Annual Reports

 
Quarterly Reports

  • 10-Q (Aug 5, 2014)
  • 10-Q (May 6, 2014)
  • 10-Q (Feb 5, 2014)
  • 10-Q (Aug 6, 2013)
  • 10-Q (May 7, 2013)
  • 10-Q (Feb 5, 2013)

 
8-K

 
Other

Walt Disney Company 10-Q 2010
Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended

July 3, 2010

  

Commission File Number 1-11605

LOGO

 

Incorporated in Delaware

   I.R.S. Employer Identification
   No. 95-4545390

500 South Buena Vista Street, Burbank, California 91521

(818) 560-1000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes      X    No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes      X    No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).

 

Large accelerated filer           X              Accelerated filer                          
Non-accelerated filer (do not check if smaller reporting company)                             Smaller reporting company                          

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes             No    X

There were 1,912,606,953 shares of common stock outstanding as of August 3, 2010.


PART I. FINANCIAL INFORMATION

Item 1: Financial Statements

THE WALT DISNEY COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited; in millions, except per share data)

 

     Quarter Ended    Nine Months Ended
         July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Revenues

     $     10,002         $ 8,596         $ 28,321         $ 26,282   

Costs and expenses

     (7,723)            (6,998)            (23,116)            (22,180)  

Restructuring and impairment charges

     (36)        (21)        (212)        (326)  

Other income

     43         —         140         114   

Net interest expense

     (89)        (75)        (322)        (342)  

Equity in the income of investees

     139         155         382         449   
                           

Income before income taxes

     2,336         1,657         5,193         3,997   

Income taxes

     (831)        (626)        (1,846)        (1,462)  
                           

Net income

     1,505         1,031         3,347         2,535   

Less: Net income attributable to noncontrolling interests

     (174)        (77)        (219)        (123)  
                           

Net income attributable to The Walt Disney Company (Disney)

     $ 1,331         $ 954         $ 3,128         $ 2,412   
                           

Earnings per share attributable to Disney:

           

Diluted

     $ 0.67         $ 0.51         $ 1.60         $ 1.29   
                           

Basic

     $ 0.68         $ 0.51         $ 1.63         $ 1.30   
                           

Weighted average number of common and common equivalent shares outstanding:

           

Diluted

     1,978         1,874         1,951         1,871   
                           

Basic

     1,945         1,857         1,917         1,855   
                           

See Notes to Condensed Consolidated Financial Statements

 

2


THE WALT DISNEY COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited; in millions, except per share data)

 

     July 3,
2010
   October 3,
2009

ASSETS

     

Current assets

     

Cash and cash equivalents

       $ 2,951           $ 3,417   

Receivables

     5,744         4,854   

Inventories

     1,322         1,271   

Television costs

     731         631   

Deferred income taxes

     1,162         1,140   

Other current assets

     691         576   
             

Total current assets

     12,601         11,889   

Film and television costs

     4,825         5,125   

Investments

     2,587         2,554   

Parks, resorts and other property, at cost

     

Attractions, buildings and equipment

     32,036         32,475   

Accumulated depreciation

     (17,808)        (17,395)  
             
     14,228         15,080   

Projects in progress

     1,811         1,350   

Land

     1,115         1,167   
             
     17,154         17,597   

Intangible assets, net

     5,065         2,247   

Goodwill

     23,709         21,683   

Other assets

     2,364         2,022   
             

Total assets

       $   68,305           $ 63,117   
             

LIABILITIES AND EQUITY

     

Current liabilities

     

Accounts payable and other accrued liabilities

       $ 5,100           $ 5,616   

Current portion of borrowings

     1,823         1,206   

Unearned royalties and other advances

     2,566         2,112   
             

Total current liabilities

     9,489         8,934   

Borrowings

     10,804         11,495   

Deferred income taxes

     3,246         1,819   

Other long-term liabilities

     5,165         5,444   

Commitments and contingencies

     

Disney Shareholders’ equity

     

Preferred stock, $.01 par value

     

Authorized – 100 million shares, Issued – none

     

Common stock, $.01 par value

     

Authorized – 4.6 billion shares and 3.6 billion shares, Issued – 2.7 billion shares and 2.6 billion shares at July 3, 2010 and October 3, 2009, respectively

     28,542         27,038   

Retained earnings

     33,493         31,033   

Accumulated other comprehensive loss

     (1,593)        (1,644)  
             
     60,442         56,427   

Treasury stock, at cost, 767.7 million shares at July 3, 2010 and 781.7 million shares at October 3, 2009

     (22,483)            (22,693)  
             

Total Disney Shareholders’ equity

     37,959         33,734   

Noncontrolling interests

     1,642         1,691   
             

Total equity

     39,601         35,425   
             

Total liability and equity

       $ 68,305           $ 63,117   
             

See Notes to Condensed Consolidated Financial Statements

 

3


THE WALT DISNEY COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in millions)

 

     Nine Months Ended
     July 3,
2010
   June 27,
2009

OPERATING ACTIVITIES

     

Net income

     $ 3,347         $       2,535   

Depreciation and amortization

     1,279         1,206   

Gains on dispositions

     (118)        (114)  

Deferred income taxes

     464         283   

Equity in the income of investees

     (382)        (449)  

Cash distributions received from equity investees

     350         375   

Net change in film and television costs

     31         (280)  

Equity-based compensation

     391         336   

Impairment charges

     126         206   

Other

     13         (72)  

Changes in operating assets and liabilities:

     

Receivables

     (711)        506   

Inventories

     (1)        (71)  

Other assets

     112         (382)  

Accounts payable and other accrued liabilities

     (319)        (414)  

Income taxes

     (210)        (84)  
             

Cash provided by operations

     4,372         3,581   
             

INVESTING ACTIVITIES

     

Investments in parks, resorts and other property

     (1,313)        (1,127)  

Proceeds from dispositions

     170         185   

Acquisitions

     (2,280)        (169)  

Other

     (40)        1   
             

Cash used in investing activities

           (3,463)        (1,110)  
             

FINANCING ACTIVITIES

     

Commercial paper borrowings/(repayments), net

     794         (1,985)  

Borrowings

     —         1,747   

Reduction of borrowings

     (579)        (795)  

Dividends

     (653)        (648)  

Repurchases of common stock

     (1,489)        (104)  

Exercise of stock options and other

     552         (559)  
             

Cash used in financing activities

     (1,375)        (2,344)  
             

(Decrease)/increase in cash and cash equivalents

     (466)        127   

Cash and cash equivalents, beginning of period

     3,417         3,001   
             

Cash and cash equivalents, end of period

     $ 2,951         $ 3,128   
             

See Notes to Condensed Consolidated Financial Statements

 

4


THE WALT DISNEY COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(unaudited; in millions)

 

    Quarter Ended
    July 3, 2010   June 27, 2009
    Disney
    Shareholders    
  Non-
  controlling  
Interests
  Total
    Equity    
  Disney
    Shareholders    
  Non-
  controlling  
Interests
  Total
    Equity    

Beginning Balance

    $ 37,480        $     1,489        $     38,969        $ 33,272        $ 1,027        $     34,299   

Net income

    1,331        174        1,505        954        77        1,031   

Other comprehensive income:

           

Market value adjustments for hedges and investments

    (22)       —        (22)       (110)       —        (110)  

Pension and postretirement medical adjustments

    31        —        31        (8)       —        (8)  

Foreign currency translation and other

    (43)       (20)       (63)       49        (7)       42   
                                   

Other comprehensive income

    (34)       (20)       (54)       (69)       (7)       (76)  
                                   

Comprehensive income

    1,297        154        1,451        885        70       955   

Equity compensation activity

    436        —        436        139        —        139   

Common stock repurchases

    (1,249)       —        (1,249)       —        —        —   

Acquisition of Jetix

    —        —        —        —        (2)       (2)  

Distributions and other

    (5)       (1)       (6)       —        7        7   
                                   

Ending Balance

    $ 37,959        $ 1,642        $ 39,601        $ 34,296        $     1,102        $ 35,398   
                                   

See Notes to Condensed Consolidated Financial Statements

 

5


THE WALT DISNEY COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (cont’d)

(unaudited; in millions)

 

    Nine Months Ended
    July 3, 2010   June 27, 2009
    Disney
    Shareholders    
  Non-
controlling
    Interests    
  Total
      Equity      
  Disney
    Shareholders    
  Non-
controlling
    Interests    
  Total
      Equity      

Beginning Balance

    $ 33,734         $ 1,691         $ 35,425         $ 32,323         $ 1,344         $ 33,667    

Net income

    3,128         219         3,347         2,412         123         2,535    

Other comprehensive income:

           

Market value adjustments for hedges and investments

    (2)        —         (2)        26         —         26    

Pension and postretirement medical adjustments

    121         —         121         (17)        —         (17)   

Foreign currency translation and other

    (68)        (34)        (102)        (50)        (26)        (76)   
                                   

Other comprehensive income

    51         (34)        17         (41)        (26)        (67)   
                                   

Comprehensive income

    3,179         185         3,364         2,371         97         2,468    

Equity compensation activity

    1,306         —         1,306         287         —         287    

Dividends

    (653)        —         (653)        (648)        —         (648)   

Common stock repurchases

    (1,489)        —         (1,489)        (104)        —         (104)   

Acquisition of Jetix

    —         —         —         —         (86)        (86)   

Acquisition of Marvel

    1,887         90         1,977         —         —         —    

Adoption of new pension and postretirement medical plan measurement date (net of tax of $37 million)

    —         —         —         65         —         65    

Distributions and other

    (5)        (324)        (329)        2         (253)        (251)   
                                   

Ending Balance

    $ 37,959         $ 1,642         $ 39,601         $ 34,296         $ 1,102         $ 35,398    
                                   

See Notes to Condensed Consolidated Financial Statements

 

6


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

1.   Principles of Consolidation

These Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. We believe that we have included all normal recurring adjustments necessary for a fair statement of the results for the interim period. Operating results for the quarter and nine months ended July 3, 2010 are not necessarily indicative of the results that may be expected for the year ending October 2, 2010. Certain reclassifications have been made in the prior year financial statements to conform to the current year presentation.

