Walt Disney Company 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES ü NO
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES NO ü
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 and (2) has been subject to such filing requirements for the past 90 days.
YES ü NO
Indicate by check mark if disclosure of delinquent filers pursuant to Rule 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer ü Accelerated filer Non accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
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The aggregate market value of common stock held by non-affiliates (based on the closing price on the last business day of the registrants most recently completed second fiscal quarter as reported on the New York Stock Exchange-Composite Transactions) was $64.3 billion. All executive officers and directors of the registrant and all persons filing a Schedule 13D with the Securities and Exchange Commission in respect to registrants common stock have been deemed, solely for the purpose of the foregoing calculation, to be affiliates of the registrant.
There were 1,903,484,711 shares of common stock outstanding as of November 14, 2007.
Documents Incorporated by Reference
Certain information required for Part III of this report is incorporated herein by reference to the proxy statement for the 2008 annual meeting of the Companys shareholders.
THE WALT DISNEY COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
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ITEM 1. Business
The Walt Disney Company, together with its subsidiaries, is a diversified worldwide entertainment company with operations in four business segments: Media Networks, Parks and Resorts, Studio Entertainment, and Consumer Products. For convenience, the terms Company and we are used to refer collectively to the parent company and the subsidiaries through which our various businesses are actually conducted.
Information on the Companys revenues, operating income, and identifiable assets appears in Note 1 to the Consolidated Financial Statements included in Item 8 hereof. The Company employed approximately 137,000 people as of September 29, 2007.
The Media Networks segment is comprised of a domestic broadcast television network, television production and distribution operations, domestic television stations, cable/satellite networks, domestic broadcast radio networks and stations, and internet and mobile operations.
Domestic Broadcast Television Network
The Company operates the ABC Television Network, which as of September 29, 2007, had affiliation agreements with 231 local stations reaching 99% of all U.S. television households. The ABC Television Network broadcasts programs in the following dayparts: early morning, daytime, primetime, late night, news, children and sports.
The ABC Television Network produces its own programs or acquires broadcast rights from other third-party producers, as well as production entities that are owned by the Company, and rights holders for network programming and pays varying amounts of compensation to affiliated stations for broadcasting the programs and commercial announcements included therein. The ABC Television Network derives substantially all of its revenues from the sale to advertisers of time in network programs for commercial announcements. The ability to sell time for commercial announcements and the rates received are primarily dependent on the size and nature of the audience that the network can deliver to the advertiser as well as overall advertiser demand for time on network broadcasts.
Television Production and Distribution
We produce and distribute live action and animated television programming under the ABC Studios, Buena Vista Productions, Disney-ABC Domestic Television, Disney-ABC International Television, Walt Disney Television and ABC Family Productions labels. We distribute both domestically and internationally, as well as in the home entertainment market, through our distribution companies. Program development is carried out in collaboration with a number of independent writers, producers, and creative teams, with a focus on the development, production and distribution of half-hour comedies and one-hour dramas for primetime broadcasts. Programming produced either for ourselves or third parties in the 2007/2008 television season include the one-hour dramas Army Wives, Brothers & Sisters, Criminal Minds, Desperate Housewives, Dirt, Ghost Whisperer, Greys Anatomy, Kyle XY, Lost, October Road, and Ugly Betty; and the half-hour comedies According to Jim and Scrubs. In addition, Americas Funniest Home Videos and Extreme Makeover: Home Edition entered the domestic syndication market during 2007, while Greys Anatomy was licensed in 2007. New primetime series that premiered in the fall of 2007 included the one-hour dramas Cane, Dirty Sexy Money, Private Practice, and Reaper, and the half-hour comedies Carpoolers, Cavemen, and Samantha Who? Planned midseason shows include the one-hour drama Eli Stone and the comedy Miss Guided.
The Company also produces original television movies that the ABC Television Network airs along with acquired theatricals as ABC Movies of the Week.
Under the Buena Vista Productions label, we produce a variety of primetime specials for network television and live-action syndicated programming. Syndicated programming includes Live! with Regis and Kelly, a daily talk show; Ebert & Roeper, a weekly motion picture review program; and game shows, such as Who Wants to Be a Millionaire. This programming has been sold for multiple years into the future and some of the talent has signed long-term commitments.
Domestic Television Stations
We own nine very high frequency (VHF) television stations, six of which are located in the top-ten markets in the United States, and one ultra-high frequency (UHF) television station. All of our television stations are affiliated with the ABC Television Network, transmit both analog and digital signals, and collectively reach 24% of the nations television households.
Markets and other station details for the stations we own are as follows:
Our cable/satellite networks are engaged in broadcasting of television programming, licensing of television programming to domestic and international markets and investing in foreign television broadcasting, programming, production and distribution entities. Programming at our cable/satellite networks is both internally produced and acquired from third parties.
Cable/satellite networks derive substantially all of their revenues from affiliate fees charged to cable and satellite service providers and, for certain networks, the sale to advertisers of time in network programs for commercial announcements. Generally, the Companys cable/satellite networks operate under multi-year carriage agreements with cable and satellite service providers that include contractually determined affiliate fees. The amounts that we can charge to cable and satellite service providers for our cable/satellite network services are largely dependent on competition and the quality and quantity of programming that we can provide. The ability to sell time for commercial announcements and the rates received are primarily dependent on the size and nature of the audience that the network can deliver to the advertiser as well as overall advertiser demand. Certain programming developed by our cable/satellite networks is also distributed in the home entertainment markets.
The Companys most significant cable properties and our ownership percentage and estimated subscribers as of September 29, 2007 are set forth in the following table:
The Company has various other international investments in broadcast and cable properties in addition to those listed in the above table.
ESPN. ESPN is a multimedia, multinational sports entertainment company that operates six television sports networks: ESPN, ESPN2, ESPN Classic, ESPNEWS, ESPN Deportes (a Spanish language network) and ESPNU (a network devoted to college sports). ESPN also operates two high-definition television simulcast services, ESPN HD and ESPN2 HD. ESPN programs the sports schedule on the ABC Television Network, which is now branded ESPN on ABC. ESPN owns, has equity interests in or has distribution agreements with 34 international sports networks, reaching households in more than 190 countries and territories in 15 languages including a 50% equity interest in ESPN Star Sports, which distributes sports programming throughout most of Asia. In addition, ESPN holds a 30% equity interest in CTV Specialty Television, Inc., which owns The Sports Network, Le Réseau des Sports, ESPN Classic Canada, the NHL Network and Discovery Canada, among other media properties in Canada.
ESPN operates ESPN.com, a sports web site; ESPN360.com, which delivers video content to broadband subscribers; Mobile ESPN, which delivers content to mobile service providers; ESPN Regional Television, the nations largest syndicator of collegiate sports programming; the ESPN Radio Network; ESPN Radio stations; ESPN The Magazine; BASS, the largest tournament fishing organization in the world sanctioning more than 20,000 events annually through the BASS Federation Nation; and ESPN Enterprises, which develops branded licensing opportunities. ESPN Zone sports-themed dining and entertainment facilities are operated by and included in the Parks and Resorts segment.
The ESPN Radio Network format is carried on more than 750 stations, of which 355 are full-time (five stations are owned by the Company), making it the largest sports radio network in the United States.
Markets and other details for the stations we own are as follows:
Disney Channel. Disney Channel is a cable/satellite network service that targets children and families. Shows developed and produced internally for initial exhibition on Disney Channel include live-action comedy series, animated programming and educational preschool series, as well as projects for the Disney Channel Original Movie franchise, including this years Jump In and High School Musical 2. Live-action comedy series include Hannah Montana, The Suite Life of Zack & Cody, and Cory in the House. Animated programming includes Disneys The Emperors New School and The Replacements. Preschool series include My Friends Tigger & Pooh, Disneys Mickey Mouse Clubhouse, and Disneys Little Einsteins. The balance of the programming consists of products acquired from third parties and products from our theatrical film and television programming library.
Many of the live-action and animated series produced for Disney Channel also air during the ABC Television Networks Saturday morning childrens daypart, ABC Kids. These programs include Hannah Montana, The Suite Life of Zack & Cody, Thats So Raven, Disneys The Emperors New School and The Replacements.
Disney Channel also operates in more than 20 markets outside the United States. International programming consists primarily of the Companys originally produced series and movies, products acquired from third parties and locally-produced programming. We continue to explore the further development of Disney Channel in other countries around the world.
International Disney Channels (excluding feed extensions) and launch dates are set forth in the following table:
Toon Disney. Toon Disney was launched in 1998 and is intended to appeal to children and features an array of family-friendly, predominantly animated programming from the Disney library. Toon Disney is also the home of Jetix, a block consisting of action adventure programming. This year Toon Disney added the Disney Channel comedy series, The Replacements, and also offers the Big Movie Show, which airs Feature Animation releases including Disney/Pixars The Incredibles, Finding Nemo and Monsters, Inc.
SOAPnet. SOAPnet was launched in January 2000 and offers a variety of soap operas and related programming. Popular daytime dramas, including All My Children, Days of Our Lives, One Life to Live, General Hospital, and The Young and the Restless, are aired at night. In addition, the network provides inside access to stars and storylines with original programs and reality series I Wanna Be A Soap Star and The Fashionista Diaries. SOAPnet also offers primetime classics, including Melrose Place, Beverly Hills 90210 and Dallas, as well as classic daytime series Port Charles, Ryans Hope and Another World.
ABC Family. ABC Family is a U.S. television programming service that targets adults 18-34. The networks current programming includes the dramas Kyle XY, Lincoln Heights, Wildfire and Greek. The network contracts with outside production companies for these dramas but retains ownership rights. Additionally, ABC Family airs original movies, content acquired from third parties, and products from our owned theatrical film library. The most recent season included the original movies Santa Baby and Fallen as well as broadcasts of films from the Harry Potter series.
JETIX. The Company has a 73.6% ownership interest in Jetix Europe, a publicly traded pan-European integrated childrens entertainment company formerly known as Fox Kids Europe, and a 100% ownership interest in Jetix Latin America, formerly known as Fox Kids Latin America, which is operated by Disney Channel Latin America.
A&E Television Networks. The A&E Television Networks are television programming services devoted to cultural and entertainment programming and include A&E, A&E International, The History Channel, History International and The Biography Channel.
Lifetime Entertainment Services. Lifetime Entertainment Services includes Lifetime Television, which is devoted to womens lifestyle programming; the Lifetime Movie Network, a 24-hour movie channel; and Lifetime Real Women, a 24-hour cable network with programming from a womans point of view.
E! Entertainment Television. On November 21, 2006, in connection with the execution of new long-term agreements for the provision of programming to cable service provider Comcast Corporation (Comcast), the Company sold its 39.5% interest in E! Entertainment Television (E!) to Comcast (which owned the remainder of the interests in E!) for $1.2 billion, which resulted in a pre-tax gain of approximately $0.8 billion ($0.5 billion after-tax), which was recorded in the first quarter of fiscal 2007.
The Companys share of the financial results of A&E, Lifetime and other broadcast and cable equity investments is reported under the heading Equity in the income of investees in the Companys Consolidated Statements of Income.
Radio Disney. The Radio Disney Network format is intended to appeal to kids, tweens and families. It is carried in 54 markets, covering more than 60% of the U.S. market. Radio Disney is also available on RadioDisney.com, XM and Sirius satellite radio, iTunes Radio Tuner, digital cable televisions Music Choice channel, XM/DIRECTV and mobile phones. Radio Disney programming can also be downloaded via the iTunes Music Store. Radio Disney brand extensions include multiple Radio Disney Jams CDs from Walt Disney Records.
Markets and other details for Radio Disney stations we own are as follows:
Internet and Mobile Operations
The internet and mobile operations of the Media Networks segment develop, publish and distribute content for online and wireless services intended to appeal to broad consumer interest in sports, news, family and entertainment. Internet web sites and products include ABC.com, ABCNews.com, Disney.com, Disney Online, ABCFamily.com, SOAPnet.com, ESPN.com, Disneys Club Penguin and Disney Mobile Studios. The Companys internet operations derive revenue from a combination of advertising and sponsorships, subscription services and e-commerce activities.
ABC.com is the official web site of the ABC Television Network, while ABCNews.com draws on the knowledge and expertise of ABC News correspondents throughout the world to provide in-depth news coverage online. ABCNews.com also offers broadband subscriptions to the 24-hour live internet news channel, ABC News Now, and to video-on-demand news reports from all ABC News broadcasts. Content from ABC and ABC News is also available on select domestic wireless networks.
Disney.com is a centralized Disney web site that integrates many of the Companys Disney-branded internet sites including sites for the Disney Channel, Disney Parks and Resorts, Walt Disney Pictures and Disney Consumer Products. Disney Online offers a number of premium broadband services, including Disney Connection and Disneys Toontown Online.
ABCFamily.com creates digital extensions to ABC Family programming that feature interactivity and social networking. The site also features user-generated content and online programming that is downloadable and customizable based on preferences of individual users.
SOAPnet.com uses digital media to give soap fans additional information on SOAPnet daytime dramas. SOAPNETIC, a gated broadband service, provides exclusive, behind-the-scenes coverage of the world of daytime dramas.
ESPN.com delivers comprehensive sports news, information and video to millions of fans each month. ESPN360.com is a broadband service that delivers live games, highlights and inside analysis.
In August 2007, the Company acquired Club Penguin, an online virtual world for kids ages 6-14. The site features animated penguin avatars that inhabit a snow-covered world, converse with other users, participate in group activities and create and furnish a virtual home with currency earned inside the game.
Disney Mobile Studios produces and publishes mobile content that is distributed through mobile carriers and content distributors worldwide. In June 2006, the Company launched Disney Mobile, a mobile phone service specifically developed to meet the needs of parents and kids. In October 2007, the Company announced the termination of Disney Mobile.
In February 2006, the Company launched Mobile ESPN, a mobile phone service specifically targeted to sports fans. In September 2006, the Company announced Mobile ESPN would be transitioned into its existing wireless business, which distributes mobile content to various wireless devices.
ABC Radio Transaction
On June 12, 2007, the Company completed the spin-off of its wholly-owned subsidiary, ABC Radio Holdings, Inc., which was then merged into a subsidiary of Citadel Broadcasting Corporation (Citadel). Prior to the spin-off, the Company consolidated its ABC Radio business, consisting of 22 large-market radio stations and the ABC Radio Network businesses, under ABC Radio Holdings, Inc. The transaction did not include the Companys ESPN Radio or Radio Disney Networks and station businesses. Additional information regarding the ABC Radio spin-off transaction is included in Note 3 of the Consolidated Financial Statements.
Competition and Seasonality
The ABC Television Network, Disney Channel, ESPN, ABC Family Channel and our other broadcast and cable/ satellite networks compete for viewers primarily with other television networks, independent television stations and other video media, such as cable and satellite television programming services, DVDs, video games and the internet. In the sale of advertising time, the broadcasting operations, certain of our cable/satellite networks and our radio stations compete with other television networks and radio stations, independent television stations, suppliers of cable and satellite services and other advertising media such as newspapers, magazines, billboards, and the internet. For our television and radio stations, competition occurs primarily in individual market areas. A television or radio station in one market generally does not compete directly with stations in other markets.
The growth in the cable and satellite industrys share of viewers has resulted in increased competitive pressures for advertising revenues for both our broadcasting and cable/satellite networks. The Companys cable/satellite networks also face competition from other cable networks for carriage by cable and satellite service operators and distributors. The Companys contractual agreements with cable, satellite and telephone operators are renewed or
renegotiated from time to time in the ordinary course of business. Consolidation and other market conditions in the cable and satellite distribution industry and other factors may adversely affect the Companys ability to obtain and maintain contractual terms for the distribution of its various cable and satellite programming services that are as favorable as those currently in place.
