) Indemnification Agreement dated as of October 10, 1996--A. Robert
           Pisano
 
 10.21(2) Indemnification Agreement dated as of October 10, 1996--William A.
           Jones
 
 10.22(2) Indemnification Agreement dated as of October 10, 1996--James D.
           Aljian
 
 10.23(2) Indemnification Agreement dated as of October 10, 1996--Kirk
           Kerkorian
 
 10.24(2) Indemnification Agreement dated as of October 10, 1996--Jerome B.
           York
 
 10.25(3) Indemnification Agreement dated as of November 7, 1997--Alex
           Yemenidjian
 
 10.26(3) Indemnification Agreement dated as of January 28, 1998--Francis Ford
           Coppola
 
 10.27(5) Indemnification Agreement dated as of June 15, 1998--Daniel J. Taylor
 
 10.28(1) Indemnification Agreement dated as of October 10, 1996--Robert Brada
 
 10.29(1) Indemnification Agreement dated as of November 12, 1998--Alexander M.
           Haig, Jr.
 
 10.30(1) Indemnification Agreement dated as of November 12, 1998--Willie D.
           Davis
 
 10.31(2) Amended and Restated Supplemental Executive Retirement Agreement
           dated as of July 18, 1997--A. Robert Pisano
 
 10.32(2) Form of Amended and Restated Shareholders Agreement dated as of
           August 4, 1997
 
 10.33(5) Form of Waiver and Amendment No. 1 to Amended and Restated
           Shareholders Agreement dated as of August 8, 1998
 
 10.34(5) Form of Amendment No. 2 to Amended and Restated Shareholders
           Agreement dated September 1, 1998
 
 10.35(1) Form of Waiver and Amendment No. 3 to Amended and Restated
           Shareholders Agreement
 
 10.36(2) Form of Amended and Restated Investors Shareholder Agreement dated as
           of August 4, 1997
 
 10.37(5) Form of Amendment No. 1 to Amended and Restated Investors Shareholder
           Agreement dated as of September 1, 1998
 
 10.38(2) Form of Amended and Restated Stock Option Agreement between the
           Company and Tracinda
 
 10.39(2) Form of Amended and Restated Stock Option Agreement between the
           Company and Celsus Financial Corp.
 
 10.40(2) Form of Inducement Agreement dated as of November 5, 1997
 
 10.41(2) Form of Investment Agreement dated November 12, 1997 between the
           Company and Tracinda
 
 10.42(4) 1998 Non-Employee Director Stock Plan
 
 21(1)    List of Subsidiaries of Metro-Goldwyn-Mayer Inc.
 
 23(1)    Consent of Arthur Andersen LLP
 
 27(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.
 
(3) Filed as an exhibit to the Company's Form 10-K for the fiscal year ended
    December 31, 1997 (File No. 001-13481) and incorporated herein by
    reference.
 
(4) Filed as an exhibit to the Company's Form S-8 (File No. 333-52953) and
    incorporated herein by reference.
 
(5) Filed as an exhibit to the Company's Registration Statement on Form S-1,
    as amended (File No. 333-60723) and incorporated herein by reference.
 
                                      95