These financial statements should be read in conjunction with the Company’s 2009 Annual Report on Form 10-K as amended on Form 8-K dated February 18, 2010.

In December 1999, DVD Financing, Inc. (DFI), a subsidiary of Disney Vacation Development, Inc. and an indirect subsidiary of the Company, completed a receivables sale transaction that established a facility that permitted DFI to sell receivables arising from the sale of vacation club memberships on a periodic basis. In connection with this facility, DFI prepares separate financial statements, although its separate assets and liabilities are also consolidated in these financial statements. DFI’s ability to sell new receivables under this facility ended on December 4, 2008. (See Note 13 for further discussion of this facility)

The terms “Company,” “we,” “us,” and “our” are used in this report to refer collectively to the parent company and the subsidiaries through which our various businesses are actually conducted.

 

2.   Segment Information

The operating segments reported below are the segments of the Company for which separate financial information is available and for which segment results are evaluated regularly by the Chief Executive Officer in deciding how to allocate resources and in assessing performance. The Company reports the performance of its operating segments including equity in the income of investees, which consists primarily of cable businesses included in the Media Networks segment.

 

     Quarter Ended    Nine Months Ended
         July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Revenues(1) :

           

Media Networks

     $     4,729          $     3,961          $     12,748          $     11,484    

Parks and Resorts

     2,831          2,751          7,942          7,823    

Studio Entertainment

     1,639          1,261          5,110          4,641    

Consumer Products

     606          510          1,948          1,779    

Interactive Media

     197          113          573          555    
                           
     $ 10,002          $ 8,596          $ 28,321          $ 26,282    
                           

Segment operating income (loss) (1):

           

Media Networks

     $ 1,885          $ 1,319          $ 3,915          $ 3,280    

Parks and Resorts

     477          521          1,002          1,074    

Studio Entertainment

     123          (12)         589          188    

Consumer Products

     117          96          493          458    

Interactive Media

     (65)         (75)         (130)         (181)   
                           
     $ 2,537          $ 1,849          $ 5,869          $ 4,819    
                           

 

7


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

(1)

Studio Entertainment segment revenues and operating income include an allocation of Consumer Products and Interactive Media revenues which is meant to reflect royalties on sales of merchandise based on certain Studio film properties. The increases/(decreases) related to these allocations on segment revenues and operating income as reported in the above table are as follows:

 

     Quarter Ended    Nine Months Ended
         July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Studio Entertainment

     $ 51          $     21          $     136          $     98    

Consumer Products

     (50)         (20)         (129)         (85)   

Interactive Media

     (1)         (1)         (7)         (13)   
                           
     $ —          $ —          —          $     —    
                           

A reconciliation of segment operating income to income before income taxes is as follows:

 

     Quarter Ended    Nine Months Ended
       July 3,  
2010
     June 27,  
2009
     July 3,  
2010
     June 27,  
2009

Segment operating income

     $     2,537          $     1,849          $     5,869          $     4,819    

Corporate and unallocated shared expenses

     (119)         (96)         (282)         (268)   

Restructuring and impairment charges

     (36)         (21)         (212)         (326)   

Other income

     43          —          140          114    

Net interest expense

     (89)         (75)         (322)         (342)   
                           

Income before income taxes

     $ 2,336          $ 1,657          $ 5,193          $ 3,997    
                           

 

3.   Acquisitions

The Disney Store Japan

On March 31, 2010, the Company acquired all of the outstanding shares of Retail Networks Company Limited (The Disney Store Japan) in exchange for a $17 million note. At the time of the acquisition, The Disney Store Japan had a cash balance of $13 million. In connection with the acquisition, the Company recognized a $22 million non-cash gain from the deemed termination of the existing licensing arrangement. The gain is reported in “Other income” in the fiscal 2010 Condensed Consolidated Statement of Income.

Marvel

On December 31, 2009, the Company completed a cash and stock acquisition for the outstanding capital stock of Marvel Entertainment, Inc. (Marvel), a character-based entertainment company. Disney believes that this acquisition is consistent with the Company’s strategic value creation through utilization of intellectual properties across Disney’s multiple platforms and territories.

The acquisition purchase price totaled $4.2 billion. In accordance with the terms of the acquisition, Marvel shareholders received $30 per share in cash and 0.7452 Disney shares for each Marvel share they owned. In total, the Company paid $2.4 billion in cash and distributed shares valued at $1.9 billion (approximately 59 million shares of Disney common stock at a price of $32.25).

The Company is required to allocate the purchase price to tangible and identifiable intangible assets acquired and liabilities assumed based on their fair values. The excess of the purchase price over those fair values is recorded as goodwill. The Company is in the process of finalizing the valuation of the assets acquired and liabilities assumed and therefore, the fair values set forth below are subject to adjustment once the valuations are completed.

 

8


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

The following table summarizes our preliminary allocation of the purchase price:

 

       Estimated Fair  
Value

Cash and cash equivalents

     $ 105    

Accounts receivable and other assets

     137    

Film costs

     304    

Intangible assets

     2,870    

Goodwill

     2,269    
      

Total assets acquired

     5,685    

Accounts payable and other liabilities

     (320)   

Deferred income taxes

     (1,033)   
      

Total liabilities assumed

     (1,353)   

Noncontrolling interests

     (90)   
      
     $ 4,242    
      

Intangible assets primarily consist of character-based intellectual property with an estimated useful life of approximately 40 years.

The goodwill reflects the value to Disney from leveraging Marvel intellectual property across our distribution channels, taking advantage of Disney’s established global reach. The goodwill recorded as part of this acquisition is not amortizable for tax purposes.

Jetix Europe

In December 2008, the Company acquired an additional 26% interest in Jetix Europe N.V., a publicly traded pan-European kids’ entertainment company, for approximately $354 million (bringing our total ownership interest to over 99%). The Company currently intends to acquire the remaining outstanding shares through statutory buy-out proceedings.

UTV

On May 9, 2008, the Company acquired a 24% interest (bringing its undiluted interest to 37%) in UTV Software Communications Limited (UTV), a media company headquartered and publicly traded in India, for approximately $197 million. In accordance with Indian securities regulations, the Company was required to make an open tender offer to purchase up to an additional 23% of UTV’s publicly traded voting shares for a price equivalent to the May 9th, 2008 Indian rupee purchase price. In November 2008, the Company completed the open offer and acquired an incremental 23% of UTV’s voting shares for approximately $138 million bringing its undiluted interest to 60%. Due to the change in the exchange rate between the US dollar and the Indian rupee from May to November, the US dollar price per share was lower in November than in May. UTV’s founder has a four-year option which expires in November 2012 to buy all or a portion of the shares acquired by the Company during the open-offer period at a price no less than the Company’s open-offer price. If the trading price upon exercise of the option exceeds the price paid by the Company, then the option price is capped at the Company’s open-offer price plus a 10% annual return. The Company does not have the right to vote the shares subject to the option until the expiration of the option and accordingly the Company’s ownership interest in voting shares is 48%. In addition to the acquisition of UTV, on August 5, 2008, the Company invested $28 million in a UTV subsidiary, UTV Global Broadcasting Limited (along with UTV, the “UTV Group”). The Company’s investment in the UTV Group is accounted for under the equity method.

 

9


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

In fiscal 2009, the Company recorded non-cash impairment charges totaling $65 million, based on the Company’s internal valuation of the UTV business, which was estimated using a discounted cash flow model. The trading value of UTV stock has experienced considerable fluctuation, and the Company’s carrying value of its investment in the UTV Group, which is $252 million as of July 3, 2010, has exceeded the trading value by a significant amount at times. The Company will continue to monitor the recoverability of its investment in the UTV Group.

In January 2010, UTV issued additional stock in exchange for the outstanding noncontrolling interest of one of its subsidiaries diluting the Company’s direct interest in UTV to 50% (39% voting interest) while increasing the indirect interest in the subsidiary.