The Companys Media Networks businesses also compete for the acquisition of sports and other programming. The market for programming is very competitive, particularly for sports programming. The Company currently has sports rights agreements with the National Football League (NFL), National Basketball Association (NBA), National Association of Stock Car Auto Racing (NASCAR), Major League Baseball (MLB), World Cup, Indy Racing League and various college football and basketball conferences.
The Companys internet web sites and products compete with other web sites and products in their respective categories, which include kids, family, entertainment, sports and news, among others.
Advertising revenues at the Media Networks are subject to seasonal advertising patterns and changes in viewership levels. Revenues are typically somewhat higher during the fall and somewhat lower during the summer months. Affiliate revenues are typically collected ratably throughout the year. Certain affiliate revenues at ESPN are deferred until annual programming commitments are met, and these commitments are typically satisfied during the second half of the Companys fiscal year, which generally results in higher revenue recognition during this period.
Television and radio broadcasting are subject to extensive regulation by the Federal Communications Commission (FCC) under federal laws and regulations, including the Communications Act of 1934, as amended. Violation of FCC regulations can result in substantial monetary forfeitures, limited renewals of licenses and, in egregious cases, denial of license renewal or revocation of a license. FCC regulations that affect our Media Networks segment include the following:
In July 2003, the FCC adopted revised limits on television and radio station ownership. The rules adopted generally would have relaxed existing ownership restrictions and permitted entities to own more television and radio stations in some markets. They also would have eliminated the 50% discount for calculating households reached by UHF television stations operated by the top four broadcast television networks (including ABC). The new rules, however, were challenged in federal court and were remanded by the court to the FCC to review the rules. As a result,
most of the revised rules adopted by the FCC in July 2003 are not in effect. The FCC has initiated a rulemaking in response to the court remand to re-evaluate these rules in light of the court decision. Although it is possible that the FCC may implement more liberal media ownership rules than those currently in effect (other than those governed by statute), we cannot predict whether the revised rules will be implemented and if so, when such rules will become effective.
Federal legislation and FCC rules also limit the amount of commercial matter that may be shown on broadcast or cable channels during programming designed for children 12 years of age and younger. In addition, broadcast channels are generally required to provide a minimum of three hours per week of programming that has as a significant purpose meeting the educational and informational needs of children 16 years of age and younger. FCC rules also give television station owners the right to reject or refuse network programming in certain circumstances or to substitute programming that the licensee reasonably believes to be of greater local or national importance.
The foregoing is a brief summary of certain provisions of the Communications Act and other legislation and of specific FCC rules and policies. This summary focuses on provisions material to our business. Reference should be made to the Communications Act, other legislation, FCC rules and public notices and rulings of the FCC for further information concerning the nature and extent of the FCCs regulatory authority.
FCC laws and regulations are subject to change, and the Company generally cannot predict whether new legislation, court action or regulations, or a change in the extent of application or enforcement of current laws and regulations, would have an adverse impact on our operations.
PARKS AND RESORTS
The Company owns and operates the Walt Disney World Resort in Florida, the Disneyland Resort in California, the Disney Vacation Club, the Disney Cruise Line and ESPN Zone facilities in several states. The Company manages and has effective ownership interests of 51% and 43%, respectively, in the Disneyland Resort Paris and Hong Kong
Disneyland Resort. The Company also licenses the operations of the Tokyo Disney Resort in Japan. The Companys Walt Disney Imagineering unit designs and develops new theme park concepts and attractions as well as resort properties.
The businesses in the Parks and Resorts segment generate revenues predominately from the sale of admissions to the theme parks, room nights at our hotels, merchandise, food and beverage sales, rentals and sales of our vacation club resort properties and cruise vacation packages. Costs consist principally of labor, depreciation, costs of merchandise, food and beverage sold, marketing and sales expense, repairs and maintenance and entertainment.
Walt Disney World Resort
The Walt Disney World Resort is located 22 miles southwest of Orlando, Florida, on approximately 25,000 acres of owned land. The resort includes theme parks (the Magic Kingdom, Epcot, Disney-MGM Studios and Disneys Animal Kingdom); hotels; vacation ownership units; a retail, dining and entertainment complex; a sports complex; conference centers; campgrounds; golf courses; water parks and other recreational facilities designed to attract visitors for an extended stay.
The Walt Disney World Resort is marketed through a variety of international, national and local advertising and promotional activities. Several attractions in each of the theme parks are sponsored by corporate participants.
Magic Kingdom The Magic Kingdom, which opened in 1971, consists of seven themed lands: Main Street USA, Adventureland, Fantasyland, Frontierland, Liberty Square, Mickeys Toontown Fair and Tomorrowland. Each land provides a unique guest experience featuring themed rides and attractions, live Disney character interaction, restaurants, refreshment areas and merchandise shops. Additionally, there are daily parades and a nighttime fireworks extravaganza, Wishes.
Epcot Epcot, which opened in 1982, consists of two major themed areas: Future World and World Showcase. Future World dramatizes certain historical developments and addresses the challenges facing the world today through major pavilions devoted to showcasing science and technology improvements, communication, energy, transportation, using your imagination, life and health, nature and food production, the ocean environment and space. World Showcase presents a community of nations focusing on the culture, traditions and accomplishments of people around the world. Countries represented with pavilions include the United States, Canada, China, France, Germany, Italy, Japan, Mexico, Morocco, Norway and the United Kingdom. Both areas feature themed rides and attractions, restaurants and merchandise shops.
Disney-MGM Studios Disney-MGM Studios, which opened in 1989, consists of a theme park, a radio studio and a film and television production facility. The park centers on Hollywood as it was during the 1930s and 1940s and provides various attractions, themed food service and merchandise facilities. The production facility consists of three sound stages, merchandise shops and a back lot and currently hosts both feature film and television productions. Disney-MGM Studios also features Fantasmic!, a nighttime entertainment spectacular.
Disneys Animal Kingdom Disneys Animal Kingdom, which opened in 1998, consists of a 145-foot Tree of Life centerpiece surrounded by six themed areas: Dinoland U.S.A., Africa, Rafikis Planet Watch, Asia, Discovery Island and Camp Minnie-Mickey. Each themed area contains adventure attractions, entertainment shows, restaurants and merchandise shops. The park features more than 300 species of mammals, birds, reptiles and amphibians and 3,000 varieties of trees and plants on more than 500 acres of land.
Resort Facilities As of September 29, 2007, the Company owned and operated 17 resort hotels at the Walt Disney World Resort, with a total of approximately 22,000 rooms and 443,000 square feet of conference meeting space. In addition, Disneys Fort Wilderness camping and recreational area offers approximately 800 campsites.
Walt Disney World also hosts a 120-acre retail, dining and entertainment complex known as Downtown Disney, which consists of the Marketplace, Pleasure Island and West Side. A number of the Downtown Disney facilities are operated by third parties that pay rent and license fees to the Company. In addition to specialty retail shops and restaurants, the Downtown Disney Marketplace is home to the 50,000-square-foot World of Disney retail store featuring Disney-branded merchandise. Pleasure Island, a nighttime entertainment complex adjacent to the Downtown Disney Marketplace, includes restaurants, nightclubs and shopping facilities. Downtown Disney West Side is situated on 66 acres on the west side of Pleasure Island and includes the DisneyQuest facility, Cirque du Soleil, House of Blues and several other retail, dining and entertainment operations.
Disneys Wide World of Sports, which opened in 1997, is a 220-acre sports complex providing professional caliber training and competition, festival and tournament events and interactive sports activities. The complexs venues accommodate more than 40 different sporting events, including baseball, tennis, basketball, softball, track and field, football and soccer. Its stadium is the spring training site for MLBs Atlanta Braves and has a seating capacity exceeding 9,500. Additionally, the complex is the pre-season training site of the NFLs Tampa Bay Buccaneers. The Amateur Athletic Union hosts more than 30 championship events per year at the facility.
In the Downtown Disney Resort area, seven independently-operated hotels are situated on property leased from the Company. These hotels have a capacity of approximately 3,700 rooms. Additionally, two hotels, the Walt Disney World Swan and the Walt Disney World Dolphin, with an aggregate capacity of approximately 2,300 rooms, are independently operated on property leased from the Company near Epcot.
Other recreational amenities and activities available at the Walt Disney World Resort include four championship golf courses, miniature golf courses, full-service spas, tennis, sailing, water skiing, swimming, horseback riding and a number of other noncompetitive sports and leisure time activities. The resort also includes two water parks: Blizzard Beach and Typhoon Lagoon.
Disney Vacation Club
The Disney Vacation Club (DVC) offers ownership interests in eight resort facilities located at the Walt Disney World Resort; Vero Beach, Florida; and Hilton Head Island, South Carolina. Available units at each facility are offered for sale under a vacation ownership plan and are operated as rental property until the units are sold. After the completion of Saratoga Springs Resort & Spa in May 2007 and the first phase of Disneys Animal Kingdom Villas in July 2007, DVC has approximately 2,400 vacation ownership units. Development of approximately 680 additional units is under construction at Walt Disney World. These accommodations are scheduled for development in phases with an anticipated completion date of the final phase planned for summer 2009. In 2007, the Company announced plans to open the first DVC villas in Anaheim, California, and on the island of Oahu, Hawaii. In Anaheim, 50 DVC villas and 200 additional hotel rooms at Disneys Grand Californian Hotel & Spa are scheduled for completion in late 2009. In Oahu, the Company has purchased 21 acres of oceanfront property which will be home to a new DVC resort. This resort, scheduled to open in phases beginning in 2011, is expected to have more than 800 units, including DVC villas and hotel rooms.
The Company owns 461 acres and has the rights under long-term lease for use of an additional 49 acres of land in Anaheim, California. The Disneyland Resort includes two theme parks (Disneyland and Disneys California Adventure), three hotels and Downtown Disney, a retail, dining and entertainment district designed to attract visitors for an extended stay.
The entire Disneyland Resort is marketed as a destination resort through international, national and local advertising and promotional activities. A number of the attractions and restaurants at each of the theme parks are sponsored by other corporations through long-term agreements.
Disneyland Disneyland, which opened in 1955, consists of Main Street USA and seven principal areas: Adventureland, Critter Country, Fantasyland, Frontierland, New Orleans Square, Tomorrowland and Toontown. These areas feature themed rides and attractions, shows, restaurants, merchandise shops and refreshment stands.
Disneys California Adventure Disneys California Adventure, which opened in 2001, is adjacent to Disneyland and includes four principal areas: Golden State, Hollywood Pictures Backlot, Paradise Pier and a bugs land. These areas include rides, attractions, shows, restaurants, merchandise shops and refreshment stands.
In October 2007, the Company announced a multi-year expansion that will bring new entertainment and family-oriented attractions to Disneys California Adventure, including an entirely new 12-acre Cars Land inspired by the Disney/Pixar animated film Cars.
Resort Facilities Disneyland Resort includes three Company-owned hotels: the 969-room Disneyland Hotel, 489-room Disneys Paradise Pier Hotel and Disneys Grand Californian Hotel & Spa, a deluxe 745-room hotel located
adjacent to Disneys California Adventure. The Company has plans to expand Disneys Grand Californian Hotel & Spa by late 2009, adding more than 200 new hotel rooms and introducing 50 Disney Vacation Club villas to the Disneyland Resort.
The Resort also includes Downtown Disney, a themed 7-acre outdoor complex of entertainment, dining and shopping venues, located adjacent to both Disneyland Park and Disneys California Adventure. A number of the Downtown Disney facilities are operated by third parties, who pay rent and license fees to the Company.
Disneyland Resort Paris
The Company has a 51% effective ownership interest in the Disneyland Resort Paris, which is a 4,800-acre development located in Marne-la-Vallée, approximately 20 miles east of Paris, France being developed pursuant to a 1987 master agreement with the French governmental authorities. Euro Disney S.C.A., a publicly-traded French entity in which the Company holds a 40% interest, and its subsidiaries operate the Disneyland Resort Paris, which includes the Disneyland Park; the Walt Disney Studios Park; seven themed hotels with approximately 5,800 rooms; two convention centers; the Disney Village, a shopping, dining and entertainment complex; and a 27-hole golf facility. Of the 4,800 acres comprising the site, approximately 2,400 acres have been developed to date which includes the Val dEurope development discussed below. An indirect, wholly-owned subsidiary of the Company is responsible for managing Disneyland Resort Paris. Euro Disney S.C.A. is required to pay royalties and management fees to certain indirect, wholly-owned subsidiaries of The Walt Disney Company based on the operating performance of the park.
Disneyland Park Disneyland Park, which opened in 1992, consists of Main Street and four principal themed areas: Adventureland, Discoveryland, Fantasyland and Frontierland. These areas include themed rides, attractions, shows, restaurants, merchandise shops and refreshment stands.
Walt Disney Studios Park Walt Disney Studios Park opened in March 2002 adjacent to Disneyland Park. The park takes guests into the worlds of cinema, animation and television and includes four principal themed areas: Front Lot, Toon Studios, Production Courtyard and Backlot. These areas each include themed rides, attractions, shows, restaurants, merchandise shops and refreshment stands.
Val dEurope is a planned community that we are developing near Disneyland Resort Paris. The completed phases of the development include: a town center, which consists of a shopping center; a 150-room hotel; office, commercial, and residential space; and a regional train station. Third parties operate these developments on land leased or purchased from Euro Disney S.C.A. and its subsidiaries. In September 2003, Euro Disney S.C.A. signed an agreement with the regional development authority to begin the third phase of development. This phase will include an expansion of Disney Village and projects aimed at increasing Val dEuropes capacity to new residents.
In addition, several on-site hotels opened between 2003 and 2006 that are owned and operated by third-party developers and provide approximately 2,300 rooms. Agreements have been signed with additional third-parties to develop approximately 275 time-share units over the next two years.
In fiscal 2005, Euro Disney S.C.A. completed a financial restructuring, which provided for an increase in capital and refinancing of its borrowings. Pursuant to the financial restructuring, the Company has agreed to conditionally and unconditionally defer certain management fees and royalties and convert them into long-term subordinated debt and provide a new ten year 150 million line of credit for liquidity needs, which reduces to 100 million after five years. See Note 5 to the Consolidated Financial Statements for further discussion.
Hong Kong Disneyland Resort
The Company owns a 43% interest in the Hong Kong Disneyland Resort through Hongkong International Theme Parks Limited, an entity in which the Government of the Hong Kong Special Administrative Region owns a 57% majority interest. A separate Hong Kong subsidiary of the Company is responsible for managing Hong Kong Disneyland Resort.
Located on 311 acres on Lantau Island, the resort is in close proximity to the Hong Kong International Airport. Hong Kong Disneyland Resort includes one theme park and two themed hotels.
Hong Kong Disneyland Hong Kong Disneyland opened in September 2005 and consists of the following lands: Adventureland, Fantasyland, Main Street USA and Tomorrowland. These areas feature themed rides and attractions, shows, restaurants, merchandise shops and refreshment stands.
Resort Facilities Hong Kong Disneyland Resort includes two themed hotels: the 400-room Hong Kong Disneyland Hotel and the 600-room Disneys Hollywood Hotel.
The master project agreement signed by the Company and the Hong Kong government in 1999 permits further phased buildout of the development under certain circumstances.
Based on the operating performance of Hong Kong Disneyland Resort, the Company is entitled to receive royalties and management fees. The Company has, however, agreed to waive management fees for the 2008 and 2009 fiscal years, and to defer royalties for the same period. See Note 7 to the Consolidated Financial Statements for further discussion.
Tokyo Disney Resort
Tokyo Disney Resort is located on approximately 494 acres of land, six miles east of downtown Tokyo, Japan. The resort includes two theme parks (Tokyo Disneyland and Tokyo DisneySea); two Disney-branded hotels; six independently-operated hotels; and a retail, dining and entertainment complex.
Tokyo Disneyland Tokyo Disneyland, which opened in 1983, was the first Disney theme park to open outside the United States. Tokyo Disneyland consists of seven principal areas: Adventureland, Critter Country, Fantasyland, Tomorrowland, Toontown, Westernland and World Bazaar.
Tokyo DisneySea Tokyo DisneySea, adjacent to Tokyo Disneyland, opened in 2001. The park is divided into seven unique ports of call, including Mediterranean Harbor, American Waterfront, Port Discovery, Lost River Delta, Mermaid Lagoon, Mysterious Island and Arabian Coast.
Resort Facilities The resort includes the 502-room Tokyo Disney Sea Hotel MiraCosta and the 504-room Disney Ambassador Hotel. A third Disney-branded hotel, the Tokyo Disneyland Hotel, is scheduled to open in July 2008 and will add an additional 706 guest rooms. The resort also includes the Disney Resort Line monorail, which links theme parks and resort hotels with Ikspiari, a retail, dining and entertainment complex, and with Bon Voyage, a Disney-themed merchandise location.
The Company earns royalties on revenues generated by the Tokyo Disney Resort, which is owned and operated by Oriental Land Co., Ltd. (OLC), a Japanese corporation in which the Company has no investment. OLC markets the Tokyo Disney Resort primarily through a variety of local, domestic and international advertising and promotional activities. In addition, third parties sponsor many of the theme park attractions under long-term arrangements.
Disney Cruise Line
Disney Cruise Line, which is operated out of Port Canaveral, Florida, is a vacation cruise line that includes two 85,000-ton ships, the Disney Magic and the Disney Wonder. Both ships cater to children, families and adults, with distinctly-themed areas and activities for each group. Each ship features 877 staterooms, 73% of which are outside staterooms providing guests with ocean views. Cruise vacations often include a visit to Disneys Castaway Cay, a 1,000-acre private Bahamian island. The Company packages three, four and seven-day cruise vacations with visits to the Walt Disney World Resort and also offers cruise-only options.
In February 2007, the Company announced that it is expanding its cruise business by adding two new ships, one in 2011 and one in 2012. The new ships will each be 124,000 tons with 1,250 staterooms.
The ESPN Zone concept combines three interactive areas under one roof for a complete sports and entertainment experience: the Studio Grill, offering dining in an ESPN studio environment; the Screening Room, offering fans an exciting sports viewing environment; and the Sports Arena, challenging guests with a variety of interactive and
competitive attractions. The Company currently operates eight ESPN Zone restaurants located in Anaheim, California; Atlanta, Georgia; Baltimore, Maryland; Chicago, Illinois; Denver, Colorado; Las Vegas, Nevada; New York, New York; and Washington, D.C.
Walt Disney Imagineering
Walt Disney Imagineering provides master planning, real estate development, attraction and show design, engineering support, production support, project management and other development services, including research and development for the Companys operations.
Competition and Seasonality
The Companys theme parks and resorts compete with other forms of entertainment, lodging, tourism and recreational activities. The profitability of the leisure-time industry may be influenced by various factors that are not directly controllable, such as economic conditions including business cycle and exchange rate fluctuations, travel industry trends, amount of available leisure time, oil and transportation prices and weather patterns.
All of the theme parks and the associated resort facilities are operated on a year-round basis. Historically, the theme parks and resort business experiences fluctuations in theme park attendance and resort occupancy resulting from the seasonal nature of vacation travel and local entertainment excursions. Peak attendance and resort occupancy generally occur during the summer months when school vacations occur and during early-winter and spring-holiday periods.
The Studio Entertainment segment produces and acquires live-action and animated motion pictures, direct-to-video programming, musical recordings and live stage plays.
The Company distributes produced and acquired films (including its film and television library) in the theatrical, home entertainment and television markets. Each of these market windows is discussed in more detail below.
Walt Disney Pictures, a subsidiary of the Company, produces and acquires live-action motion pictures that are distributed primarily under the Walt Disney Pictures and Touchstone Pictures banners. As part of a shift in strategy, the Company expects to weight production of films more toward Disney-branded films and away from Touchstone films. Miramax Film Corp. (Miramax), another subsidiary of the Company, acquires and produces motion pictures under the Miramax banner. The Company distributed motion pictures under the Dimension banner through September 30, 2005. All releases under the Dimension banner after September 30, 2005 are owned and distributed by The Weinstein Company, a third-party company operated by the former co-chairmen of Miramax. The Company retains a license to continue to use the Dimension banner on titles that were released prior to September 30, 2005. The Company also produces and distributes animated motion pictures under the banners, Walt Disney Pictures and Pixar.
During fiscal 2008, we expect to distribute domestically approximately 13 feature films under the Walt Disney Pictures, Pixar and Touchstone Pictures banners and approximately nine films under the Miramax banner. These expected releases include several live-action family films and full-length animated films, with the remainder targeted to teenagers and/or adults. As of September 29, 2007, the Company had released domestically 911 full-length live-action features, 79 full-length animated features, approximately 544 cartoon shorts and 53 live action shorts under the Walt Disney Pictures, Pixar, Touchstone Pictures, Hollywood Pictures, Miramax and Dimension banners.
We distribute and market our filmed products principally through our own distribution and marketing companies in the U.S. In the international market, we distribute our filmed products both directly and through independent distribution companies. Films released theatrically in the U.S. can be released simultaneously theatrically in international territories or generally up to six months later.
The Company incurs significant marketing and advertising costs before and throughout the theatrical release of a film in an effort to generate public awareness of the film, to increase the publics intent to view the film and to help
generate significant consumer interest in the subsequent home entertainment and other ancillary markets. These costs are expensed as incurred; therefore, we typically incur losses in the theatrical markets on a film, including the quarters before the theatrical release of the film.
Home Entertainment Market
In the domestic market, we distribute home-entertainment releases under each of our motion picture banners. In the international market, we distribute home-entertainment releases under each of our motion picture banners both directly and through independent foreign distribution companies. In addition, we acquire and produce original programming for direct-to-video release.
The domestic and international home-entertainment window typically starts four to six months after each theatrical release with the issuance of a variety of physical and electronic versions of each title (including DVD, Blu-ray and electronic formats). Most titles are sold simultaneously to both rentailers, such as Blockbuster, and retailers, such as Wal-Mart and Best Buy. In fiscal 2006, we began to distribute our films in the home-entertainment market electronically, including via iTunes and other distribution services.
As of September 29, 2007, under the banners Walt Disney Pictures, Pixar, Touchstone Pictures, Hollywood Pictures, Miramax and Dimension, 1,410 produced and acquired titles, including 1,176 live-action titles and 234 cartoon shorts and animated features, were available to the domestic home-entertainment marketplace and 3,070 produced and acquired titles, including 2,270 live-action titles and 800 cartoon shorts and animated features, were available to the international home-entertainment market.
Pay-Per-View (PPV): Generally about one to two months after the home entertainment window begins, the studios television distributors, Disney-ABC Domestic Television and Disney-ABC International Television, license titles to cable, satellite and internet platforms for showing on a pay-per-view basis. PPV services, such as iN DEMAND and DirecTV, deliver one-time rentals electronically to consumers televisions at a price comparable to that of physical media rentals. Video-on-Demand (VOD) is an extension of PPV and currently shares the PPV window. The PPV/VOD window generally lasts about three months.
Pay Television (Pay 1): There are generally two pay television windows. The first window is generally sixteen months in duration and follows the PPV/VOD window. The Company has licensed exclusive domestic pay television rights to certain films released under the Walt Disney Pictures, Pixar, Touchstone Pictures, Hollywood Pictures, Miramax and Dimension banners to the Encore pay television services over a multi-year period.
Free Television (Free 1): The Pay 1 window is followed by a free television window with telecasts accessible to consumers without charge. This free window may last up to 84 months. Motion pictures are usually sold in the Free 1 window on an ad-hoc basis to major networks and basic cable services. For films released theatrically prior to October 1, 2004, the Studio maintained only one output arrangement with the ABC Television Network. Films released after that date can be sold on an ad-hoc basis to all networks, including the ABC Television Network.
Pay Television 2 (Pay 2) and Free Television 2 (Free 2): In the U.S., Free 1 is generally followed by a fourteen- month Pay 2 window, included under our license arrangement with Encore, and finally by a Free 2 window. The Free 2 window is a syndication window where films are licensed both to basic cable networks and to third-party television station groups. Major packages of the Companys feature films and animated television programming have been licensed for broadcast under multi-year agreements.
International Television: The Company also licenses its theatrical and television properties outside of the U.S. The typical windowing sequence is broadly consistent with the domestic cycle such that titles premiere on television in PPV/VOD then air in pay TV before airing in free TV. Windowing strategies are developed in response to local market practices and conditions, and the exact sequence and length of each window can vary country by country.
Disney Music Group
The Disney Music Group includes Walt Disney Records, Hollywood Records (including the Mammoth Records and Buena Vista Records labels), Lyric Street Records, Buena Vista Concerts and Disney Music Publishing.
Walt Disney Records produces and distributes compact discs and music DVDs in the United States. Music categories include infant, childrens read-along, teens, all-family and soundtracks from film and television series distributed by Walt Disney Pictures and Disney Channel. It also licenses the creation of similar products throughout the rest of the world. Hollywood Records develops, produces and markets recordings from new talent across a spectrum of popular music. Nashville-based Lyric Street Records develops, produces and markets recordings in the country music genre.
Each of the labels commissions new music for the Companys motion picture and television programs, records the songs and licenses the song copyrights to others for printed music, records, audio-visual devices, public performances and digital distribution. Buena Vista Concerts produces live-entertainment events with artists signed to the Disney Music Group record labels.
Disney Music Publishing controls the copyrights of thousands of musical compositions derived from the Companys motion picture, television, record and theme park properties, as well as musical compositions written by songwriters under exclusive contract. It is responsible for the management, protection, growth and licensing of the Disney song catalog on a worldwide basis, including licensing for printed music, records, audio-visual works and new media.
Disney Theatrical Group
The Disney Theatrical Group includes both Disney Theatrical Productions and Disney Live Family Entertainment.
Disney Theatrical Productions develops, produces and licenses live entertainment events. The Company has produced and licensed Broadway musicals around the world, including Beauty and the Beast, The Lion King, Elton John & Tim Rices Aida, Mary Poppins (a co-production with Cameron Mackintosh Ltd), TARZAN®, and the professional touring stage version of High School Musical, which was launched in August 2007. Disneys musical The Little Mermaid will open on Broadway in December 2007. In addition, the Company licenses musical titles for local school and community theatre productions.
Disney Live Family Entertainment delivers worldwide touring productions under the Disney On Ice and Disney Live! brands through our license to Feld Entertainment. In September 2007, Disney On Ice launched High School Musical: the Ice Tour, and Disney Live! launched Playhouse Disney Live!.
On May 5, 2006, the Company acquired Pixar in an all-stock transaction and Pixar became a wholly-owned subsidiary of the Company. As a result of the acquisition, the Company now produces feature animation films under both the Disney and Pixar banners. Prior to the acquisition, the Company co-financed and distributed animated motion pictures developed in conjunction with Pixar. Both parties co-financed and co-branded the films and shared equally in the profits of each picture and any related merchandise or ancillary products, after the Company recovered all marketing costs and received a distribution fee. Additional information regarding the acquisition of Pixar is set forth in Note 3 to the consolidated financial statements.
Competition and Seasonality
The success of Studio Entertainment operations is heavily dependent upon public taste and preferences. In addition, Studio Entertainment operating results fluctuate due to the timing and performance of releases in the theatrical, home entertainment and television markets. Release dates are determined by several factors, including competition and the timing of vacation and holiday periods.
The Studio Entertainment businesses compete with all forms of entertainment. A significant number of companies produce and/or distribute theatrical and television films, exploit products in the home entertainment market, provide pay television programming services and sponsor live theater. We also compete to obtain creative and performing talents, story properties, advertiser support, broadcast rights and market share, that are essential to the success of our Studio Entertainment businesses.
The Consumer Products segment engages with licensees, manufacturers, publishers and retailers throughout the world to design, develop, publish, promote and sell a wide variety of products based on existing and new Disney characters and other intellectual property. In addition to leveraging the Companys film and television properties, Consumer Products also develops new intellectual property with the potential of being used in the Companys other businesses. The Company also engages in retail and online distribution of products based on the Companys characters and films through The Disney Store and DisneyShopping.com, respectively. The Disney Store is owned and operated in Europe and is franchised in North America and Japan.
Character Merchandise Licensing
The Companys worldwide merchandise licensing operations are divided among several product categories, including toys, apparel, accessories, footwear, home furnishings, home décor, health, beauty, food, stationery and consumer electronics. The Company earns royalties, which are usually based on a fixed percentage of the wholesale or retail selling price of the products. The Company licenses characters from its film, television and other properties. Some of the major properties licensed by the Company include Mickey Mouse, Winnie the Pooh, Disney Princess, Cars and High School Musical. The Company has also expanded its ability to design individual products and create exclusive themed and seasonal promotional campaigns for retailers based on characters, movies and TV shows.
Books and Magazines
Disney Publishing Worldwide (DPW) publishes childrens books and magazines in multiple countries and languages. DPWs businesses include Disney Global Book Group, U.S. Consumer Magazines and Global Disney Magazines. During 2007, the Companys U.S. and international childrens book group published several new titles, including the third book in the Percy Jackson and the Olympians Series by Rick Riordan, The Titans Curse, Disneys Pirates of the Caribbean: At Worlds End by T. t. Sutherland, High School Musical 2: The Junior Novel by N.B. Grace and the second illustrated storybook Fairy Dust and the Quest for the Wand by Gail Carlson Levine, as well as several titles for Cars and Princess franchises. The U.S. Consumer Magazine business includes such titles as FamilyFun and Wondertime. The international childrens magazine group includes titles such as Mickey Mouse and Donald Duck weekly comic magazines and Princess. In fiscal 2006, the Company sold Discover magazine and discontinued Disney magazine in the U.S. Disney Publishing also licenses books, magazines and English language learning programs.
Disney Interactive Studios (Formerly Buena Vista Games)
Disney Interactive Studios (DIS) creates, develops, markets and distributes multi-platform video games worldwide. DIS primarily focuses on multi-platform games derived from the Companys creative content, such as Pirates of the Caribbean: At Worlds End, Spectrobes and Meet The Robinsons. DIS is increasing its investment in internally developed and published games through the acquisition of studios and increased product development spending. DIS also licenses properties such as Kingdom Hearts 2 and Ratatouille to third-party developers.
DisneyShopping.com offers Disney-themed merchandise through an internet site, which includes internally developed Disney merchandise as well as merchandise from Disney licensees.
The Disney Store
The Company markets Disney-themed products directly through retail stores operated under the Disney Store name. These facilities are generally located in leading shopping malls and other retail complexes. The stores carry a wide variety of Disney merchandise and promote other businesses of the Company. The Company owns and operates 105 stores in Europe. In Japan, the stores are operated by a subsidiary of Oriental Land Co., Ltd., under a licensing arrangement. In fiscal 2005, 315 stores in North America were sold to a wholly-owned subsidiary of The Childrens Place, which operates them under a licensing and operating arrangement. At September 29, 2007, the Childrens Place operated 328 stores under this arrangement. See Note 3 to the Consolidated Financial Statements for discussion on the sale of the Disney Store chain in North America.
Competition and Seasonality
The Company competes in its character merchandising and other licensing, publishing, interactive and retail activities with other licensors, publishers and retailers of character, brand and celebrity names. Based on independent surveys, we believe the Company is the largest worldwide licensor of character-based merchandise and producer/distributor of childrens film-related products based on retail sales. Operating results for the licensing and retail distribution business are influenced by seasonal consumer purchasing behavior and by the timing and performance of animated theatrical releases and cable programming broadcasts.