Goodwill

The changes in the carrying amount of goodwill for the nine months ended July 3, 2010, are as follows:

 

     Media
  Networks  
     Parks and  
Resorts
   Studio
  Entertainment  
     Consumer  
Products
     Interactive  
Media
     Total  

Goodwill

     $ 15,744         $ 172         $ 4,737         $ 422         $ 637         $ 21,712   

Accumulated Impairments

     —          —         —         —         (29)        (29)  
                                         

Balance at Oct. 3, 2009

     15,744         172         4,737         422         608         21,683   

Acquisitions (1)

     —          —         528         1,499         271         2,298   

Disposition

     (3)        —         —         (9)        —         (12)  

Other, net (2)

     (8)        (1)        (250)        (1)        —         (260)  
                                         

Balance at Jul. 3, 2010

     $ 15,733         $ 171         $ 5,015         $ 1,911         $ 879         $ 23,709   
                                         
(1)

During the nine months ended July 3, 2010, the Company completed the acquisition of Marvel and recorded $2,269 million of goodwill. See discussion above on the Marvel acquisition.

(2)

On July 29, 2010, the Company entered into an agreement to sell the majority of the assets of the Miramax business. The Miramax assets along with $232 million of allocable goodwill have been classified as held for sale and reported in “Other Assets” in the fiscal 2010 Condensed Consolidated Balance Sheet. See Note 16 for further details.

Intangibles

The Company’s intangible assets are as follows:

 

       July 3,  
2010
     October 3,  
2009

Copyrights and other character intangibles

     $  3,115         $ 358   

Other amortizable intangible assets

     301         296   

Accumulated amortization

     (325)        (249)  
             

Net amortizable intangible assets

     3,091         405   
             

FCC licenses

     736         713   

Trademarks

     1,218         1,109   

Other indefinite lived intangible assets

     20         20   
             

Total intangible assets

     $  5,065         $ 2,247   
             

 

10


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

Amortization expense was $75 million and $40 million for the nine months ended July 3, 2010 and June 27, 2009, respectively. As a result of the acquisition of Marvel, intangible assets increased by $2.9 billion. The Company expects its aggregate annual amortization expense for existing amortizable intangible assets for fiscal years 2010 through 2014 to be as follows:

 

2010

   $      106

2011

      121

2012

      117

2013

      109

2014

      106

Amortizable intangible assets are generally amortized on a straight-line basis over periods up to 40 years. The costs to periodically renew our intangible assets are expensed as incurred. The Company has determined that there are currently no legal, competitive, economic or other factors that materially limit the useful life of our FCC licenses and trademarks.

 

4.   Dispositions

On May 12, 2010, the Company sold the rights and assets related to the Power Rangers property for $65 million, resulting in a pre-tax gain of $43 million reported in “Other income” in the Fiscal 2010 Condensed Consolidated Statements of Income.

On January 27, 2010, the Company sold its investment in a pay television service in Europe for $78 million, resulting in a pre-tax gain of $48 million reported in “Other income” in the Fiscal 2010 Condensed Consolidated Statement of Income.

On November 25, 2009, the Company sold its investment in a television service in Europe for $37 million, resulting in a pre-tax gain of $27 million reported in “Other income” in the Fiscal 2010 Condensed Consolidated Statement of Income.

On December 22, 2008, the Company sold its investment in two pay television services in Latin America, for approximately $185 million, resulting in a pre-tax gain of $114 million reported in “Other income” in the Fiscal 2009 Condensed Consolidated Statement of Income.

 

5.   Borrowings

During the nine months ended July 3, 2010, the Company’s borrowing activity was as follows:

 

       October 3,  
2009
     Additions          Payments        Other
    Activity    
       July 3,    
2010

Commercial paper borrowings

       $ —        $ 794        $ —           $ —          $ 794    

U.S. medium-term notes

     7,618        —        (50)          3          7,571    

European medium-term notes

     347        —        (88)          5          264    

Other foreign currency denominated debt

     904        —        —           22          926    

Film financing

     350        —        (350)         —          —    

Other

     614        —        —           15          629    

Euro Disney borrowings(1)

     2,344        —        (91)         (307)         1,946    

Hong Kong Disneyland borrowings

     524        —        —           (27)         497    
                                  

Total

       $     12,701        $     794        $     (579)         $     (289)         $     12,627    
                                  

 

(1)

The other activity is primarily the impact of foreign currency translation as a result of the strengthening of the U.S. dollar against the Euro.

 

11


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

6.   Euro Disney and Hong Kong Disneyland

The Company has a 51% effective ownership interest in the operations of Euro Disney and a 47% ownership interest in the operations of Hong Kong Disneyland, both of which are consolidated in the Company’s financial statements.

The following table presents summarized balance sheet information for the Company as of July 3, 2010, reflecting the impact of consolidating the balance sheets of Euro Disney and Hong Kong Disneyland.

 

     Before Euro
Disney and
Hong Kong
Disneyland
      Consolidation      
   Euro Disney,
Hong Kong
    Disneyland and    
Adjustments
           Total        

Cash and cash equivalents

     $ 2,425              $ 526              $ 2,951    

Other current assets

     9,442              208              9,650    
                    

Total current assets

     11,867              734              12,601    

Investments

     3,506              (919)             2,587    

Fixed assets

     13,196              3,958              17,154    

Other assets

     35,933              30              35,963    
                    

Total assets

     $     64,502              $ 3,803              $ 68,305    
                    

Current portion of borrowings

     $ 1,675              $ 148              $ 1,823    

Other current liabilities

     7,164              502              7,666    
                    

Total current liabilities

     8,839              650              9,489    

Borrowings

     8,509              2,295              10,804    

Deferred income taxes and other long-term liabilities

     8,277              134              8,411    

Equity

     38,877              724              39,601    
                    

Total liabilities and equity

     $ 64,502              $     3,803              $ 68,305    
                    

The following table presents summarized income statement information of the Company for the nine months ended July 3, 2010, reflecting the impact of consolidating the income statements of Euro Disney and Hong Kong Disneyland.

 

     Before Euro
Disney and

Hong Kong
Disneyland
    Consolidation    
   Euro Disney,
Hong Kong
    Disneyland and    
Adjustments
           Total        

Revenues

     $ 26,853              $ 1,468              $ 28,321        

Cost and expenses

     (21,610)             (1,506)             (23,116)       

Restructuring and impairment charges

     (212)             —               (212)       

Other income

     140              —               140        

Net interest expense

     (238)             (84)             (322)       

Equity in the income of investees

     320              62              382        
                    

Income before income taxes

     5,253              (60)             5,193        

Income taxes

     (1,837)             (9)             (1,846)       
                    

Net income

     $ 3,416              $ (69)             $ 3,347        
                    

 

12


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

The following table presents summarized cash flow statement information of the Company for the nine months ended July 3, 2010, reflecting the impact of consolidating the cash flow statements of Euro Disney and Hong Kong Disneyland.

 

     Before Euro
Disney and

Hong Kong
Disneyland
    Consolidation    
   Euro Disney,
Hong Kong
Disneyland

and
    Adjustments    
       Total    

Cash provided by operations

     $ 4,179              $ 193              $ 4,372    

Investments in parks, resorts and other property

     (1,165)             (148)             (1,313)   

Other investing activities

     (2,194)             44              (2,150)   

Cash used by financing activities

     (1,206)             (169)             (1,375)   
                    

Decrease in cash and cash equivalents

     (386)             (80)             (466)   

Cash and cash equivalents, beginning of period

     2,811              606              3,417    
                    

Cash and cash equivalents, end of period

     $     2,425              $ 526              $     2,951    
                    

 

7.   Pension and Other Benefit Programs

The components of net periodic benefit cost are as follows:

 

     Pension Plans    Postretirement Medical Plans
     Quarter Ended    Nine Months Ended    Quarter Ended    Nine Months Ended
     July 3,
2010
   June 27,
2009
   July 3,
2010
   June 27,
2009
   July 3,
2010
   June 27,
2009
   July 3,
2010
   June 27,
2009

Service cost

     $ 66          $ 42          $ 198          $ 125          $ 5          $ 5          $ 16          $ 13    

Interest cost

     99          91          297          272          17          17          52          53    

Expected return on plan assets

         (104)         (93)             (311)         (279)         (6)         (6)         (19)         (19)   

Amortization of prior year service costs

     3          4          10          11          —           (1)         (1)         (2)   

Recognized net actuarial loss

     39          (3)         116          (7)         2          (2)         5          (6)   
                                                       

Net periodic benefit cost

     $ 103          $ 41          $ 310          $ 122          $ 18          $ 13          $ 53          $ 39    
                                                       

During the nine months ended July 3, 2010, the Company made contributions to its pension and postretirement medical plans totaling $409 million, which included discretionary contributions above the minimum requirements for our pension plans. The Company does not anticipate making any material contributions to its pension and postretirement medical plans during the remainder of fiscal 2010.

 

13


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

8.   Earnings Per Share

Diluted earnings per share amounts are based upon the weighted average number of common and common equivalent shares outstanding during the period and are calculated using the treasury stock method for equity-based compensation awards (Awards). A reconciliation of the weighted average number of common and common equivalent shares outstanding and Awards excluded from the diluted earnings per share calculation, as they were anti-dilutive, are as follows:

 

     Quarter Ended    Nine Months Ended
         July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Shares (in millions):

           

Weighted average number of common shares outstanding (basic)

   1,945        1,857        1,917        1,855    

Weighted average dilutive impact of equity-based compensation awards

   33        17        34        16    
                   

Weighted average number of common and common equivalent shares outstanding (diluted)

   1,978        1,874        1,951        1,871    
                   

Awards excluded from diluted earnings per share

   14        149        39        155    
                   

 

9.   Equity

The Company declared a $653 million dividend ($0.35 per share) on December 2, 2009 related to fiscal 2009 for shareholders of record on December 14, 2009, which was paid on January 19, 2010. The Company paid a $648 million dividend ($0.35 per share) during the third quarter of fiscal 2009 related to fiscal 2008.