INTELLECTUAL PROPERTY PROTECTION
The Companys businesses throughout the world are affected by its ability to exploit and protect against infringement of its intellectual property, including trademarks, trade names, copyrights, patents and trade secrets. Important intellectual property includes rights in the content of motion pictures, television programs, electronic games, sound recordings, character likenesses, theme park attractions, books and magazines.
The Companys ability to exploit and protect intellectual property rights is affected by the strength and effectiveness of intellectual property laws in the United States and abroad. Inadequate laws or enforcement mechanisms to protect intellectual property in one country can adversely affect the results of the Companys operations worldwide, despite the Companys efforts to protect its intellectual property rights. In addition, a variety of factors, including technological advances, the falling prices of devices incorporating such new technologies, and increased broadband internet speed and penetration have made infringement easier and faster and enforcement more challenging. Therefore, the Company devotes significant resources to protecting its intellectual property against unauthorized use in the United States and foreign markets.
The Company is also subject to the risk of challenges by third parties claiming infringement of their proprietary rights. Regardless of their validity, such claims may result in substantial costs and diversion of resources which could have an adverse effect on the Companys operations.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available without charge on our website, www.disney.com/investors, as soon as reasonably practicable after they are filed electronically with the SEC. We are providing the address to our internet site solely for the information of investors. We do not intend the address to be an active link or to otherwise incorporate the contents of the website into this report.
ITEM 1A. Risk Factors
For an enterprise as large and complex as the Company, a wide range of factors could materially affect future developments and performance. In addition to the factors affecting specific business operations identified in connection with the description of these operations and the financial results of these operations elsewhere in this report, the most significant factors affecting our operations include the following:
Changes in U.S., global, or regional economic conditions could adversely affect the profitability of any of our businesses.
A decrease in economic activity in the United States or in other regions of the world in which we do business could adversely affect demand for any of our businesses, thus reducing our revenue and earnings. A decline in economic conditions could reduce attendance and spending at one or more of our parks and resorts, purchase of or prices for advertising on our broadcast or cable networks or owned stations, prices that cable operators will pay for our cable programming, performance of our theatrical and home entertainment releases, and purchases of Company-branded consumer products. In addition, an increase in price levels generally, or in price levels in a particular sector such as the energy sector, could result in a shift in consumer demand away from the entertainment and consumer products we offer, which could also adversely affect our revenues and, at the same time, increase our costs. Changes in exchange rates for foreign currencies may reduce international demand for our products, increase our labor or supply costs in non-United States markets, or reduce the United States dollar value of revenue we receive from other markets.
Labor disputes may disrupt our operations and adversely affect the profitability of any of our businesses.
A significant number of employees in various of our businesses are covered by collective bargaining agreements, including employees of our theme parks and resorts as well as writers, directors, actors, production personnel and others employed in our media networks and studio operations. In addition, the employees of licensees who manufacture and retailers who sell our consumer products may be covered by labor agreements with their employers. Collective bargaining agreements with guilds and unions representing writers, directors, actors, technicians and others either have expired or are scheduled to expire during fiscal 2008, and negotiations with some of these guilds and unions have taken place, are scheduled or are underway. In general, a labor dispute involving our employees or the employees of our licensees or retailers who sell our consumer products may disrupt our operations and reduce our revenues, and resolution of disputes may increase our costs. On November 5, 2007, members of the Writers Guild of America commenced a work stoppage. On November 10, 2007, members of Local One of the International Alliance of Theatrical Stage Employees commenced a work stoppage affecting one of the Companys theatrical productions in New York City. The Company does not currently expect this work stoppage to have a material impact on the Companys financial results. With respect to the work stoppage by the Writers Guild of America, if this or another work stoppage by unions involved in the production of television or film programming is prolonged, we may be unable to produce or air original programming or produce and distribute new theatrical releases, either of which could result in reduced revenue. While we would pursue measures to mitigate the impact of a sustained work stoppage through alternative programming and reduction of costs, we expect that a continued work stoppage could have an adverse effect on our profitability.
Changes in public and consumer tastes and preferences for entertainment and consumer products could reduce demand for our entertainment offerings and products and adversely affect the profitability of any of our businesses.
Each of our businesses creates entertainment or consumer products whose success depends substantially on consumer tastes and preferences that change in often unpredictable ways. The success of our businesses depends on our ability to consistently create and distribute filmed entertainment, broadcast and cable programming, theme park attractions, resort facilities and consumer products that meet the changing preferences of the broad consumer market. Many of our businesses increasingly depend on worldwide acceptance of our offerings and products, and their success therefore depends on our ability to successfully predict and adapt to changing consumer tastes and preferences outside as well as inside the United States. Moreover, we must often invest substantial amounts in film production, broadcast and cable programming, theme park attractions, or resort facilities before we learn the extent to which these products will earn consumer acceptance. If our entertainment offerings and products do not achieve sufficient consumer acceptance, our revenue from advertising sales (which are based in part on ratings for the programs in which advertisements air) or subscription fees for broadcast and cable programming, from theatrical film receipts or home video sales, from theme park admissions, resort room charges and merchandise, food and beverage sales, from sales of licensed consumer products or from sales of our other consumer products and services may decline and adversely affect the profitability of one or more of our businesses.
Changes in technology and in consumer consumption patterns may affect demand for our entertainment products or the cost of producing or distributing products.
The media and entertainment businesses in which we participate depend significantly on our ability to acquire, develop, adopt and exploit new technologies to distinguish our products and services from those of our competitors. In addition, new technologies affect the demand for our products, the time and manner in which consumers acquire and view some of our entertainment products and the options available to advertisers for reaching their desired markets. For example:
The unauthorized use of our intellectual property rights may increase the cost of protecting these rights or reduce our revenues.
The success of our businesses is highly dependent on maintenance of intellectual property rights in the entertainment products and services we create. New technologies such as the convergence of computing, communication, and entertainment devices, the falling prices of devices incorporating such technologies, and increased broadband internet speed and penetration have made the unauthorized digital copying and distribution of our films, television productions and other creative works easier and faster and enforcement of intellectual property rights more challenging. There is evidence that unauthorized use of intellectual property rights in the entertainment industry generally is a significant and rapidly growing phenomenon. These developments require us to devote substantial resources to protecting our intellectual property against unauthorized use and present the risk of increased losses of revenue as a result of unauthorized digital distribution of our content and sales of unauthorized DVDs and other counterfeit products.
A variety of uncontrollable events may reduce demand for our products and services, impair our ability to provide our products and services or increase the cost of providing our products and services.
Demand for our products and services, particularly our theme parks and resorts, is highly dependent on the general environment for travel and tourism. The environment for travel and tourism, as well as demand for other entertainment products, can be significantly adversely affected in the United States, globally or in specific regions as a result of a variety of factors beyond our control, including: adverse weather conditions or natural disasters (such as excessive heat or rain, hurricanes and earthquakes); health concerns; international, political or military developments; and terrorist attacks. These events and others, such as fluctuations in travel and energy costs and computer virus attacks or other widespread computing or telecommunications failures, may also damage our ability to provide our products and services or to obtain insurance coverage with respect to these events. In addition, we derive royalties from the sales of our licensed goods and services by third parties and the management of businesses operated under brands licensed from the Company, and we are therefore dependent on the successes of those third parties for that portion of our revenue. A wide variety of factors could influence the success of those third parties and if negative factors significantly impacted a sufficient number of our licensees they could adversely affect the profitability of one or more of our businesses. We obtain insurance against the risk of losses relating to some but not all of these events, and when insurance is obtained it is subject to deductibles, exclusions and caps. The types and levels of coverage we obtain vary from time to time depending on our view of the likelihood of specific types and levels of loss in relation to the cost of obtaining coverage for such types and levels of loss.
Changes in our business strategy or restructuring of our businesses may increase our costs or otherwise affect the profitability of our businesses.
As changes in our business environment occur we may need to adjust our business strategies to meet these changes or we may otherwise find it necessary to restructure our operations or particular businesses or assets. In addition, external events including acceptance of our theatrical offerings and changes in macro-economic conditions may impair the value of our assets. When these changes or events occur, we may incur costs to change our business strategy and may need to write down the value of assets. We may also need to invest in new businesses that have short-term returns that are negative or low and whose ultimate business prospects are uncertain. In any of these events, our costs may increase, we may have significant charges associated with the write-down of assets or returns on new investments may be lower than prior to the change in strategy or restructuring.
Macro-economic factors may impede access to or increase the cost of financing our operations and investments.
Changes in U.S. and global financial and equity markets, including market disruptions and significant interest rate fluctuations, may make it more difficult for us to obtain financing for our operations or investments or increase the cost of obtaining financing. In addition, our borrowing costs can be affected by short and long-term debt ratings assigned by independent rating agencies which are based, in significant part, on the Companys performance as measured by credit metrics such as interest coverage and leverage ratios. A decrease in these ratings could increase our cost of borrowing or make it more difficult for us to obtain financing.
Increased competitive pressures may reduce our revenues or increase our costs.
We face substantial competition in each of our businesses from alternative providers of the products and services we offer and from other forms of entertainment, lodging, tourism and recreational activities. We also must compete to obtain human resources, programming and other resources we require in operating our business. For example:
Competition in each of these areas may divert consumers from our creative or other products, or to other products or other forms of entertainment, which could reduce our revenue or increase our marketing costs. Competition for the acquisition of resources can increase the cost of producing our products and services.
Sustained increases in costs of pension and postretirement medical and other employee health and welfare benefits may reduce our profitability.
With more than 137,000 employees, our profitability is substantially affected by costs of pension benefits and current and postretirement medical benefits. In some recent years, we experienced significant increases in these costs as a result of macro-economic factors beyond our control, including increases in health care costs. In addition, changes in investment returns and discount rates used to calculate pension and related liabilities may have an unfavorable impact on our costs in some years. At least some of these macro-economic factors may put upward pressure on the cost of providing pension and medical benefits. Although we have actively sought to control increases in these costs, there can be no assurance that we will succeed in limiting cost increases, and continued upward pressure could reduce the profitability of our businesses.
Our results may be adversely affected if long-term programming or carriage contracts are not renewed on sufficiently favorable terms.
We enter into long-term contracts for both the acquisition and the distribution of media programming and products, including contracts for the acquisition of programming rights for sporting events and other programs, and contracts for the distribution of our programming to cable and satellite operators. As these contracts expire, we must renew or renegotiate the contracts, and if we are unable to renew them on acceptable terms, we may lose programming rights or distribution rights. Even if these contracts are renewed, the cost of obtaining programming rights may increase (or increase at faster rates than our historical experience) or the revenue from distribution of programs may be reduced (or increase at slower rates than our historical experience). With respect to the acquisition of programming rights, particularly sports programming rights, the impact of these long-term contracts on our results over the term of the contracts depends on a number of factors, including the strength of advertising markets, effectiveness of marketing efforts and the size of viewer audiences. There can be no assurance that revenues from programming based on these rights will exceed the cost of the rights plus the other costs of producing and distributing the programming.
Changes in regulations applicable to our businesses may impair the profitability of our businesses.
Our broadcast networks and television stations are highly regulated, and each of our other businesses is subject to a variety of United States and overseas regulations. These regulations include:
Changes in any of these regulatory areas may require us to spend additional amounts to comply with the regulations, or may restrict our ability to offer products and services that are profitable.
The Companys acquisition of Pixar causes short term dilution in earnings per share and there can be no assurance that anticipated improvements in earnings per share will be realized.
On May 5, 2006, the Company completed its all stock acquisition of Pixar. To purchase Pixar, Disney exchanged 2.3 shares of its common stock for each share of Pixar common stock, resulting in the issuance of 279 million shares of Disney common stock and converted previously issued vested and unvested Pixar equity-based awards into approximately 45 million Disney equity-based awards.
As anticipated, the earnings contributed by Pixars operations in fiscal 2007 per share issued in the transaction were less than the earnings per share of the remainder of our businesses, effectively reducing earnings per share in fiscal 2007 compared to what earnings per share would have been in the absence of the transaction. The Company believes, however, that the transaction yields benefits beyond the earnings contributed by the operations of Pixar and that the transaction will ultimately be accretive to earnings per share. There can be no assurance that the increase in earnings per share expected in the longer term will be achieved. In order to achieve increases in earnings per share as a result of the acquisition, the Company will, among other things, need to effectively continue the successful operations of Pixar, develop successful sequels to prior Pixar productions and improve the overall performance of the Disney feature animation business.
Provisions in our corporate documents and Delaware state law could delay or prevent a change of control, even if that change would be beneficial to shareholders.
Our Restated Certificate of Incorporation contains a provision regulating the ability of shareholders to bring matters for action before annual and special meetings and authorizes our Board of Directors to issue and set the terms of preferred stock. The regulations on shareholder action could make it more difficult for any person seeking to acquire control of the Company to obtain shareholder approval of actions that would support this effort. The issuance of preferred stock could effectively dilute the interests of any person seeking control or otherwise make it more difficult to obtain control. In addition, we are subject to the anti-takeover provisions of the Delaware General Corporation Law, which could have the effect of delaying or preventing a change of control in some circumstances.
The seasonality of certain of our businesses could exacerbate negative impacts on our operations.
Each of our businesses is normally subject to seasonal variations, as follows:
Accordingly, if a short term negative impact on our business occurs during a time of high seasonal demand (such as hurricane damage to our parks during the summer travel season), the effect could have a disproportionate effect on the results of that business for the year.
ITEM 1B. Unresolved Staff Comments
The Company has received no written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of its 2007 fiscal year and that remain unresolved.
ITEM 2. Properties
The Walt Disney World Resort, Disneyland Park and other properties of the Company and its subsidiaries are described in Item 1 under the caption Parks and Resorts. Film library properties are described in Item 1 under the caption Studio Entertainment. Radio and television stations owned by the Company are described under the caption Media Networks.
The Company and its subsidiaries own and lease properties throughout the world. In addition to the properties noted above, the table below provides a brief description of other significant properties and the related business segment.
ITEM 3. Legal Proceedings
Milne and Disney Enterprises, Inc. v. Stephen Slesinger, Inc. On November 5, 2002, Clare Milne, the granddaughter of A. A. Milne, author of the Winnie the Pooh books, and the Companys subsidiary Disney Enterprises, Inc. (DEI) filed a complaint against Stephen Slesinger, Inc. (SSI) in the United States District Court for the Central District of California. On November 4, 2002, Ms. Milne served notices to SSI and DEI terminating A. A. Milnes prior grant of rights to Winnie the Pooh, effective November 5, 2004, and granted all of those rights to DEI. In their lawsuit, Ms. Milne and DEI sought a declaratory judgment, under United States copyright law, that Ms. Milnes termination notices were valid; that SSIs rights to Winnie the Pooh in the United States terminated effective November 5, 2004; that upon termination of SSIs rights in the United States, the 1983 licensing agreement that is the subject of the Stephen Slesinger, Inc. v. The Walt Disney Company lawsuit terminated by operation of law; and that, as of November 5, 2004, SSI was entitled to no further royalties for uses of Winnie the Pooh. SSI filed (a) an answer denying the material allegations of the complaint and (b) counterclaims seeking a declaration that (i) Ms. Milnes grant of rights to DEI is void and unenforceable and (ii) DEI remains obligated to pay SSI royalties under the 1983 licensing agreement. The District Court ruled that Milnes termination notices were invalid. The Court of Appeals for the Ninth Circuit affirmed, and on June 26, 2006, the United States Supreme Court denied Milnes petition for a writ of certiorari. On June 23, 2003, SSI filed an amended answer and counterclaims and a third-party complaint against Harriet Hunt (heir to E. H. Shepard, illustrator of the original Winnie the Pooh stories), who had served a notice of termination and a grant of rights similar to Ms. Milnes, and asserted counterclaims against the Company allegedly arising from the Milne and Hunt terminations and the grant of rights to DEI for (a) unlawful and unfair business practices; and (b) breach of the 1983 licensing agreement.