During the nine months ended July 3, 2010, the Company repurchased 45 million shares of its common stock for approximately $1.5 billion. As of July 3, 2010, the Company had remaining authorization in place to repurchase approximately 134 million additional shares. The repurchase program does not have an expiration date.

The Company received proceeds of $1.1 billion from the exercise of 43 million employee stock options during the nine months ended July 3, 2010.

Accumulated other comprehensive income (loss), net of tax, is as follows:

 

           July 3,      
2010
       October 3,    
2009

Market value adjustments for investments and hedges

     $ 16          $ 18    

Foreign currency translation and other

     37          105    

Unrecognized pension and postretirement medical expense

     (1,646)         (1,767)   
             

Accumulated other comprehensive income (loss) (1)

     $ (1,593)         $ (1,644)   
             

 

(1)

Accumulated other comprehensive income (loss) and components of other comprehensive income (loss) are net of 37% estimated tax

 

14


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

10.    Equity-Based Compensation

The amount of compensation expense related to stock options and restricted stock units (RSUs) is as follows:

 

     Quarter Ended    Nine Months Ended
         July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Stock options

       $ 49            $ 53            $ 171            $ 166    

RSUs

     70          58          220          170    
                           

Total equity-based compensation expense

       $ 119            $ 111            $ 391            $ 336    
                           

Unrecognized compensation cost related to unvested stock options and RSUs totaled approximately $265 million and $586 million, respectively, as of July 3, 2010.

In January 2010, the Company made stock compensation grants, which included its regular annual grant, consisting of 11.5 million stock options and 13.4 million RSUs, of which 0.4 million RSUs included market and/or performance conditions.

The weighted average grant date fair values of options issued during the nine months ended July 3, 2010, and June 27, 2009, were $9.42 and $7.43, respectively.

 

11.   Commitments and Contingencies

Legal Matters

Celador International Ltd. v. The Walt Disney Company. On May 19, 2004, an affiliate of the creator and licensor of the television program, “Who Wants to be a Millionaire,” filed an action against the Company and certain of its subsidiaries, including American Broadcasting Companies, Inc. and Buena Vista Television, LLC, alleging it was damaged by defendants improperly engaging in certain intra-company transactions and charging merchandise distribution expenses, resulting in an underpayment to the plaintiff. On July 7, 2010, the jury returned a verdict for breach of contract against certain subsidiaries of the Company, awarding plaintiff damages of $269.4 million. The plaintiff has advised the Company that it intends to seek an award of prejudgment interest on the verdict amount. Although we cannot predict the ultimate outcome of this lawsuit, the Company believes the jury’s verdict is in error and intends to vigorously pursue its position in post-trial motions and, if those motions are unsuccessful, on appeal.

The Company, together with, in some instances, certain of its directors and officers is a defendant or codefendant 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 material liability by reason of these actions.

Contractual Guarantees

The Company has guaranteed bond issuances by the Anaheim Public Authority that were used by the City of Anaheim to finance construction of infrastructure and a public parking facility adjacent to the Disneyland Resort. Revenues from sales, occupancy and property taxes from the Disneyland Resort and non-Disney hotels are used by the City of Anaheim to repay the bonds. In the event of a debt service shortfall, the Company will be responsible to fund the shortfall. As of July 3, 2010, the remaining debt service obligation guaranteed by the Company was $370 million, of which $94 million was principal. To the extent that tax revenues exceed the debt service payments in subsequent periods, the Company would be reimbursed for any previously funded shortfalls. To date, tax revenues have exceeded the debt service payments for the Anaheim bonds.

 

15


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

ESPN STAR Sports, a joint venture in which ESPN owns a 50% equity interest, has an agreement for global programming rights to International Cricket Council events from 2007 through 2015. Under the terms of the agreement, ESPN and the other joint-venture partner have jointly guaranteed the programming rights obligation of approximately $0.9 billion over the remaining term of the agreement.

Accounts Receivable Risk

In light of the recent turmoil in the domestic and global economy, our estimates and judgments with respect to the collectibility of our receivables have become subject to greater uncertainty than in more stable periods.

Income Taxes

During the nine months, the Company settled certain tax matters with various jurisdictions. As a result of these settlements, the Company reduced its unrecognized tax benefits by $164 million.

During the nine months, the Company recorded a $72 million charge related to the health care reform legislation enacted in March 2010. Under this legislation the Company’s deductions for retiree prescription drug benefits will be reduced by the amount of Medicare Part D drug subsidies received beginning in fiscal year 2014. Under applicable accounting rules, the Company is required in the period of enactment to reduce its existing deferred tax asset, which was established for the future deductibility of retiree prescription drug benefit costs, to reflect the lost deductions.

In the next twelve months, it is reasonably possible that our unrecognized tax benefits could change due to payments for or resolution of open tax matters for post-2004 years. These resolutions and payments would reduce our unrecognized tax benefits by $43 million.

 

12.   New Accounting Pronouncements

Revenue Arrangements with Multiple Deliverables

In October 2009, the Financial Accounting Standards Board (FASB) issued guidance on revenue arrangements with multiple deliverables effective for the Company’s 2011 fiscal year. The guidance revises the criteria for separating, measuring, and allocating arrangement consideration to each deliverable in a multiple element arrangement. The guidance requires companies to allocate revenue using the relative selling price of each deliverable, which must be estimated if the Company does not have a history of selling the deliverable on a stand-alone basis or third-party evidence of selling price. The Company does not expect the adoption of this guidance to have a material impact on its financial statements.

Variable Interest Entities

In June 2009, the FASB issued guidance to revise the approach to determine when a variable interest entity (VIE) should be consolidated. The new consolidation model for VIEs considers whether an entity has the power to direct the activities that most significantly impact the VIE’s economic performance and shares in the significant risks and rewards of the entity. The guidance on VIE’s requires companies to continually reassess VIEs to determine if consolidation is appropriate and provide additional disclosures. The guidance is effective for the Company’s 2011 fiscal year. The Company is assessing the potential effect this guidance will have on its financial statements.

 

16


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

Collaborative Arrangements

In December 2007, the FASB issued guidance that defines collaborative arrangements and establishes accounting and reporting requirements for such arrangements. A collaborative arrangement is a contractual arrangement that involves a joint operating activity, for example an agreement to co-produce and distribute a motion picture with another studio. The Company adopted the provisions of this collaborative arrangement guidance at the beginning of fiscal year 2010. The adoption did not have a material impact on the Company’s financial statements.

Business Combinations

In December 2007, the FASB issued guidance that establishes principles and requirements for determining how a company recognizes and measures the fair value of certain assets and liabilities acquired in a business combination, including noncontrolling interests, contingent consideration, and certain acquired contingencies. The guidance on business combinations also requires acquisition-related transaction expenses and restructuring costs be expensed as incurred rather than capitalized. The Company adopted the provisions of this business combination guidance and applied the guidance prospectively beginning fiscal year 2010.

Noncontrolling Interests

In December 2007, the FASB issued guidance on the accounting and reporting for a noncontrolling interest in a subsidiary which requires that noncontrolling interests be reported as a separate component of shareholders’ equity and that net income attributable to the noncontrolling interests and net income attributable to the shareholders of the Company be presented separately in the consolidated statement of income. The Company adopted the provisions of this noncontrolling interest guidance at the beginning of fiscal year 2010.

 

13.   Fair Value Measurements

Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified in the following categories:

 

   

Level 1 – Quoted prices for identical instruments in active markets

 

   

Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets

 

   

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable

 

17


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

The Company’s assets and liabilities measured at fair value on a recurring basis as of July 3, 2010 are summarized in the following table:

 

         Level 1            Level 2            Level 3            Total    

Assets

           

Investments

     $     39          $ 43          $ 2          $ 84    

Derivatives (1)

           

Interest rate

     —          199          —          199    

Foreign exchange

     —          594          —          594    

Residual Interests

     —          —          54          54    

Liabilities

           

Derivatives (1)

           

Interest rate

     —          (19)         —          (19)   

Foreign exchange

     —          (445)         —          (445)   

Other derivatives

     —          (1)         —          (1)   

Other

     —          —          (1)         (1)   
                           

Total

     $ 39          $     371          $     55          $     465    
                           

 

(1)

The Company has a master netting arrangement by counterparty with respect to certain derivative contracts. Contracts in a liability position totaling $257 million have been netted against contracts in an asset position in the July 3, 2010 Condensed Consolidated Balance Sheet

The fair value of Level 2 investments is primarily determined by reference to market prices based on recent trading activity and other relevant information including pricing for similar securities as determined by third-party pricing services.

The fair values of Level 2 derivatives, which consist of interest rate and foreign currency hedges, are primarily determined based on the present value of future cash flows using internal models that use observable inputs, such as interest rates, yield curves and foreign currency exchange rates. Counterparty credit risk, which is mitigated by master netting agreements and collateral posting arrangements with certain counterparties, did not have a material impact on derivative fair value estimates.

Level 3 residual interests consist of our residual interests in securitized vacation ownership mortgage receivables and are valued using a discounted cash flow model that considers estimated interest rates, discount rates, prepayment, and defaults. There were no material changes in the residual interests in the first nine months of fiscal 2010.

Transfers of Financial Assets

Through December 4, 2008, the Company sold mortgage receivables arising from sales of its vacation ownership units under a facility that expired on December 4, 2008 and was not renewed. The Company sold $17 million of mortgage receivables during the three months ended December 27, 2008 which resulted in immaterial gains.

The Company continues to service the sold receivables and has a residual interest in those receivables. As of July 3, 2010, the outstanding principal amount for sold mortgage receivables was $331 million, and the carrying value of the Company’s residual interest, which is recorded in other long-term assets, was $54 million.

The Company repurchases defaulted and certain delinquent mortgage receivables at their outstanding balance. The Company did not make material repurchases in the nine months ended July 3, 2010 or June 27, 2009. The Company generally has been able to sell the repurchased vacation ownership units for amounts that exceed the amounts at which they were repurchased.

 

18


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

The Company also provides credit support for up to 70% of the outstanding balance of the sold mortgage receivables which the mortgage receivable acquirer may draw on in the event of losses under the facility. The Company maintains a reserve for estimated credit losses related to these receivables.

Fair Value of Financial Instruments

In addition to the financial instruments listed above, the Company’s financial instruments also include cash, cash equivalents, receivables, accounts payable and borrowings.

The fair values of cash and cash equivalents, receivables and accounts payable approximated the carrying values. The estimated fair values of other financial instruments subject to fair value disclosures, determined based on broker quotes or quoted market prices or interest rates for the same or similar instruments, and the related carrying amounts are as follows:

 

     July 3, 2010    October 3, 2009

Asset/(Liability)

       Carrying    
Amount
       Fair    
Value
       Carrying    
Amount
       Fair    
Value

Investments

     $            84        $            84        $            78        $            78    

Borrowings

   (12,627)       (13,693)       (12,701)       (12,643)   

Derivatives

   328        328        252        252    

 

14.   Derivative Instruments

The Company manages its exposure to various risks relating to its ongoing business operations according to a risk management policy. The primary risks managed with derivative instruments are interest rate risk and foreign exchange risk.

The following table summarizes the fair value of the Company’s derivative positions as of July 3, 2010:

 

         Current    
Assets
       Other    
Assets
   Other
Accrued
    Liabilities    
   Other
    Long-Term    
Liabilities

Derivatives designated as hedges

           

Foreign exchange

     $     287          $ 92          $     (261)        $     (92)   

Interest rate

     3          196          —          —    

Derivatives not designated as hedges

           

Foreign exchange

     84          131          (62)         (30)   

Interest rate

     —          —          —          (19)   

Other

     —          —          (1)         —    
                           

Gross fair value of derivatives

     374          419          (324)         (141)   

Counterparty netting

     (178)         (79)         179          78    
                           

Total Derivatives (1)

     $     196          $     340          $ (145)         $ (63)   
                           

 

19


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

The following table summarizes the fair value of the Company’s derivative positions as of October 3, 2009:

 

         Current    
Assets
       Other    
Assets
   Other
Accrued
    Liabilities    
   Other
    Long-Term    
Liabilities

Derivatives designated as hedges

           

Foreign exchange

     $ 84          $     111          $     (115)         $     (55)   

Interest rate

     4          186          —          —    

Derivatives not designated as hedges

           

Foreign exchange

     37          127          (70)         (37)   

Interest rate

     —          —          —          (18)   

Other

     —          —          (2)         —    
                           

Gross fair value of derivatives

     125          424          (187)         (110)   

Counterparty netting

     (98)         (72)         103          67    
                           

Total Derivatives (1)

     $ 27          $     352          $ (84)         $ (43)   
                           

 

(1)

Refer to Note 13 for further information on derivative fair values and counterparty netting.

Interest Rate Risk Management

The Company is exposed to the impact of interest rate changes primarily through its borrowing activities. The Company’s objective is to mitigate the impact of interest rate changes on earnings and cash flows and on the market value of its investments and borrowings. In accordance with its policy, the Company targets its fixed-rate debt as a percentage of its net debt between a minimum and maximum percentage. The Company typically uses pay-floating and pay-fixed interest rate swaps to facilitate its interest rate management activities.

The Company designates pay-floating interest rate swaps as fair value hedges of fixed-rate borrowings effectively converting fixed-rate borrowings to variable rate borrowings indexed to LIBOR. As of July 3, 2010 and October 3, 2009, the total notional amount of the Company’s pay-floating interest rate swaps was $1.5 billion and $1.6 billion, respectively. The following table summarizes adjustments related to fair value hedges included in net interest expense in the Consolidated Statements of Income.

 

     Quarter Ended    Nine Months Ended
       July 3,  
2010
     June 27,  
2009
     July 3,  
2010
     June 27,  
2009

Gain (loss) on interest rate swaps

     $ 49          $ (64)         $ 9           $ 80    

Gain (loss) on hedged borrowings

        (49)           64            (9)             (80)   

The Company may designate pay-fixed interest rate swaps as cash flow hedges of interest payments on floating-rate borrowings. Pay-fixed swaps effectively convert floating-rate borrowings to fixed-rate borrowings. The unrealized gain or losses from these cash flow hedges are deferred in accumulated other comprehensive income (AOCI) and recognized in interest expense as the interest payments occur. The Company did not have pay-fixed interest rate swaps that were designated as cash flow hedges of interest payments at July 3, 2010 nor at October 3, 2009.

Foreign Exchange Risk Management

The Company transacts business globally and is subject to risks associated with changing foreign currency exchange rates. The Company’s objective is to reduce earnings and cash flow fluctuations associated with foreign currency exchange rate changes, enabling management to focus on core business issues and challenges.

 

20


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

The Company enters into option and forward contracts that change in value as foreign currency exchange rates change to protect the value of its existing foreign currency assets, liabilities, firm commitments and forecasted but not firmly committed foreign currency transactions. In accordance with policy, the Company hedges its forecasted foreign currency transactions for periods generally not to exceed five years within an established minimum and maximum range of annual exposure. The gains and losses on these contracts offset changes in the U.S. dollar equivalent value of the related forecasted transaction, asset, liability or firm commitment. The principal currencies hedged are the Euro, British pound, Japanese yen and Canadian dollar. Cross-currency swaps are used to effectively convert foreign currency-denominated borrowings into U.S. dollar denominated borrowings.

The Company designates foreign exchange forward and option contracts as cash flow hedges of firmly committed and forecasted foreign currency transactions. As of July 3, 2010 and October 3, 2009, the notional amount of the Company’s net foreign exchange cash flow hedges was $2.7 billion and $2.8 billion, respectively. Mark to market gains and losses on these contracts are deferred in AOCI and are recognized in earnings when the hedged transactions occur, offsetting changes in the value of the foreign currency transactions. Gains and losses recognized related to ineffectiveness for the nine months ended July 3, 2010 and June 27, 2009 were not material. The following table summarizes adjustments to AOCI for foreign exchange cash flow hedges.

 

     Quarter Ended    Nine Months Ended
       July 3,  
2010
     June 27,  
2009
     July 3,  
2010
   June 27,
2009

Gain (loss) recorded in AOCI

     $ (20)         $ (118)         $ (27)         $ 230    

Reclassification of (gains) losses from AOCI into revenues and costs and expenses

       (22)           (59)           12            (195)   
                           

Net change in AOCI

     $ (42)         $ (177)         $ (15)         $ 35    
                           

Foreign exchange risk management contracts with respect to foreign currency assets and liabilities are not designated as hedges and do not qualify for hedge accounting. The notional amount of these foreign exchange contracts at July 3, 2010 and October 3, 2009 was $2.5 billion and $2.1 billion, respectively. For the nine months ended July 3, 2010, the impact to net income from these foreign exchange contracts, net of the related exposure, was not material.

Commodity Price Risk Management

The Company is subject to the volatility of commodities prices and designates certain commodity forward contracts as cash flow hedges of forecasted commodity purchases. Mark to market gains and losses on these contracts are deferred in AOCI and are recognized in earnings when the hedged transactions occur, offsetting changes in the value of commodity purchases. The fair value of the commodity hedging contracts was not material at July 3, 2010.

Risk Management – Derivatives Not Designated as Hedges

The Company enters into certain other risk management contracts that are not designated as hedges and do not quality for hedge accounting. These contracts, which include pay fixed interest rate swaps and certain commodity swap contracts, are intended to offset economic exposures of the Company and are carried at market value with any changes in value recorded in earnings.

The notional amount of these contracts at July 3, 2010 and October 3, 2009 was $226 million and $253 million, respectively. For the nine months ended July 3, 2010, the impact to net income from these risk management contracts was not material.

 

21


THE WALT DISNEY COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

Contingent Features

The Company’s derivative financial instruments may require the Company to post collateral in the event that a net liability position with a counterparty exceeds limits defined by contract and varying with Disney’s credit rating. If the Company’s credit ratings were to fall below investment grade, certain counterparties would have the right to terminate our derivative contracts, which could lead to a net payment to or from the Company for the aggregate net value by counterparty of our derivative contracts. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position by counterparty on July 3, 2010 and October 3, 2009 were $208 million and $125 million, respectively.