On October 19, 2006, the parties stipulated to SSIs filing its Fourth Amended Answer and Counterclaims (Fourth Amended Answer) seeking (a) to invalidate the Hunt termination notice, (b) to terminate the Companys rights vis-à-vis SSI, and (c) damages in excess of two billion dollars, among other relief. That stipulation also provided that Hunt and the Company need not respond to the Fourth Amended Answer until the conclusion of two events: the state court appeal in Stephen Slesinger, Inc. v. The Walt Disney Company, and the trial in the District Court on the validity of the Hunt termination notice. SSI then sought to withdraw both the Fourth Amended Answer and its stipulation, but on November 3, 2006, the District Court denied that request. SSIs motion for summary judgment on the validity of Hunts 2002 attempt to recapture E. H. Shepards rights was granted on February 15, 2007, and thereafter, on March 27, 2007, the District Court dismissed as moot all claims against Hunt and three of SSIs counterclaims against the Company related to the Companys agreements with Milne and Hunt concerning the termination and disposition of their rights. In a related development, on January 23, 2007, and on August 22, 2007, SSI initiated proceedings in the United States Patent and Trademark Office (PTO) seeking, among other things, cancellation of certain Pooh trademark registrations. On February 22, 2007, the PTO suspended the first proceeding on the grounds that the relief sought is effectively duplicative of that sought in the Fourth Amended Answer, and on October 2, 2007, the Company moved to suspend the second proceeding on the same ground.
Stephen Slesinger, Inc. v. The Walt Disney Company. In this lawsuit, filed on February 27, 1991, in the Los Angeles County Superior Court, the plaintiff claims that a Company subsidiary defrauded it and breached a 1983 licensing agreement with respect to certain Winnie the Pooh properties, by failing to account for and pay royalties on revenues earned from the sale of Winnie the Pooh movies on videocassette and from the exploitation of Winnie the Pooh merchandising rights. The plaintiff seeks damages for the licensees alleged breaches as well as confirmation of the plaintiffs interpretation of the licensing agreement with respect to future activities. The plaintiff also seeks the right to terminate the agreement on the basis of the alleged breaches. If each of the plaintiffs claims were to be confirmed in a final judgment, damages as argued by the plaintiff could total as much as several hundred million dollars and adversely impact the value to the Company of any future exploitation of the licensed rights. On March 29, 2004, the Court granted the Companys motion for terminating sanctions against the plaintiff for a host of discovery abuses, including the withholding, alteration, and theft of documents and other information, and, on April 5, 2004, dismissed plaintiffs case with prejudice. On September 25, 2007, the California Court of Appeal affirmed the dismissal, and on November 5, 2007, plaintiff filed a petition seeking review by the California Supreme Court.
Management believes that it is not currently possible to estimate the impact, if any, that the ultimate resolution of pending matters noted above will have on the Companys results of operations, financial position, or cash flows.
The Company, together with, in some instances, certain of its directors and officers, is a defendant or co-defendant in various other legal actions involving copyright, breach of contract and various other claims incident to the conduct of its businesses. Management does not expect the Company to suffer any material liability by reason of such actions.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of shareholders during the fourth quarter of the fiscal year covered by this report.
Executive Officers of the Company
The executive officers of the Company are elected each year at the organizational meeting of the Board of Directors, which follows the annual meeting of the shareholders, and at other Board of Directors meetings, as appropriate. Each of the executive officers has been employed by the Company in the position or positions indicated in the list and pertinent notes below. Except as noted, each of the executive officers have been employed by the Company for more than five years.
At September 29, 2007, the executive officers of the Company were as follows:
ITEM 5. Market for the Companys Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Companys common stock is listed on the New York Stock Exchange under the ticker symbol DIS. The following table shows, for the periods indicated, the high and low sales prices per share of common stock as reported in the Bloomberg Financial markets services.
The Company declared a $637 million dividend ($0.31 per share) on November 28, 2006 related to fiscal 2006.
As of September 29, 2007, the approximate number of common shareholders of record was 990,671.
The following table provides information about Company purchases of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act during the quarter ended September 29, 2007:
ITEM 6. Selected Financial Data
ITEM 7. Managements Discussion and Analysis of Financial Condition and Results of Operation
(in millions, except per share data)
Organization of Information
Managements Discussion and Analysis provides a narrative on the Companys financial performance and condition that should be read in conjunction with the accompanying financial statements. It includes the following sections:
2007 vs. 2006
Revenues for the year increased 5%, or $1.8 billion, to $35.5 billion; net income increased 39%, or $1.3 billion, to $4.7 billion; and diluted earnings per share increased 37% to $2.25.
At our operating segments, earnings growth was primarily due to higher affiliate and advertising revenues at our cable businesses, improved home entertainment performance driven by the success of Disney/Pixars Cars and Pirates of the Caribbean: Dead Mans Chest, strong sales of ABC Studios productions, increased guest spending and theme park attendance at Walt Disney World and Disneyland Resort Paris and lower costs for sports programming due to fewer hours at the ABC Television Network.
Net income for the year included certain items that affected comparability, including gains from the sales of E! Entertainment and Us Weekly ($0.31 per diluted share), favorable adjustments related to prior-year income tax matters ($0.03 per diluted share), income from the discontinued operations of the ABC Radio business ($0.01 per diluted share) and an equity-based compensation plan modification charge ($0.01 per diluted share). Including the impact of rounding, these items collectively resulted in a net benefit of $0.33 per diluted share. The prior year included income from the discontinued operations of the ABC Radio business ($0.03 per diluted share), gains on sales of a Spanish cable equity investment and Discover Magazine ($0.02 per diluted share), favorable adjustments related to prior-year income tax matters ($0.02 per diluted share) and a net benefit associated with the completion of the Pixar acquisition ($0.01 per diluted share). Including the impact of rounding, these items collectively benefited diluted earnings per share by $0.09.
2006 vs. 2005
Revenues for the year increased 8%, or $2.4 billion, to $33.7 billion; net income increased 33%, or $841 million, to $3.4 billion; and diluted earnings per share increased 34% to $1.64.
At our operating segments, earnings growth was due to lower distribution costs resulting from fewer Miramax theatrical releases, improved margins at worldwide home entertainment driven by reduced marketing and trade programs and lower distribution costs, strong performance at both of our domestic theme parks, growth at ESPN and improved primetime results at the ABC Television Network.
Net income for fiscal 2005 included certain items which affected comparability, including favorable adjustments related to prior-year income tax matters ($0.06 per diluted share), income from discontinued operations of the ABC Radio business ($0.05 per diluted share), a benefit from the restructuring of Euro Disneys borrowings ($0.02 per diluted share), an income tax benefit from the repatriation of foreign earnings under the American Jobs Creation Act ($0.02 per diluted share), a gain on the sale of the Mighty Ducks of Anaheim ($0.01 per diluted share), a write-off of
investments in leveraged leases ($0.03 per diluted share), a charge from the cumulative effect of accounting change ($0.02 per diluted share), a write-down related to the MovieBeam venture ($0.02 per diluted share), an impairment charge for a cable television investment in Latin America ($0.01 per diluted share) and restructuring and impairment charges related to the sale of The Disney Stores North America ($0.01 per diluted share). These items collectively resulted in a net benefit of $0.07 per diluted share.
BUSINESS SEGMENT RESULTS 2007 vs. 2006
The Company evaluates the performance of its operating segments based on segment operating income and management uses aggregate segment operating income as a measure of the overall performance of the operating businesses. The Company believes that information about aggregate segment operating income assists investors by allowing them to evaluate changes in the operating results of the Companys portfolio of businesses separate from factors other than business operations that affect net income. As a result of the spin-off of the ABC Radio business in fiscal 2007, ABC Radio is reported as discontinued operations for all periods presented (see Note 3 to the Consolidated Financial Statements for further discussion). Previously, the ABC Radio business was included in the Media Networks segment. Prior period information has been reclassified to conform to the current presentation. The following table reconciles segment operating income to income from continuing operations before income taxes, minority interests, and the cumulative effect of accounting change.
The following table provides supplemental revenue and operating income detail for the Media Networks segment:
Media Networks revenues increased 7%, or $946 million, to $15.0 billion, consisting of a 12% increase, or $1.0 billion, at the Cable Networks and a 1% decrease, or a $62 million, at Broadcasting.
Increased Cable Networks revenues were primarily due to growth of $601 million from cable and satellite operators, $240 million from advertising revenues and $167 million from other revenues. Revenues from cable and satellite operators are generally derived from fees charged on a per-subscriber basis, and the increase in the current year was driven by contractual rate increases and subscriber growth primarily at ESPN and, to a lesser extent, at the international Disney Channels and the domestic Disney-ABC Cable Networks. Higher advertising revenues reflected
the addition of NASCAR programming at ESPN and also increases at the domestic Disney-ABC Cable Networks primarily due to higher rates. Higher other revenues were driven by DVD sales, primarily High School Musical, and the settlement of a distributor claim.
Certain of the Companys existing contracts with cable and satellite operators include annual live programming commitments. In these cases, recognition of revenues subject to the commitments is deferred until the annual commitments are satisfied, which generally results in higher revenue recognition in the second half of the year.
Decreased Broadcasting revenues were primarily due to a decline in advertising revenue at the ABC Television Network partially offset by higher sales of ABC Studios productions. The decrease in advertising revenue at the ABC Television Network was primarily due to fewer hours of sports programming reflecting the absence of Monday Night Football, the Super Bowl and three College Bowl games, partially offset by an increase in primetime. In primetime, higher advertising rates and sold inventory were partially offset by lower ratings. Increased sales of ABC Studios productions reflected higher international and DVD sales of the hit dramas Desperate Housewives, Greys Anatomy, and Ugly Betty.
Costs and Expenses
Costs and expenses, which consist primarily of programming rights costs, production costs, participation costs, distribution and marketing expenses and general and administrative costs, increased 2%, or $181 million, to $11.2 billion, consisting of an 8% increase, or $462 million, at the Cable Networks partially offset by a 5% decrease, or $281 million, at Broadcasting. The increase at Cable Networks was primarily due to increased costs at ESPN primarily due to higher programming and production costs for the addition of NASCAR and for Monday Night Football compared to Sunday Night Football in the prior year, and higher programming and other costs at the domestic Disney-ABC Cable Networks and international Disney Channels. These increases were partially offset by lower costs due to the transition of ESPNs mobile phone operations to a licensing model. The decrease at Broadcasting was due to lower sports programming costs, partially offset by higher costs of Disney-branded mobile phone service, including costs associated with its shutdown, as well as higher production cost amortization due to increased sales of ABC Studios productions.
Sports Programming Costs
The Company has various contractual commitments for the purchase of rights for multi-year sports and other programming arrangements, including the National Football League (NFL), National Basketball Association (NBA), NASCAR, Major League Baseball (MLB) and various college football and basketball conferences and football bowl games. The costs of these contracts have increased significantly in recent years. We enter into these contractual commitments with the expectation that, over the life of the contracts, revenue from advertising during the programming and affiliate fees will exceed the costs of the programming. While contract costs may initially exceed incremental revenues and negatively impact operating income, it is our expectation that the combined value to our networks from all of these contracts will result in long-term benefits. The actual impact of these contracts on the Companys results over the term of the contracts is dependent upon a number of factors, including the strength of advertising markets, effectiveness of marketing efforts and the size of viewer audiences.
Segment Operating Income
Segment operating income increased 23%, or $805 million, to $4.3 billion for the year due to increases of $577 million at the Cable Networks and $228 million at Broadcasting. The increase at the Cable Networks was due primarily to growth at ESPN, the international Disney Channels and the domestic Disney-ABC Cable Networks. The increase at Broadcasting was due to strong sales of ABC Studios productions, fewer hours of sports programming and higher primetime advertising revenues at the ABC Television Network, partially offset by higher costs associated with the Disney mobile phone service. Segment operating income includes income from equity investees of $484 million for the year, compared to $444 million in the prior year.
ABC Radio Transaction
On June 12, 2007, the Company completed the spin-off of its wholly-owned subsidiary, ABC Radio Holdings, Inc., which was then merged into a subsidiary of Citadel Broadcasting Corporation (Citadel). Prior to the spin-off, the Company consolidated its ABC Radio business, consisting of 22 large-market radio stations and the ABC Radio Network businesses, under ABC Radio Holdings, Inc. The transaction did not include the Companys ESPN Radio or Radio Disney network and station businesses. The results of the ABC Radio business have been reported as discontinued operations for all periods presented. The Company now includes the ESPN Radio and Radio Disney
network and stations businesses with Cable Networks in the Media Networks segment. Prior to the transaction, the Companys radio businesses were included with Broadcasting in the Media Networks segment. Previously reported results have been reclassified to reflect this presentation.
Summarized financial information for the discontinued operations is as follows (in millions, except per share data):
Sale of E! Entertainment Television
On November 21, 2006, in connection with the execution of new long-term agreements for the provision of programming to cable service provider Comcast Corporation (Comcast), the Company sold its 39.5% interest in E! Entertainment Television (E!) to Comcast (which owned the remainder of the interest in E!) for $1.23 billion, which resulted in a pre-tax gain of $780 million ($487 million after-tax) reported in Gains on sales of equity investments and businesses. Equity income from E! was included in Media Networks segment operating income through the date of the sale.
Writers Guild of America Work Stoppage
On November 5, 2007, members of the Writers Guild of America commenced a work stoppage. If this work stoppage is prolonged, the Company may be unable to produce or air original programming, which could result in reduced revenue. The Company is pursuing opportunities to mitigate the impact of a sustained work stoppage through alternative programming and reduction of costs, however, an extended work stoppage could have an adverse effect on our profitability.
Parks and Resorts
Revenues at Parks and Resorts increased 7%, or $701 million, to $10.6 billion due to increases of $483 million at our domestic resorts and a net increase of $218 million at our international resorts.
Domestic Parks and Resorts
At our domestic parks and resorts, revenue growth was due to increases at Walt Disney World and Disneyland Resort. At Walt Disney World, revenue growth was due to increased guest spending, theme park attendance and vacation club ownership sales. Higher guest spending at Walt Disney World was due to increased food, beverage and merchandise spending, higher average ticket prices and a higher average daily hotel room rate. At Disneyland Resort, revenue growth was due to increased guest spending, primarily due to higher average ticket prices.
The following table presents attendance, per capita theme park guest spending, and hotel statistics for our domestic properties:
Per room guest spending consists of the average daily hotel room rate as well as guest spending on food, beverage and merchandise at the hotels.
International Parks and Resorts
At our international parks and resorts, revenue growth was due to an increase at Disneyland Resort Paris partially offset by a decrease at Hong Kong Disneyland Resort due to lower theme park attendance. At Disneyland Resort Paris, revenue growth was due to the favorable impact of foreign currency translation, as a result of the weakening of the U.S. dollar against the Euro, and higher theme park attendance, guest spending, and hotel occupancy. Increased guest spending was primarily due to a higher average daily hotel room rate.
Costs and Expenses
Costs and expenses, which consist principally of labor, depreciation, costs of merchandise, food and beverage sold, marketing and sales expense, repairs and maintenance and entertainment, increased 6%, or $525 million. The increase in costs and expenses was due to increases at Walt Disney World and Disneyland Resort Paris. The increase at Walt Disney World was primarily due to volume-related costs, labor cost inflation, and new guest offerings, partially offset by lower pension and postretirement medical expense. The increase at Disneyland Resort Paris was primarily due to the unfavorable impact of foreign currency translation, as a result of the weakening of the U.S. dollar against the Euro, higher volume-related costs, and labor cost inflation.
Segment Operating Income
Segment operating income increased 11%, or $176 million, to $1.7 billion primarily due to continued strength at both domestic resorts and Disneyland Resort Paris, partially offset by results at Hong Kong Disneyland Resort.
Revenues for the year were essentially flat at $7.5 billion compared to the prior year as a decrease of $470 million in worldwide theatrical distribution was largely offset by an increase of $234 million in domestic home entertainment and an increase of $139 million in music distribution.
Lower worldwide theatrical revenues were primarily due to the strong box-office performance of Pirates of the Caribbean: Dead Mans Chest in the prior year. Other significant titles in the prior-year included The Chronicles of Narnia: The Lion, The Witch and The Wardrobe, Disney/Pixars Cars and Chicken Little while the current year included Pirates of the Caribbean: At Worlds End, Disney/Pixars Ratatouille and Wild Hogs. The increase in domestic home entertainment revenues was primarily due to higher DVD unit sales reflecting the strong performance of Pirates of the Caribbean: Dead Mans Chest, Cars and the Little Mermaid Platinum Release in the current year. The revenue growth in music distribution was driven by the strong performance of the Hannah Montana and High School Musical soundtracks.
Cost and Expenses
Costs and expenses, which consist primarily of production cost amortization, distribution and marketing expenses, product costs and participation costs, decreased 8%, or $510 million, primarily due to decreases in worldwide theatrical distribution and worldwide home entertainment, partially offset by an increase in music distribution.
Lower costs in worldwide theatrical distribution were primarily due to lower distribution expenses, participation costs and film cost write-downs. Lower distribution expenses were driven by a decrease in international markets as the prior year included more high profile films that had extensive marketing campaigns. The decrease in participation costs were driven by the strong performance of Pirates of the Caribbean: Dead Mans Chest and The Chronicles of Narnia: The Lion, The Witch and The Wardrobe in the prior year.
Segment Operating Income
Segment operating income increased $472 million to $1.2 billion, primarily due to an improvement in domestic home entertainment performance in the current year.
On May 5, 2006, the Company acquired Pixar in an all-stock transaction. As a result of the acquisition, the Company now produces feature animation films under both the Disney and Pixar banners. Additional information regarding the acquisition of Pixar is set forth in Note 3 to the consolidated financial statements and in Item 1A Risk Factors, above.
Writers Guild of America Work Stoppage
On November 5, 2007, members of the Writers Guild of America commenced a work stoppage. See page 34 for a discussion of the possible effects of this work stoppage.
Revenues increased 7%, or $154 million, to $2.3 billion, primarily due to increases of $102 million at Merchandise Licensing and $61 million at Disney Interactive Studios. Growth at Merchandise Licensing was due to higher earned royalties across multiple product categories led by the strong performance of Cars merchandise. Growth at Disney Interactive Studios was due to the performance of current period titles driven by Pirates of the Caribbean: At Worlds End, Spectrobes and Meet the Robinsons compared to prior period titles, which included The Chronicles of Narnia and Chicken Little. These gains were partially offset by lower contractual minimum guarantee revenues.
Costs and Expenses
Costs and expenses, which consist primarily of cost of sales, salaries and benefits, marketing and video game development, increased 7%, or $113 million, primarily due to an increase at Disney Interactive Studios due to higher cost of sales, video game development costs and marketing costs and higher operating costs at Merchandise Licensing.
Segment operating income increased 2%, or $13 million, to $631 million, driven by higher earned royalties at Merchandise Licensing, partially offset by the increased investment in video game development at Disney Interactive Studios.
Sale of Us Weekly
On October 2, 2006, the Company sold its 50% stake in Us Weekly for $300 million, which resulted in a pre-tax gain of $272 million ($170 million after-tax) reported in Gains on sales of equity investments and businesses. Equity income from Us Weekly was included in Consumer Products segment operating income through the date of the sale.
NON-SEGMENT ITEMS 2007 vs. 2006
Corporate and Unallocated Shared Expenses
Corporate and unallocated shared expenses decreased 5%, from $522 million to $497 million, primarily due to lower information technology costs including the absence of transition costs from the transfer of certain information technology functions and services to third-party service providers that were incurred in the prior year.
Net Interest Expense
Net interest expense is detailed below:
Net interest expense was relatively flat as the increase in interest expense, primarily due to higher effective interest rates at Hong Kong Disneyland, was offset by higher interest and investment income reflecting higher average cash balances.
Effective Income Tax Rate
The effective income tax rate increased 2.7 percentage points from 34.5% in fiscal 2006 to 37.2% in fiscal 2007. The higher effective tax rate was primarily due to a reduction in the tax benefits realized from an exclusion of certain
foreign source income. The exclusion of certain foreign source income was repealed on a phase-out basis as part of the American Jobs Creation Act of 2004. No exclusion is available for transactions originating after the first quarter of fiscal 2007.
Minority interest expense decreased from $183 million to $177 million reflecting the impact of increased losses at Hong Kong Disneyland, partially offset by the impacts of increased profits at ESPN and decreased losses at Disneyland Resort Paris. The minority interest impact is determined on income after royalties, financing costs and income taxes.
PENSION AND POSTRETIREMENT MEDICAL BENEFIT COSTS
Pension and postretirement medical benefit plan costs affect results in all of our segments, with approximately one-half of these costs being borne by the Parks and Resorts segment. The Company recognized pension and postretirement medical benefit plan expenses of $278 million, $462 million and $314 million for fiscal years 2007, 2006, and 2005, respectively. The decrease in fiscal 2007 was primarily due to an increase in the discount rate used to measure the present value of plan obligations. The discount rate assumption increased from 5.25% to 6.40%, reflecting trends in prevailing market interest rates at our June 30, 2006 valuation date. The assumed discount rate reflects market rates for high-quality corporate bonds currently available. The Companys discount rate was determined by considering the average of pension yield curves constructed of a large population of high quality corporate bonds. The resulting discount rate reflects the matching of plan liability cash flows to the yield curves.
We expect pension and postretirement medical costs to decrease to $244 million in fiscal 2008 primarily due to the improved funded status of the Companys pension plans driven by Company contributions and the return on plan assets. During fiscal 2007, the Company contributed approximately $416 million to its pension and postretirement medical plans, which included discretionary contributions above the minimum requirements for the pension plans. Based on current actuarial projections, the Company anticipates that it will not be required to make additional contributions during fiscal 2008 under the funding regulations associated with the Pension Protection Act of 2006 (PPA). However, final funding requirements for fiscal 2008 will be determined based on our January 1, 2008 funding actuarial valuation. Additionally, the Company may also choose to make discretionary contributions above the minimum requirements. The Company anticipates contributing approximately $30 million to postretirement medical and other pension plans not subject to the PPA.
BUSINESS SEGMENT RESULTS 2006 vs. 2005
Media Networks revenues increased 12%, or $1.5 billion, to $14.1 billion, consisting of a 10% increase, or $760 million, at the Cable Networks and a 13% increase, or $703 million, at Broadcasting.
Increased Cable Networks revenues were primarily due to growth of $440 million from cable and satellite operators, $216 million in advertising revenues and $104 million from other revenues. The increase in revenues from cable and satellite operations in fiscal 2006 was due to contractual rate increases and, to a lesser extent, subscriber growth at ESPN. Increased advertising revenue was due to higher ratings and rates at ESPN.
The increase in Broadcasting revenues was due to increased advertising revenues at the ABC Television Network and increased sales of ABC Studios productions. The growth in advertising revenues at the ABC Television Network was primarily due to higher rates, strong upfront sales, and strength in ratings. Higher advertising revenues at the ABC Television Network also reflected the airing of the Super Bowl which we did not have in fiscal 2005, partially offset by lower advertising revenues from the absence of Monday Night Football (MNF) which moved to ESPN. Increased sales of ABC Studios productions reflected higher international syndication and DVD sales of hit dramas Lost, Greys Anatomy, and Desperate Housewives, as well as higher third party license fees led by Scrubs, which completed its fifth season of network television.
Costs and Expenses
Costs and expenses increased 10%, or $1.0 billion, to $11.1 billion consisting of a 10% increase, or $511 million, at the Cable Networks, and a 10% increase, or $496 million, at Broadcasting. The increase at Cable Networks was
primarily due to increased costs at ESPN driven by higher programming costs from the new Major League Baseball (MLB) and National Football League (NFL) long-term rights agreements and an additional NFL game. ESPN also incurred higher costs associated with mobile phone operations, which have now transitioned to a licensing model, and higher general and administrative expenses. The increase in Broadcasting was due to higher programming and production costs, higher costs at the internet operations, and the increased number and costs of pilot productions. The increase in programming and production costs reflected costs related to the Super Bowl as well as higher production costs due to increased sales of ABC Studio productions. These increases were partially offset by the absence of costs from Monday Night Football in the fourth quarter of fiscal year 2006. The cost increase at the internet operations was primarily due to the launch of Disney branded mobile phone services as well as costs of other new initiatives.
Segment Operating Income
Segment operating income increased 14%, or $440 million, to $3.5 billion for fiscal 2006 due to an increase of $243 million at the Cable Networks and an increase of $197 million at Broadcasting. The increase at the Cable Networks was primarily due to growth at ESPN. The increase at Broadcasting was due to increased advertising revenues at the ABC Television Network and increased sales of ABC Studios productions, partially offset by higher costs at the Internet Group, and the increased number and costs of pilot productions. Segment operating income includes income from equity investees of $444 million for fiscal 2006 compared to $460 million for fiscal 2005.
Parks and Resorts
Revenues at Parks and Resorts increased 10%, or $902 million, to $9.9 billion due to increases of $647 million at our domestic resorts and a net increase of $255 million at our international resorts.
Domestic Parks and Resorts
At our domestic parks and resorts, increased revenues were due to increased guest spending, theme park attendance, and hotel occupancy, as well as higher vacation club ownership sales. Higher guest spending was due to a higher average daily hotel room rate, higher average ticket prices, and greater merchandise spending at both resorts. Increases in attendance and hotel occupancy were led by the 50th anniversary celebration at both domestic resorts, which concluded at the end of September 2006.
The following table presents attendance, per capita theme park guest spending, and hotel statistics for our domestic properties:
Per room guest spending consists of the average daily hotel room rate as well as guest spending on food, beverages and merchandise at the hotels.
International Parks and Resorts
International revenue growth reflected the first full year of theme park operations at Hong Kong Disneyland Resort as compared to the prior year when the park opened in mid-September 2005. Local currency revenues at Disneyland Resort Paris also increased, however this increase was more than offset by the unfavorable impact of foreign currency translation as a result of the strengthening of the U.S. dollar against the Euro.
Costs and Expenses
Costs and expenses increased 7%, or $547 million primarily due to increased volume-related costs and costs associated with new guest offerings and attractions at the domestic resorts, and higher operating costs at Hong Kong Disneyland Resort reflecting a full year of theme park operations. These increases were partially offset by the absence of pre-opening costs at Hong Kong Disneyland Resort, lower costs at Disneyland Resort Paris due to the favorable impact of foreign currency translation adjustments as a result of the strengthening of the U.S. dollar against the Euro, and the benefit from adjustments to actuarially determined workers compensation and guest claims liabilities based on favorable claims experience at the domestic resorts.
Segment Operating Income
Segment operating income increased 30%, or $356 million, to $1.5 billion primarily due to continued strength at both domestic resorts, led by the success of the 50th anniversary celebration, the first year of operations at Hong Kong Disneyland Resort, and improvements at Disneyland Resort Paris.
Revenues decreased 1%, or $58 million, to $7.5 billion primarily due to a decrease of $578 million in worldwide home entertainment partially offset by an increase of $415 million in worldwide theatrical distribution, and an increase of $60 million in music distribution.
Lower worldwide home entertainment revenues were primarily due to a decline in unit sales resulting from a higher number of strong performing titles in the prior year partially offset by increased sales of television DVD box-sets and reduced marketing and trade programs. Significant fiscal 2006 titles included The Chronicles of Narnia: The Lion, The Witch and The Wardrobe, Cinderella Platinum Release, and Chicken Little, while fiscal 2005 titles included Disney/Pixars The Incredibles, National Treasure, Aladdin Platinum Release, and Bambi Platinum Release.
The increase in worldwide theatrical distribution revenues was primarily due to the strong box-office performance of Pirates of the Caribbean: Dead Mans Chest, The Chronicles of Narnia: The Lion, The Witch and The Wardrobe, and Disney/Pixars Cars compared to the fiscal 2005 titles, which included The Incredibles and National Treasure. The increase was partially offset by lower revenue resulting from fewer domestic Miramax theatrical releases in fiscal 2006.
Costs and Expenses
Costs and expenses decreased 8%, or $580 million primarily due to a decrease in worldwide home entertainment, partially offset by increases in worldwide theatrical distribution and higher music distribution expenses.
The decline in costs at worldwide home entertainment was primarily due to reduced marketing expenditures, lower production cost amortization driven by decreased unit sales, and lower distribution costs driven in part by fewer returns.
Higher costs in worldwide theatrical distribution were primarily due to increases in distribution costs, production cost amortization and participation costs. The increase in distribution costs was driven by higher profile films in the current year that had more extensive marketing campaigns to launch the films. Higher production cost amortization and participation costs were driven by the strong performance of Pirates of the Caribbean: Dead Mans Chest and The Chronicles of Narnia: The Lion, The Witch and The Wardrobe. These increases were partially offset by lower costs resulting from fewer domestic Miramax theatrical releases in fiscal 2006.
Segment Operating Income
Segment operating income increased $522 million, to $729 million, primarily due to improvements in worldwide theatrical distribution and worldwide home entertainment.
Revenues increased 3%, or $66 million, to $2.2 billion, primarily due to increases of $112 million at Disney Interactive Studios and $91 million at Merchandise Licensing. These increases were partially offset by a decrease of $106 million at the Disney Stores primarily due to the sale of The Disney Store North America chain in the first quarter of 2005.
Sales growth at Disney Interactive Studios was due to the release of self-published titles based on The Chronicles of Narnia: The Lion, The Witch and The Wardrobe, Chicken Little, and Pirates of the Caribbean. Sales growth at Merchandise Licensing was driven by higher earned royalties across multiple product categories, led by the strong performance of Cars, Disney Princess, and Pirates of the Caribbean merchandise.
Costs and Expenses
Costs and expenses were essentially flat at $1.6 billion as decreases at The Disney Stores were offset by increases at Disney Interactive Studios. The decrease in costs at The Disney Stores was primarily due to the sale of The Disney Store North America chain in the first quarter of fiscal 2005. Costs increased at Disney Interactive Studios due to higher costs of goods sold driven by increased volumes, increased video game development spending on both current and future titles, and higher marketing expenditures.
Segment Operating Income
Segment operating income increased 14%, or $75 million, to $618 million, due to growth at Merchandise Licensing, partially offset by a decrease at Disney Interactive Studios. Growth at Merchandise Licensing was due to higher earned royalties across multiple product categories. The decrease at Disney Interactive Studios was driven by increased video game development spending on future self-published titles.
NON-SEGMENT ITEMS 2006 vs. 2005
Net Interest Expense
Net interest expense is detailed below:
Interest expense increased 17% for the year primarily due to higher interest expense at Hong Kong Disneyland and higher effective interest rates and average debt balances. During fiscal 2005, Hong Kong Disneylands interest expense was capitalized while the park was under construction.
Interest and investment income for fiscal 2006 increased due to a $42 million write-down in the prior year of an investment in a company that licenses technology to the MovieBeam venture and increased interest income from higher cash balances.
Effective Income Tax Rate
The effective income tax rate increased 3.7 percentage points from 30.8% in 2005 to 34.5% in 2006. The lower effective tax rate for the prior year reflected a greater release of reserves as a result of the favorable resolution of certain tax matters and the benefit from a one-time deduction permitted under the American Jobs Creation Act of 2004 related to the repatriation of foreign earnings.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $1.3 billion during fiscal 2007. The change in cash and cash equivalents is as follows:
Cash provided by continuing operating activities for fiscal 2007 decreased 9% or $0.6 billion to $5.4 billion as higher operating performance at Media Networks, Studio Entertainment and Parks and Resorts was more than offset by higher income tax payments, including taxes paid on the E! Entertainment and Us Weekly gains, and timing of film and television spending and accounts receivable collections.