 

15.   Restructuring and Impairment Charges

The Company recorded $212 million of restructuring and impairment charges in the current nine months related to organizational and cost structure initiatives primarily at our Studio Entertainment and Media Networks segments. Impairment charges of $126 million, of which $30 million were recorded in the current quarter, consisted of write-offs of capitalized costs primarily related to abandoned film projects, the closure of a studio production facility and the closure of five ESPN Zone locations. Restructuring charges of $86 million, of which $6 million were recorded in the current quarter, were primarily severance and other costs.

In the prior-year nine months, the Company recorded $326 million of restructuring and impairment charges which included non-cash impairment charges of $206 million and restructuring costs of $120 million, of which $21 million was recorded in the prior-year third quarter. The most significant of the impairment charges were $108 million related to radio FCC licenses and $49 million related to our investment in UTV Group. The restructuring charges consisted of severance and other costs as a result of various organizational and cost structure initiatives across our businesses, primarily at the Parks and Resorts and Media Networks segments.

 

16.   Subsequent Events

On July 27, 2010, the Company entered into an agreement to acquire all the outstanding shares of Playdom, Inc. (Playdom), a company that develops online social games. Playdom shareholders will receive total consideration of approximately $563 million, subject to certain conditions, and additional consideration of up to $200 million that may be paid if Playdom achieves predefined revenues and earnings targets for the calendar year ended 2012. The transaction is subject to customary closing conditions and is expected to close in fiscal 2010. A portion of the acquisition cost will be recognized as post-close compensation expense.

On July 29, 2010, the Company entered into an agreement to sell the majority of the assets of the Miramax business (Miramax) for $663 million, subject to closing conditions and adjustments. The Miramax assets along with $232 million of allocable goodwill have been classified as held for sale and reported in “Other Assets” in the fiscal 2010 Condensed Consolidated Balance Sheet. The transaction is expected to close by the end of calendar 2010.

 

22


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

ORGANIZATION OF INFORMATION

Management’s Discussion and Analysis provides a narrative of the Company’s financial performance and condition that should be read in conjunction with the accompanying financial statements. It includes the following sections:

Overview

Seasonality

Business Segment Results

Quarter Results

Nine-month Results

Other Financial Information

Financial Condition

Commitments and Contingencies

Other Matters

Market Risk

OVERVIEW

Our summary consolidated results are presented below:

 

     Quarter Ended         Nine months Ended     
(in millions, except per share data)      July 3,  
2010
     June 27,  
2009
     % Change  
Better/
(Worse)
     July 3,  
2010
     June 27,  
2009
     % Change  
Better/
(Worse)

Revenues

     $ 10,002           $ 8,596         16   %          $ 28,321           $ 26,282         8   %    

Costs and expenses

     (7,723)          (6,998)        (10)  %          (23,116)          (22,180)        (4)  %    

Restructuring and impairment charges

     (36)          (21)        (71)  %          (212)          (326)        35   %    

Other income

     43           —           nm                140           114         23   %    

Net interest expense

     (89)          (75)        (19)  %          (322)          (342)        6   %    

Equity in the income of investees

     139           155         (10)  %          382           449         (15)  %    
                                 

Income before income taxes

     2,336           1,657         41   %          5,193           3,997         30   %    

Income taxes

     (831)          (626)        (33)  %          (1,846)          (1,462)        (26)  %    
                                 

Net income

     1,505           1,031         46   %          3,347           2,535         32   %    

Less: Net income attributable to noncontrolling interests

     (174)          (77)        nm                (219)          (123)        (78)  %    
                                 

Net income attributable to Disney

     $ 1,331           $ 954         40   %          $ 3,128           $ 2,412         30   %    
                                 

Diluted earnings per share

     $ 0.67           $ 0.51         31   %          $ 1.60           $ 1.29         24   %    
                                 

Quarter Results

Diluted earnings per share (EPS) increased 31% for the quarter driven by improved operating results. Improved operating results reflected increased fees (Affiliate Fees) from Multi-channel Video Service Providers (MVSP), including a benefit from earlier recognition of previously deferred revenue, and higher advertising revenues at ESPN, the strong worldwide theatrical performance of Toy Story 3, Alice in Wonderland and Iron Man 2, increased guest spending at our domestic and international parks and resorts and cost improvements in our home entertainment business. These increases were partially offset by higher costs, decreased attendance and lower hotel occupancy at our domestic parks and resorts, higher programming and production costs for the World Cup and a new UK channel at ESPN, and higher film cost write-downs.

 

23


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Nine-month Results

Diluted earnings per share (EPS) increased 24% for the nine months driven by improved operating results and an aggregate $0.05 per share net year-over-year favorable impact from lower restructuring and impairment charges and other income as discussed in the following paragraph. Improved operating results reflected higher Affiliate Fees, including a benefit from earlier recognition of previously deferred revenue, and higher advertising revenues at ESPN, the strong worldwide theatrical performance of Alice in Wonderland, Toy Story 3 and Iron Man 2, cost improvements in our home entertainment business and increased guest spending at our domestic and international parks. These increases were partially offset by higher programming and production costs at ESPN, including costs for our new UK channel, and higher costs at our domestic parks.

The current nine months included restructuring and impairment charges, gains on the sales of investments in two television services in Europe, a gain on the sale of the rights and assets related to the Power Rangers property and an accounting gain related to the acquisition of The Disney Store Japan, which together had a $0.02 negative impact on EPS. The prior year nine months included restructuring and impairment charges and a gain on the sale of an investment in two pay television services in Latin America which together had a $0.07 negative impact on EPS.

SEASONALITY

The Company’s businesses are subject to the effects of seasonality. Consequently, the operating results for the quarter and nine months ended July 3, 2010 for each business segment, and for the Company as a whole, are not necessarily indicative of results to be expected for the full year.

Media Networks revenues are subject to seasonal advertising patterns and changes in viewership levels. In general, advertising revenues are 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 Company’s fiscal year which generally results in higher revenue recognition during that period.

Parks and Resorts revenues fluctuate with changes in theme park attendance and resort occupancy resulting from the seasonal nature of vacation travel and leisure activities. Peak attendance and resort occupancy generally occur during the summer months when school vacations occur and during early-winter and spring-holiday periods.

Studio Entertainment revenues 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.

Consumer Products revenues are influenced by seasonal consumer purchasing behavior, which generally results in increased revenues during the Company’s first fiscal quarter, and by the timing and performance of theatrical releases and cable programming broadcasts.

Interactive Media revenues fluctuate due to the timing and performance of video game releases which are determined by several factors, including theatrical releases and cable programming broadcasts, competition and the timing of holiday periods. Revenues from certain of our internet and mobile operations are subject to similar seasonal trends.

 

24


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

BUSINESS SEGMENT RESULTS

The Company evaluates the performance of its operating segments based on segment operating income, which is shown below along with segment revenues:

 

     Quarter Ended         Nine months Ended     
(in millions)      July 3,  
2010
     June 27,  
2009
     %Change  
Better/
(Worse)
     July 3,  
2010
     June 27,  
2009
     %Change  
Better/
(Worse)

Revenues:

                 

Media Networks

     $     4,729           $     3,961         19   %          $     12,748           $ 11,484         11   %    

Parks and Resorts

     2,831           2,751         3   %          7,942           7,823         2   %    

Studio Entertainment

     1,639           1,261         30   %          5,110           4,641         10   %    

Consumer Products

     606           510         19   %          1,948           1,779         9   %    

Interactive Media

     197           113         74   %          573           555         3   %    
                                 
     $ 10,002           $ 8,596         16   %          $ 28,321           $ 26,282         8   %    
                                 

Segment operating income (loss):

                 

Media Networks

     $ 1,885           $ 1,319         43   %          $ 3,915           $ 3,280         19   %    

Parks and Resorts

     477           521        (8)  %          1,002           1,074         (7)  %    

Studio Entertainment

     123           (12)        nm                 589           188         nm           

Consumer Products

     117           96         22   %          493           458         8   %    

Interactive Media

     (65)          (75)        13   %          (130)          (181)        28   %    
                                 
     $ 2,537           $ 1,849         37   %          $ 5,869           $ 4,819         22   %    
                                 

The following table reconciles segment operating income to income before income taxes:

 

     Quarter Ended         Nine months Ended     
(in millions)      July 3,  
2010
     June 27,  
2009
     %Change  
Better/
(Worse)
       July 3,    
2010
     June 27,  
2009
     %Change  
Better/
(Worse)

Segment operating income

     $     2,537           $   1,849         37   %          $ 5,869           $     4,819         22   %    

Corporate and unallocated shared expenses

     (119)          (96)        (24)  %          (282)          (268)        (5)  %    

Restructuring and impairment charges

     (36)          (21)        (71)  %          (212)          (326)        35   %    

Other income

     43           —         nm                 140           114         23   %    

Net interest expense

     (89)          (75)        (19)  %          (322)          (342)        6   %    
                                 

Income before income taxes

     $ 2,336           $ 1,657         41   %          $ 5,193           $ 3,997         30   %    
                                 

 

25


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Depreciation expense is as follows:

 

     Quarter Ended      % Change      Nine months Ended      % Change  
(in millions)      July 3,  
2010
     June 27,  
2009
   Better/
(Worse)
     July 3,  
2010
     June 27,  
2009
   Better/
(Worse)