Cash provided by continuing operating activities for fiscal 2006 increased 44% or $1.8 billion to $6.0 billion driven by operating income growth at all of the segments, partially offset by higher income tax payments.
Depreciation expense from continuing operations is as follows:
The Companys Studio Entertainment and Media Networks segments incur costs to acquire and produce television and feature film programming. Film and television production costs include all internally produced content such as live action and animated feature films, animated direct-to-video programming, television series, television specials, theatrical stage plays or other similar product. Programming costs include film or television product licensed for a specific period from third parties for airing on the Companys broadcast, cable networks, and television stations. Programming assets are generally recorded when the programming becomes available to us with a corresponding increase in programming liabilities. Accordingly, we analyze our programming assets net of the related liability.
The Companys film and television production and programming activity for fiscal years 2007, 2006 and 2005 are as follows:
Investing activities from continuing operations consist principally of investments in parks, resorts, and other property and acquisition and divestiture activity. The Companys investments in parks, resorts and other property from continuing operations for the last three years are as follows:
Capital expenditures for the Parks and Resorts segment are principally for theme park and resort expansion, new rides and attractions, recurring capital and capital improvements. The increase in capital expenditures was driven by a deposit on two new cruise ships and new rides and attractions at Disneyland Resort including the Finding Nemo Submarine Voyage.
Capital expenditures at Media Networks primarily reflect investments in facilities and equipment for expanding and upgrading broadcast centers, production facilities, and television station facilities.
Capital expenditures at Corporate primarily reflect investments in information technology and other equipment and corporate facilities.
Other Investing Activities
During fiscal 2007, the Company received $1.5 billion in proceeds from the sales of our interests in E! Entertainment Television and Us Weekly, which was partially offset by payments for acquisitions driven by the acquisitions of Club Penguin Entertainment, Inc. and NASN Limited.
During fiscal 2006, $1.1 billion of financial investments were liquidated and the sales of a cable television equity investment and a magazine business generated $81 million.
During fiscal 2005, the Company received $100 million for working capital transferred to the buyer of The Disney Store North America and $29 million from the sale of the Mighty Ducks of Anaheim.
Cash used in continuing financing activities during fiscal 2007 of $3.6 billion primarily reflected share repurchases and dividends, partially offset by an increase in borrowings and the proceeds from stock option exercises. The increase in borrowings included $1.35 billion of pre-spin-off borrowings of ABC Radio Holdings, Inc. that were removed from the Companys balance sheet in connection with the spin-off.
Cash used in continuing financing activities during fiscal 2006 of $5.2 billion reflected share repurchases and payment of dividends to shareholders, partially offset by an increase in borrowings and the proceeds from stock option exercises.
Cash used in continuing financing activities during fiscal 2005 of $2.9 billion reflected share repurchases, net repayments of borrowings and payment of dividends to shareholders, partially offset by proceeds from stock option exercises.
During the year ended September 29, 2007, the Companys borrowing activity was as follows:
The Companys bank facilities are as follows:
These bank facilities allow for borrowings at LIBOR-based rates plus a spread, which depends on the Companys public debt rating and can range from 0.175% to 0.75%. As of September 29, 2007, the Company had not borrowed under these bank facilities. The Company also has the ability to issue up to $800 million of letters of credit under the facility expiring in 201l, which if utilized, reduces available borrowing under this facility. As of September 29, 2007, $282 million of letters of credit had been issued, of which $212 million was issued under this facility.
The Company may use commercial paper borrowings up to the amount of its above unused bank facilities, in conjunction with term debt issuance and operating cash flow, to retire or refinance other borrowings before or as they come due.
As of the filing date of this report, the Board of Directors had not yet declared a dividend related to fiscal 2007. The Company paid a $637 million dividend ($0.31 per share) during the second quarter of fiscal 2007 related to fiscal 2006. The Company paid a $519 million dividend ($0.27 per share) during the second quarter of fiscal 2006 related to fiscal 2005; and paid a $490 million dividend ($0.24 per share) during the second quarter of fiscal 2005 related to fiscal 2004.
During fiscal 2007, the Company repurchased 202 million shares of Disney common stock for $6.9 billion. During fiscal 2006, the Company repurchased 243 million shares of Disney common stock for $6.9 billion. During fiscal 2005, the Company repurchased 91 million shares of Disney common stock for $2.4 billion. On May 1, 2007, the Board of Directors of the Company increased the share repurchase authorization to a total of 400 million shares. As of September 29, 2007, the Company had remaining authorization in place to repurchase approximately 323 million additional shares. The repurchase program does not have an expiration date.
We believe that the Companys financial condition is strong and that its cash balances, other liquid assets, operating cash flows, access to debt and equity capital markets and borrowing capacity, taken together, provide adequate resources to fund ongoing operating requirements and future capital expenditures related to the expansion of existing businesses and development of new projects. However, the Companys operating cash flow and access to the capital markets can be impacted by macroeconomic factors outside of its control. In addition to macroeconomic factors, the Companys borrowing costs can be impacted by short and long-term debt ratings assigned by independent rating agencies, which are based, in significant part, on the Companys performance as measured by certain credit metrics such as interest coverage and leverage ratios. As of September 29, 2007, Moodys Investors Services long and short-term debt ratings for the Company were A2 and P-1, respectively, with stable outlook; and Standard & Poors long and short-term debt ratings for the Company were A- and A-2, respectively, on CreditWatch positive. On October 4, 2007, Standard and Poors raised the long and short-term debt ratings to A and A-1, respectively, and placed the Company on stable outlook. The Companys bank facilities contain only one financial covenant, relating to interest coverage, which the Company met on September 29, 2007, by a significant margin. The Companys bank facilities also specifically exclude certain entities, such as Euro Disney and Hong Kong Disneyland, from any representations, covenants or events of default.
Prior to November 14, 2007, Hong Kong Disneylands commercial term loan and revolving credit facility agreement contained semi-annual financial performance covenants and had a final maturity of October 26, 2015. In anticipation of the prospect that the covenants would not be met as of the September 29, 2007 measurement date, effective November 14, 2007, the agreement was amended to remove the financial performance covenants, shorten the maturity of the loan to September 30, 2008 and decrease the amount of the revolving credit facility from HK$1 billion (approximately $129 million) to HK$800 million (approximately $103 million). The commercial term loan had a balance of approximately $284 million as of the effective date of the amendment, and the full amount of the revised revolving credit facility became available as of that date.
To support operating needs in the near-term, the Company agreed to waive management fees for fiscal 2008 and fiscal 2009 and defer royalties for those years, with payment of the deferred royalties dependent upon the future operating performance of Hong Kong Disneyland. Hong Kong Disneyland expects to need additional sources of financing to meet its financial and development needs at and beyond the maturity of the commercial loan and revolving credit facility and is currently engaged in discussions with the Company and Hong Kong Disneylands majority shareholder (the Government of the Hong Kong Special Administrative Region) regarding financing arrangements to assist in meeting these needs. The Company expects that such financing likely would include additional investment by the Company.
Euro Disney has covenants under its debt agreements that limit its investment and financing activities. Beginning with fiscal year 2006, Euro Disney has also been required to meet financial performance covenants that necessitated improvements to its operating margin. As a result of revenue growth in excess of increases in costs and expenses during fiscal year 2007, Euro Disney believes that it is in compliance with these covenants for fiscal 2007. There can be no assurance that these covenants will be met for any particular measurement period in the future. To the extent that conditions are such that the covenants appear unlikely to be met, management would pursue measures to meet the covenants or would seek to obtain waivers from the debt holders.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF BALANCE SHEET ARRANGEMENTS
The Company has various contractual obligations which are recorded as liabilities in our consolidated financial statements. Other items, such as certain purchase commitments and other executory contracts are not recognized as liabilities in our consolidated financial statements but are required to be disclosed in the footnotes to the financial statements. For example, the Company is contractually committed to acquire broadcast programming and make certain minimum lease payments for the use of property under operating lease agreements.
The following table summarizes our significant contractual obligations and commitments on an undiscounted basis at September 29, 2007 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal and interest payments on outstanding borrowings. Additional details regarding these obligations are provided in the footnotes to the financial statements, as referenced in the table:
The Company also has obligations with respect to its pension and post retirement medical benefit plans. See Note 9 to the Consolidated Financial Statements.
Contingent Commitments and Contractual Guarantees
The Company also has certain contractual arrangements that would require the Company to make payments or provide funding if certain circumstances occur. The Company does not currently expect that these arrangements will result in any significant amounts being paid by the Company. See Note 14 to the Consolidated Financial Statements for information regarding the Companys contingent commitments and contractual guarantees.
Legal and Tax Matters
As disclosed in Notes 8 and 14 to the Consolidated Financial Statements, the Company has exposure for certain legal and tax matters.
ACCOUNTING POLICIES AND ESTIMATES
We believe that the application of the following accounting policies, which are important to our financial position and results of operations, require significant judgments and estimates on the part of management. For a summary of our significant accounting policies, including the accounting policies discussed below, see Note 2 to the Consolidated Financial Statements.
Film and Television Revenues and Costs
We expense the cost of film and television productions over the applicable product life cycle based upon the ratio of the current periods gross revenues to the estimated remaining total gross revenues (Ultimate Revenues) for each production. If our estimate of Ultimate Revenues decreases, amortization of film and television costs may be accelerated. Conversely, if estimates of Ultimate Revenues increase, film and television cost amortization may be slowed. For film productions, Ultimate Revenues include revenues from all sources that will be earned within ten years of the date of the initial theatrical release. For television series, we include revenues that will be earned within ten years of the delivery of the first episode, or if still in production, five years from the date of delivery of the most recent episode, if later.
With respect to films intended for theatrical release, the most sensitive factor affecting our estimate of Ultimate Revenues (and therefore affecting future film cost amortization and/or impairment) is domestic theatrical performance. Revenues derived from other markets subsequent to the domestic theatrical release (e.g. the home video or international theatrical markets) have historically been highly correlated with domestic theatrical performance. Domestic theatrical performance varies primarily based upon the public interest and demand for a particular film, the quality of competing films at the time of release, as well as the level of marketing effort. Upon a films release and determination of domestic theatrical performance, the Companys estimates of revenues from succeeding windows and markets are revised based on historical relationships and an analysis of current market trends. The most sensitive factor affecting our estimate of Ultimate Revenues for released films is the extent of home entertainment sales achieved. Home entertainment sales vary based on the volume and quality of competing home video products as well as the manner in which retailers market and price our products.
With respect to television series or other television productions intended for broadcast, the most sensitive factor affecting estimates of Ultimate Revenues is the programs rating. Program ratings, which are an indication of market acceptance, directly affect the Companys ability to generate advertising revenues during the airing of the program. In addition, television series with greater market acceptance are more likely to generate incremental revenues through the eventual sale of the program rights in the syndication, international and home entertainment markets. Alternatively, poor ratings may result in a television series cancellation, which would require the immediate write-off of any unamortized production costs.
We expense the cost of television broadcast rights for acquired movies, series and other programs based on the number of times the program is expected to be aired or on a straight-line basis over the useful life, as appropriate. Amortization of those television programming assets being amortized on a number of airings basis may be accelerated if we reduce the estimated future airings and slowed if we increase the estimated future airings. The number of future airings of a particular program is impacted primarily by the programs ratings in previous airings, expected advertising rates and availability and quality of alternative programming. Accordingly, planned usage is reviewed periodically and revised if necessary. Rights costs for multi-year sports programming arrangements are amortized based upon the ratio of the current periods gross revenues to Ultimate Revenues (the Projected Revenue Method) or on a straight-line basis, as appropriate. Gross revenues include both advertising revenues and an allocation of affiliate fees. If the annual contractual payments related to each season over the term of a multi-year sports programming arrangement approximate each seasons rights cost based on the Projected Revenue Method, we expense the related annual payments during the applicable season. If Ultimate Revenues change significantly from projections, rights costs amortization may be accelerated or slowed.
Costs of film and television productions and programming rights for our broadcast businesses and cable networks are subject to regular recoverability assessments in accordance with applicable accounting rules. The net realizable value of the television broadcast program licenses and rights are reviewed using a daypart methodology. A daypart is defined as an aggregation of programs broadcast during a particular time of day or programs of a similar type. The Companys dayparts are: early morning, daytime, late night, primetime, news, children, and sports (includes network and cable). The net realizable values of other cable programming assets are reviewed on an aggregated basis for each cable channel. Individual programs are written-off when there are no plans to air or sublicense the program. Estimated values are based upon assumptions about future demand and market conditions. If actual demand or market conditions are less favorable than our projections, film, television and programming cost write-downs may be required.
The Company has revenue recognition policies for its various operating segments that are appropriate to the circumstances of each business. See Note 2 to the Consolidated Financial Statements for a summary of these revenue recognition policies.
We record reductions to home entertainment and software product revenues for estimated future returns of merchandise and for customer programs and sales incentives. These estimates are based upon historical return experience, current economic trends and projections of customer demand for and acceptance of our products. If we underestimate the level of returns and concessions in a particular period, we may record less revenue in later periods when returns exceed the estimated amount. Conversely, if we overestimate the level of returns and concessions for a period, we may have additional revenue in later periods when returns and concessions are less than estimated.
Revenues from advance theme park ticket sales are recognized when the tickets are used. For non-expiring, multi-day tickets, we recognize revenue over a three-year time period based on estimated usage patterns, which are derived from historical usage patterns. A change in these estimated usage patterns could have an impact on the timing of revenue recognition.
Pension and Postretirement Medical Plan Actuarial Assumptions
The Companys pension and postretirement medical benefit obligations and related costs are calculated using a number of actuarial assumptions. Two critical assumptions, the discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement. We evaluate these critical assumptions annually. Other assumptions include the healthcare cost trend rate and employee demographic factors such as retirement patterns, mortality, turnover and rate of compensation increase.
The discount rate enables us to state expected future cash payments for benefits as a present value on the measurement date. The guideline for setting this rate is a high-quality long-term corporate bond rate. A lower discount rate increases the present value of benefit obligations and increases pension expense. We decreased our discount rate to 6.35% at the end of fiscal 2007 from 6.40% at the end of fiscal 2006 to reflect market interest rate conditions at our June 30, 2007 measurement date. This decrease in the discount rate will affect net periodic pension and postretirement medical expense in fiscal 2008. The assumed discount rate reflects market rates for high-quality corporate bonds currently available. The Companys discount rate was determined by considering the average of pension yield curves constructed of a large population of high quality corporate bonds. The resulting discount rate reflects the matching of plan liability cash flows to the yield curves. A one percentage point decrease in the assumed discount rate would
increase total net periodic pension and postretirement medical expense for fiscal 2008 by $122 million and would increase the projected benefit obligation at September 29, 2007 by $999 million, respectively. A one percentage point increase in the assumed discount rate would decrease these amounts by $74 million and $849 million, respectively.
To determine the expected long-term rate of return on the plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class. A lower expected rate of return on pension plan assets will increase pension expense. Our long-term expected return on plan assets was 7.50% in both 2007 and 2006, respectively. A one percentage point change in the long-term return on pension plan asset assumption would impact fiscal 2008 annual pension and postretirement medical expense by approximately $51 million.
See Note 9 to the Consolidated Financial Statements for more information on our pension and postretirement medical plans.