Media Networks

                 

Cable Networks

     $     29          $     26        (12)  %          $ 87          $ 82        (6)  %    

Broadcasting

     23          22        (5)  %          71          66        (8)  %    
                                 

Total Media Networks

     52          48        (8)  %          158          148        (7)  %    
                                 

Parks and Resorts

                 

Domestic

     205          200        (3)  %          614          606        (1)  %    

International

     78          83        6   %          249          239        (4)  %    
                                 

Total Parks and Resorts

     283          283        —   %          863          845        (2)  %    
                                 

Studio Entertainment

     14          12        (17)  %          42          36        (17)  %    

Consumer Products

     8          8        —   %          22          21        (5)  %    

Interactive Media

     3          7        57  %          16          20        20   %    

Corporate

     39          32        (22)  %          103          96        (7)  %    
                                 

Total depreciation expense

       $ 399            $ 390        (2)  %          $ 1,204          $ 1,166        (3)  %    
                                 

Media Networks

The following table provides supplemental revenue and segment operating income detail for the Media Networks segment:

 

     Quarter Ended      % Change      Nine months Ended      % Change  
(in millions)        July 3,    
2010
       June 27,    
2009
   Better/
(Worse)
       July 3,    
2010
       June 27,    
2009
   Better/
(Worse)

Revenues:

                 

Cable Networks

     $ 3,280          $ 2,563        28   %          $ 8,346          $ 7,219        16   %    

Broadcasting

     1,449          1,398        4   %          4,402          4,265        3   %    
                                 
     $ 4,729          $ 3,961        19   %          $ 12,748          $ 11,484        11   %    
                                 

Segment operating income:

                 

Cable Networks

     $ 1,676          $ 1,115        50   %          $ 3,403          $ 2,776        23   %    

Broadcasting

     209          204        2   %          512          504        2   %    
                                 
     $ 1,885          $ 1,319        43   %          $ 3,915          $ 3,280        19   %    
                                 

Revenues

Media Networks revenues increased 19%, or $768 million, to $4.7 billion, consisting of a 28% increase, or $717 million, at the Cable Networks and a 4% increase, or $51 million, at Broadcasting.

Cable Networks revenues reflected increases of $573 million from Affiliate Fees and $180 million from advertising revenues. The increase in Affiliate Fees was primarily due to an increase at ESPN and, to a lesser extent, at the worldwide Disney Channels. The increase at ESPN was primarily due to earlier recognition of previously deferred revenues related to annual programming commitments. During the quarter, ESPN recognized a net $344 million of previously deferred revenue compared to a net deferral of $37 million in the prior-year quarter. In addition to the timing of deferred revenue recognition, higher Affiliate Fees at ESPN reflected contractual rate increases and subscriber growth, which was driven by the launch of a new network in the United Kingdom. The increase at the worldwide Disney Channels reflected higher contractual rates and subscriber growth. Higher advertising revenue was primarily due to higher sold inventory and higher rates at ESPN and to a lesser extent, an increase at the international Disney Channel.

 

26


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Increased Broadcasting revenues were primarily due to higher advertising revenues at the owned television stations and higher revenues from ABC Studios Productions driven by international sales of Castle, Lost and Ghost Whisperer and increased third party network license fees for Criminal Minds. Advertising revenues at the ABC Television Network were comparable to the prior-year quarter as a decrease in sold inventory and lower ratings were offset by higher rates.

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 7%, or $186 million, to $3.0 billion, consisting of a 9% increase, or $139 million, at the Cable Networks and a 4% increase, or $47 million, at Broadcasting. The increase at Cable Networks was driven by higher programming and production costs at ESPN reflecting coverage of the World Cup and ESPN’s new network in the United Kingdom. The increase at Broadcasting reflected higher programming costs at the ABC Television Network driven by programming write offs, unfavorable foreign currency impacts at our television distribution business, higher production cost amortization related to international sales of ABC Studios productions and higher pension and post-retirement medical expense.

Segment Operating Income

Segment operating income increased 43%, or $566 million, to $1.9 billion, consisting of a 50% increase, or $561 million, at the Cable Networks and a 2% increase, or $5 million, at Broadcasting. The increase at the Cable Networks was primarily due to an increase at ESPN and to a lesser extent, at the worldwide Disney Channels. The increase at Broadcasting was primarily due to growth at the owned television stations and higher revenues from ABC Studios productions, largely offset by higher costs.

Restructuring and impairment charges

The Company recorded charges totaling $34 million and $18 million for the current quarter and prior-year quarter, respectively. The charges in the current quarter were for the closure of five ESPN Zone locations, while the charges in the prior-year quarter were primarily due to severance and related costs. The charges were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Parks and Resorts

Revenues

Parks and Resorts revenues increased 3%, or $80 million, to $2.8 billion due to an increase of $97 million at our international operations, partially offset by a $17 million decrease at our domestic operations.

 

27


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

The following table presents attendance, per capita theme park guest spending and hotel statistics for our domestic properties:

 

     East Coast    West Coast    Total Domestic
     Quarter Ended    Quarter Ended    Quarter Ended
         July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Parks

                 

(Increase/decrease)

                 

Attendance

     (2)  %          —                 (4)  %          10  %          (3)  %          3   %    

Per Capita Guest Spending

     3   %          (4)  %          8   %          (8)  %          5   %          (6)  %    

Hotels (1)

                 

Occupancy

     83   %          91   %          80   %          83             82   %          91   %    

Available Room Nights (in thousands)

     2,193                 2,143                 220                 200                 2,413                 2,343          

Per Room Guest Spending

       $ 223                   $ 214                   $ 301                   $ 308                   $ 230                   $ 221          

 

(1)

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. Hotel statistics include rentals of Disney Vacation Club units.

Increased revenues at our international operations reflected the sale of a real estate property and higher guest spending, hotel occupancy and attendance at Disneyland Paris along with increased attendance, guest spending and hotel occupancy at Hong Kong Disneyland Resort. These increases were partially offset by a decrease at Disneyland Paris reflecting the unfavorable impact of foreign currency translation as a result of the strengthening of the U.S. dollar against the Euro.

At our domestic operations, decreased revenues reflected lower attendance and hotel occupancy at our parks and resorts and fewer passenger cruise days at Disney Cruise Line, partially offset by higher guest spending at our parks and resorts. Decreased attendance in part reflected an unfavorable impact due to a shift in the timing of the Easter holiday period relative to our fiscal periods. Higher guest spending was primarily due to higher average ticket prices.

Costs and Expenses

Costs and expenses, which consist primarily of labor, depreciation, costs of merchandise, food and beverage sold, marketing and sales expense, repairs and maintenance and entertainment, increased 6%, or $124 million, to $2.4 billion. Higher costs were driven by increases at the domestic parks and resorts and Disney Cruise Line. The increase at our domestic parks and resorts reflected labor cost inflation, higher pension and post-retirement medical expenses and costs for new guest offerings, including World of Color at Disneyland Resort, partially offset by lower volume-related costs. The increase at Disney Cruise Line was due to increased operating costs to support the fleet expansion and higher fuel costs. Costs and expenses at Disneyland Paris were flat as costs associated with the sale of a real estate property were essentially offset by the favorable impact of foreign currency translation as a result of the strengthening of the U.S. dollar against the Euro.

Segment Operating Income

Segment operating income decreased 8% to $477 million primarily due to decreases at the domestic parks and Disney Cruise Line, partially offset by improvements at the international operations.

 

28


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Restructuring and impairment charges

The Company recorded charges totaling $2 million in the prior-year quarter for severance and related costs which were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Studio Entertainment

Revenues

Revenues for the quarter increased 30%, or $378 million, to $1.6 billion primarily due to increases of $362 million in worldwide theatrical distribution, including our participation in Iron Man 2, and $47 million in worldwide television distribution.

The revenue growth in worldwide theatrical distribution was primarily due to the strong performance of Toy Story 3, Alice in Wonderland and Iron Man 2. The prior-year quarter included Up, Hannah Montana: The Movie and The Proposal. The increase in worldwide television distribution was driven by the timing of titles available in international markets.

Costs and Expenses

Costs and expenses, which consist primarily of production cost amortization, distribution and marketing expenses, product costs and participation costs, increased 19%, or $243 million, primarily due to an increase in worldwide theatrical distribution and higher film cost write-downs, partially offset by a decrease in domestic home entertainment.

The increase in worldwide theatrical distribution was primarily due to higher production cost amortization, driven by Prince of Persia: The Sands of Time and Iron Man 2, and higher participation costs driven by Alice in Wonderland.

Lower costs and expenses in domestic home entertainment were primarily due to a lower production cost amortization rate and lower distribution and marketing expense resulting from cost reduction initiatives. Key releases included Alice in Wonderland in the current quarter versus Bedtime Stories, Bolt and Confessions of a Shopaholic in the prior-year quarter.

Segment Operating Income

Segment operating income increased $135 million to $123 million due to the strong worldwide theatrical performance of Toy Story 3, Alice in Wonderland and Iron Man 2 and increases at domestic home entertainment and worldwide television distribution, partially offset by higher film cost write-downs.