Goodwill, Intangible Assets and Investments
SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142) requires that goodwill and other indefinite-lived intangible assets be tested for impairment on an annual basis. In assessing the recoverability of goodwill and other indefinite-lived intangible assets, market values and projections regarding estimated future cash flows and other factors are used to determine the fair value of the respective assets. If these estimates or related projections change in the future, we may be required to record impairment charges for these assets.
As required by SFAS 142, goodwill is allocated to various reporting units, which are generally one reporting level below the operating segment. SFAS 142 requires the Company to compare the fair value of each reporting unit to its carrying amount on an annual basis to determine if there is potential goodwill impairment. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than the carrying value of its goodwill.
To determine the fair value of our reporting units, we generally use a present value technique (discounted cash flow) corroborated by market multiples when available and as appropriate. The factor most sensitive to change with respect to our discounted cash flow analyses is the estimated future cash flows of each reporting unit which is, in turn, sensitive to our estimates of future revenue growth and margins for these businesses. If actual revenue growth and/or margins are lower than our expectations, the impairment test results could differ. A present value technique was not used to determine the fair value of the ABC Television Network, a business within the Television Broadcasting reporting unit within the Media Networks operating segment. To determine the fair value of the ABC Television Network, we used a revenue multiple, as a present value technique may not consistently capture the full fair value of the ABC Television Network and there is little comparable market data available due to the scarcity of television networks. If there were a publicly disclosed sale of a comparable network, this may provide better market information with which to estimate the value of the ABC Television Network and could impact our impairment assessment. We applied what we believe to be the most appropriate valuation methodology for each of the reporting units. If we had established different reporting units or utilized different valuation methodologies, the impairment test results could differ.
SFAS 142 requires the Company to compare the fair values of other indefinite-lived intangible assets to their carrying amounts. If the carrying amount of an indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized. Fair values of other indefinite-lived intangible assets are determined based on discounted cash flows or appraised values, as appropriate.
The Company has cost and equity investments. The fair value of these investments is dependent on the performance of the investee companies, as well as volatility inherent in the external markets for these investments. In assessing potential impairment for these investments, we consider these factors as well as forecasted financial performance of our investees. If these forecasts are not met, impairment charges may be required.
We completed our impairment testing as of September 29, 2007, which resulted in a non-cash impairment charge of $26 million related to ESPN Radio and Radio Disney FCC licenses. During fiscal 2006, the Company recorded a non-cash impairment charge of $32 million related to FCC licenses primarily associated with ESPN Radio stations. These impairment charges reflected overall market declines in certain radio markets in which we operate. During fiscal 2005, the Company adopted EITF D-108 and recorded a non-cash impairment charge of $57 million primarily associated with ESPN and Radio Disney FCC licenses.
Contingencies and Litigation
We are currently involved in certain legal proceedings and, as required, have accrued estimates of the probable and estimable losses for the resolution of these claims. These estimates have been developed in consultation with outside counsel and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in our assumptions or the effectiveness of our strategies related to these proceedings. See Note 14 to the Consolidated Financial Statements for more detailed information on litigation exposure.
Income Tax Audits
As a matter of course, the Company is regularly audited by federal, state and foreign tax authorities. From time to time, these audits result in proposed assessments. Our recorded estimates of liability related to income tax audits are made in consultation with outside tax and legal counsel where appropriate and are based upon the expected outcome of proceedings (or negotiations) with taxing and legal authorities in consideration of applicable tax statutes and related interpretations and precedents. The outcome of such proceedings and the ultimate liability borne by the Company may differ from our estimates based on a number of factors, including the Companys decision to settle rather than litigate a matter, relevant legal precedent related to similar matters and the Companys success in supporting its filing positions with taxing authorities.
Stock Option Compensation Expense
Each year during the second quarter, the Company awards stock options and restricted stock units to a broad-based group of management and creative personnel (the Annual Grant). Prior to the fiscal 2006 Annual Grant, the fair value of options granted was estimated on the grant date using the Black-Scholes option pricing model. Beginning with the fiscal 2006 Annual Grant, the Company has changed to the binomial valuation model. The binomial valuation model considers certain characteristics of fair value option pricing that are not considered under the Black-Scholes model. Similar to the Black-Scholes model, the binomial valuation model takes into account variables such as volatility, dividend yield, and the risk-free interest rate. However, the binomial valuation model also considers the expected exercise multiple (the multiple of exercise price to grant price at which exercises are expected to occur on average) and the termination rate (the probability of a vested option being cancelled due to the termination of the option holder) in computing the value of the option. Accordingly, the Company believes that the binomial valuation model should produce a fair value that is more representative of the value of an employee option.
In fiscal years 2007, 2006, and 2005, the weighted average assumptions used in the options-pricing models were as follows:
Although the initial fair value of stock options is not adjusted after the grant date, changes in the Companys assumptions may change the value and therefore, the expense related to future stock option grants. The assumptions that cause the greatest variation in fair value in the binomial valuation model are the assumed volatility and expected exercise multiple. Increases or decreases in either the assumed volatility or expected exercise multiple will cause the binomial option value to increase or decrease, respectively.
The volatility assumption considers both historical and implied volatility and may be impacted by the Companys performance as well as changes in economic and market conditions. See Note 11 to the Consolidated
Financial Statements for more detailed information. If the assumed volatility of 26% used by the Company during 2007 was increased or decreased by five percentage points (i.e. to 31% or to 21%), the weighted average grant date fair value of our 2007 stock option grants would have increased or decreased by 10%.
The expected exercise multiple may be influenced by the Companys future stock performance, stock price volatility, and employee turnover rates. If the exercise multiple assumption of 1.38 used by the Company during 2007 were increased to 1.6 or decreased to 1.2, the weighted average binomial value of our 2007 stock option grants would have increased by 7% or decreased by 12%, respectively.
In connection with the acquisition of Pixar on May 5, 2006, the Company converted previously issued vested and unvested Pixar stock-based awards into Disney stock-based awards consisting of 44 million stock options and one million RSUs. The fair value of these awards was estimated using the Black-Scholes option pricing model, as the information required to use the binomial valuation model was not reasonably available. The methodology utilized to determine the assumptions in the Black-Scholes model was consistent with that used by the Company for its option pricing models.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 gives the Company the irrevocable option to carry most financial assets and liabilities at fair value, with changes in fair value recognized in earnings. SFAS 159 is effective for the Companys 2009 fiscal year, although early adoption is permitted. The Company is currently assessing the potential effect of SFAS 159 on its financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statement Nos. 87, 88, 106, and 132(R) (SFAS 158). This statement requires recognition of the overfunded or underfunded status of defined benefit pension and other postretirement plans as an asset or liability in the statement of financial position and changes in that funded status to be recognized in comprehensive income in the year in which the changes occur. SFAS 158 also requires measurement of the funded status of a plan as of the date of the statement of financial position. The Company adopted the recognition provisions of SFAS 158 in fiscal year 2007. See Note 9 to the Consolidated Financial Statements for information regarding the impact of adopting the recognition provisions of SFAS 158. The Company has not yet adopted the measurement provisions which are not effective until fiscal year 2009.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 provides a common definition of fair value and establishes a framework to make the measurement of fair value in generally accepted accounting principles more consistent and comparable. SFAS 157 also requires expanded disclosures to provide information about the extent to which fair value is used to measure assets and liabilities, the methods and assumptions used to measure fair value, and the effect of fair value measures on earnings. SFAS 157 is effective for the Companys 2009 fiscal year, although early adoption is permitted. The Company is currently assessing the potential effect of SFAS 157 on its financial statements.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 was issued in order to eliminate the diversity in practice surrounding how public companies quantify financial statement misstatements. SAB 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The Company adopted SAB 108 at the end of fiscal 2007, and the adoption did not have a material impact on the Companys financial statements.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must
meet before a financial statement benefit is recognized. The minimum threshold is defined in FIN 48 as a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. FIN 48 must be applied to all existing tax positions upon initial adoption. The cumulative effect of applying FIN 48 at adoption is to be reported as an adjustment to beginning retained earnings for the year of adoption. FIN 48 is effective for the Companys 2008 fiscal year and will result in a reduction of approximately $160 million to beginning retained earnings in fiscal year 2008.
In September 2004, the Emerging Issues Task Force (EITF) issued Topic No. D-108, Use of the Residual Method to Value Acquired Assets Other than Goodwill (EITF D-108). EITF D-108 requires that a direct value method be used to value intangible assets acquired in business combinations completed after September 29, 2004. EITF D-108 also requires the Company to perform an impairment test using a direct value method on all intangible assets that were previously valued using the residual method. Any impairments arising from the initial application of a direct value method are reported as a cumulative effect of accounting change. For radio station acquisitions subsequent to the acquisition of Capital Cities/ABC, Inc. in 1996, the Company applied the residual value method to value the acquired FCC licenses. The Company adopted EITF D-108 for the fiscal year ended October 1, 2005 and recorded a non-cash, $57 million pre-tax charge ($36 million after-tax) as a cumulative effect of accounting change.
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Company. We may from time to time make written or oral statements that are forward-looking, including statements contained in this report and other filings with the Securities and Exchange Commission and in reports to our shareholders. Such statements may, for example, express expectations or projections about future actions that we may take, including restructuring or strategic initiatives, or about developments beyond our control including changes in domestic or global economic conditions. These statements are made on the basis of managements views and assumptions as of the time the statements are made and we undertake no obligation to update these statements. There can be no assurance, however, that our expectations will necessarily come to pass. Significant factors affecting these expectations are set forth under Item 1A Risk Factors of this Report on Form 10-K.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to the impact of interest rate changes, foreign currency fluctuations, and changes in the market values of its investments.
Policies and Procedures
In the normal course of business, we employ established policies and procedures to manage the Companys exposure to changes in interest rates, foreign currencies, and the fair market value of certain investments in debt and equity securities using a variety of financial instruments.
Our objectives in managing exposure to interest rate changes are to limit the impact of interest rate volatility on earnings and cash flows and to lower overall borrowing costs. To achieve these objectives, we primarily use interest rate swaps to manage net exposure to interest rate changes related to the Companys portfolio of borrowings. By policy, the Company maintains fixed-rate debt as a percentage of its net debt between minimum and maximum percentages.
Our objective in managing exposure to foreign currency fluctuations is to reduce volatility of earnings and cash flow in order to allow management to focus on core business issues and challenges. Accordingly, the Company enters into various contracts that change in value as foreign exchange rates change to protect the U.S. dollar equivalent value of its existing foreign currency assets, liabilities, commitments, and forecasted foreign currency revenues. The Company utilizes option strategies and forward contracts that provide for the sale of foreign currencies to hedge probable, but not firmly committed, transactions. The Company also uses forward contracts to hedge foreign currency assets and liabilities. The principal foreign currencies hedged are the Euro, British pound, Japanese yen, and Canadian
dollar. Cross-currency swaps are used to effectively convert foreign currency denominated borrowings to U.S. dollar denominated borrowings. By policy, the Company maintains hedge coverage between minimum and maximum percentages of its forecasted foreign exchange exposures generally for periods not to exceed five years. The gains and losses on these contracts offset changes in the U.S. dollar equivalent value of the related exposures.
It is the Companys policy to enter into foreign currency and interest rate derivative transactions and other financial instruments only to the extent considered necessary to meet its objectives as stated above. The Company does not enter into these transactions or any other hedging transactions for speculative purposes.
Value at Risk (VAR)
The Company utilizes a VAR model to estimate the maximum potential one-day loss in the fair value of its interest rate, foreign exchange, and market sensitive equity financial instruments. The VAR model estimates were made assuming normal market conditions and a 95% confidence level. Various modeling techniques can be used in a VAR computation. The Companys computations are based on the interrelationships between movements in various interest rates, currencies, and equity prices (a variance/co-variance technique). These interrelationships were determined by observing interest rate, foreign currency, and equity market changes over the preceding quarter for the calculation of VAR amounts at fiscal 2007 year end. The model includes all of the Companys debt as well as all interest rate and foreign exchange derivative contracts and market sensitive equity investments. Forecasted transactions, firm commitments, and receivables and accounts payable denominated in foreign currencies, which certain of these instruments are intended to hedge, were excluded from the model.
The VAR model is a risk analysis tool and does not purport to represent actual losses in fair value that will be incurred by the Company, nor does it consider the potential effect of favorable changes in market factors.
VAR on a combined basis increased to $33 million at September 29, 2007 from $21 million at September 30, 2006. The increase was primarily due to higher volatility and a higher market value of currency-sensitive instruments.
The estimated maximum potential one-day loss in fair value, calculated using the VAR model, is as follows (unaudited, in millions):
The VAR for Euro Disney and Hong Kong Disneyland is immaterial as of September 29, 2007. In calculating the VAR it was determined that credit risks are the primary driver for changes in the value of Euro Disneys debt rather than interest rate risks. Accordingly, we have excluded Euro Disneys borrowings from the above VAR calculation.
See Index to Financial Statements and Supplemental Data on page 61.
ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and made known to the officers who certify the Companys financial reports and to other members of senior management and the Board of Directors as appropriate to allow timely decisions regarding required disclosure.
Based on their evaluation as of September 29, 2007, the principal executive officer and principal financial officer of the Company have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective.
Managements Report on Internal Control Over Financial Reporting
Managements report set forth on page 62 is incorporated herein by reference.
Changes in Internal Controls
There have been no changes in our internal control over financial reporting or in factors affecting internal control over financial reporting during the fourth quarter of the fiscal year ended September 29, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 10. Directors, Executive Officers and Corporate Governance
Information regarding Section 16(a) compliance, the Audit Committee, the Companys code of ethics and background of the directors appearing under the captions Section 16(a) Beneficial Ownership Reporting Compliance, Committees, Corporate Governance Guidelines and Code of Ethics and Election of Directors in the Companys Proxy Statement for the 2008 annual meeting of Shareholders is hereby incorporated by reference.
Information regarding executive officers is included in Part I of this Form 10-K as permitted by General Instruction G(3).
ITEM 11. Executive Compensation
Information appearing under the captions Board Compensation and Executive Compensation in the 2008 Proxy Statement (other than the Compensation Committee Report) is hereby incorporated by reference.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information setting forth the security ownership of certain beneficial owners and management appearing under the caption Stock Ownership and information in the Equity Compensation Plans table appearing under the caption Overview of Plans in the 2008 Proxy Statement is hereby incorporated by reference.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
Information regarding certain related transactions appearing under the captions Certain Relationships and Related Person Transactions and Executive Compensation and information regarding director independence appearing under the caption Director Independence in the 2008 Proxy Statement is hereby incorporated by reference.
ITEM 14. Principal Accountant Fees and Services
Information appearing under the captions Auditor Fees and Services and Policy for Approval of Audit and Permitted Non-Audit Services in the 2008 Proxy Statement is hereby incorporated by reference.
ITEM 15. Exhibits and Financial Statement Schedules
See Index to Financial Statements and Supplemental Data at page 61.
The documents set forth below are filed herewith or incorporated herein by reference to the location indicated.
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.
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.
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
All schedules are omitted for the reason that they are not applicable or the required information is included in the financial statements or notes.
MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Companys assets that could have a material effect on the financial statements.
Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control Integrated Framework, management concluded that our internal control over financial reporting was effective as of September 29, 2007.
The effectiveness of our internal control over financial reporting as of September 29, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of The Walt Disney Company
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders equity and cash flows present fairly, in all material respects, the financial position of The Walt Disney Company and its subsidiaries (the Company) at September 29, 2007 and September 30, 2006, and the results of their operations and their cash flows for each of the three years in the period ended September 29, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 29, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Companys internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 2 to the consolidated financial statements, as of September 29, 2007, the Company changed its method of accounting for pension and other postretirement benefits. Also, during the year ended October 1, 2005, the Company changed the manner in which it values its FCC licenses.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Los Angeles, California
November 21, 2007
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share data)
See Notes to Consolidated Financial Statements
CONSOLIDATED BALANCE SHEETS
(in millions, except per share data)