Restructuring and impairment charges

The Company recorded charges totaling $5 million in the current quarter for severance and related costs which were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Consumer Products

Revenues

Revenues for the quarter increased 19%, or $96 million, to $606 million, driven by increases of $43 million at Publishing, $32 million at Retail, and $18 million at Merchandise Licensing.

 

29


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

The increase at Publishing was driven by the acquisition of Marvel and the success of The Red Pyramid and Percy Jackson titles. Higher revenues at Retail were due to the acquisition of The Disney Store Japan (see discussion of The Disney Store Japan acquisition below). Merchandise Licensing revenue growth was driven by the strong performance of Toy Story and sales of Marvel merchandise, partially offset by a higher revenue share with the Studio Entertainment segment. The increase in revenue share with the Studio Entertainment segment in the current quarter was primarily due to growth from Toy Story merchandise.

Costs and Expenses

Costs and expenses, which consist primarily of cost of sales, salaries and benefits, marketing, and occupancy, increased 18%, or $75 million, primarily due to increases at Publishing, Retail, and Merchandise Licensing. The increase at Publishing was primarily due to cost of sales associated with Marvel products. At Retail, higher operating costs were due to the acquisition of The Disney Store Japan, partially offset by decreased cost of sales at The Disney Store North America reflecting global procurement efficiencies. The increase at Merchandise Licensing was primarily due to operating costs and intangible asset amortization associated with Marvel.

Operating Income

Segment operating income increased 22%, or $21 million, to $117 million, primarily due to improvement at Retail driven by The Disney Store North America and growth at Publishing.

Restructuring and impairment charges

The Company recorded charges totaling $1 million in the prior-year quarter for severance and related costs which were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

The Disney Store Japan Acquisition

On March 31, 2010, the Company acquired all of the outstanding shares of Retail Networks Company Limited (The Disney Store Japan) in exchange for a $17 million note. At the time of the acquisition, The Disney Store Japan had a cash balance of $13 million. In connection with the acquisition in the second quarter of the current year, the Company recognized a $22 million non-cash gain from the deemed termination of the existing licensing arrangement. The gain is reported in “Other income” in the fiscal 2010 Condensed Consolidated Statement of Income.

Interactive Media

Revenues

Interactive Media revenues for the quarter increased 74%, or $84 million, to $197 million primarily due to increases of $64 million at Disney Interactive Studios and $10 million at Disney Online driven by increased Club Penguin subscription revenues.

At Disney Interactive Studios, the revenue growth was primarily due to higher sales of self-published video games in the current quarter. Significant current quarter releases included Toy Story 3 and Split Second while the prior-year quarter included Hannah Montana.

Costs and Expenses

Costs and expenses, which consist primarily of video game and internet product development costs, cost of sales, distribution and marketing expenses, general and administrative costs, and technology infrastructure costs, increased 39%, or $74 million, to $262 million driven by increases at Disney Interactive Studios and Disney Online.

 

30


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

The increase at Disney Interactive Studios was primarily due to higher sales and marketing expenses driven by more new releases in the current quarter primarily Toy Story 3 and Split Second, higher cost of sales driven by increased unit sales, and higher product development costs. These increases were partially offset by lower per unit video game cost of sales for catalog titles that had previously been written down to net realizable value. Higher costs and expenses at Disney Online were primarily due to increased cost of sales at Club Penguin and higher product development costs.

Operating Loss

Segment operating loss decreased 13% to $65 million due to an improvement at Disney Interactive Studios.

BUSINESS SEGMENT RESULTS – Nine Month Results

Media Networks

Revenues

Media Networks revenues increased 11%, or $1.3 billion, to $12.7 billion, consisting of a 16% increase, or $1.1 billion, at the Cable Networks and a 3% increase, or $137 million, at Broadcasting.

Increased Cable Networks revenues were primarily due to growth of $915 million from Affiliate Fees and $260 million from advertising revenues. The increase in Affiliate Fees was primarily due to increases at ESPN resulting from earlier recognition of previously deferred revenues related to annual programming commitments, higher contractual rates and subscriber growth, including growth from the launch of a new network in the United Kingdom and, to a lesser extent, at the worldwide Disney Channels due to rate increases domestically and subscriber growth internationally. During the nine months, ESPN deferred a net $166 million of revenue compared to a net $532 million in the prior-year period. Higher advertising revenue was due to an increase at ESPN driven by higher sold inventory.

Increased Broadcasting revenues were primarily due to higher revenues from ABC Studios productions driven by increased international sales led by Castle, Lost and Ghost Whisperer, higher third party network license fees for Criminal Minds and increased advertising revenue. Higher advertising revenue reflected an increase at the owned television stations and higher sports advertising revenues due to the college Bowl Championship Series (BCS) national championship game, which was not broadcast by ABC in the prior year, partially offset by lower primetime advertising revenues at the ABC Television Network. The decrease in primetime advertising revenue was driven by lower ratings, partially offset by higher rates.

Costs and Expenses

Costs and expenses increased 7%, or $573 million, to $9.2 billion, consisting of a 9% increase, or $443 million, at the Cable Networks and a 3% increase, or $131 million, at Broadcasting. The increase at Cable Networks was driven by higher rights and production costs at ESPN due to programming costs for the new network in the United Kingdom, increased contractual costs for college basketball, college football and NFL programming, and soccer programming rights for the World Cup. The increase at Broadcasting reflected higher production cost amortization driven by increased sales of ABC Studios productions and an increase in programming costs at the ABC Television Network, including costs for the BCS national championship game. These increases were partially offset by the absence of a bad debt charge which was recorded in the prior year in connection with the bankruptcy of a syndication customer.

 

31


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Segment Operating Income

Segment operating income increased 19% to $3.9 billion due to increases of $627 million at Cable Networks and $8 million at Broadcasting. The increase at the Cable Networks was primarily due to an increase at ESPN. The increase at Broadcasting was primarily due the absence of a bad debt charge which was recorded in the prior year in connection with the bankruptcy of a syndication customer and higher advertising revenue at the owned television stations, partially offset by decreased primetime advertising revenue at the ABC Television Network.

Restructuring and impairment charges

The Company recorded charges totaling $78 million and $226 million for the current and prior year nine-month periods, respectively. The charges in the current nine-month period were for severance and related costs and the closure of five ESPN Zone locations, while the charges in the prior-year nine-month period were primarily due to $108 million of radio FCC license impairments and $46 million of impairment related to our investment in UTV Group. These charges were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Parks and Resorts

Revenues

Parks and Resorts revenues increased 2%, or $119 million, to $7.9 billion due to an increase at our international operations. Revenues at our domestic operations were essentially flat.

The following table presents attendance, per capita theme park guest spending, and hotel statistics for our domestic properties:

 

     East Coast    West Coast    Total Domestic
     Nine months Ended    Nine months Ended    Nine months Ended
          July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009
       July 3,    
2010
       June 27,    
2009

Parks

                 

(Increase/decrease)

                 

Attendance

       (1)  %        (2)  %        4    %        2   %        1  %        (1)  %    

Per Capita Guest Spending

   1   %        (3)  %        3    %        (7)  %        2  %        (4)  %    

Hotels (1)

                 

Occupancy

   82   %        89   %        75    %        79%        81  %        88   %    

Available Room Nights (in thousands)

   6,555               6,390               659                599              7,214              6,989           

Per Room Guest Spending

       $    222               $    211                   $    302                    $    320                  $    229                  $    219           

 

(1)

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. Hotel statistics include rentals of Disney Vacation Club units.

Increased revenues at our international operations reflected the sale of a real estate property, the favorable impact of foreign currency translation as a result of the weakening of the U.S. dollar against the Euro and increased guest spending at Disneyland Paris along with increased guest spending and attendance at Hong Kong Disneyland Resort. These increases were partially offset by decreased attendance and occupied room nights at Disneyland Paris. Increased guest spending at Disneyland Paris and Hong Kong Disneyland Resort was driven by higher average ticket prices.

At our domestic operations, increased revenues from higher guest spending and attendance at our parks and resorts were largely offset by decreased occupied room nights at our resorts, and higher promotional activities and fewer passenger cruise days at Disney Cruise Line. Higher guest spending was primarily due to higher average ticket prices and daily hotel room rates, partially offset by lower merchandise spending.

 

32


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Costs and Expenses

Costs and expenses increased 3%, or $191 million, to $6.9 billion. Higher costs were driven by increases at the domestic parks and resorts, Disneyland Paris and Disney Cruise Line. The increase at our domestic parks and resorts reflected higher pension and post-retirement medical expenses, labor cost inflation, and costs for new guest offerings, including World of Color at Disneyland Resort. These increases were partially offset by savings from cost mitigation activities and lower volume-related expenses. The increase at Disney Cruise Line was due to higher marketing costs to support the fleet expansion. The increase at Disneyland Paris reflected the unfavorable impact of foreign currency translation as a result of the weakening of the U.S. dollar against the Euro and costs associated with the sale of a real estate property. The increase at Disney Cruise Line was due to higher operating costs to support the fleet expansion.

Segment Operating Income

Segment operating income decreased 7% to $1.0 billion driven by decreases at the domestic parks and Disney Cruise Line, partially offset by improved results at the international operations.

Restructuring and impairment charges

The Company recorded charges totaling $54 million in the prior-year nine-month period for severance and related costs which were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Studio Entertainment

Revenues

Revenues increased 10%, or $469 million, to $5.1 billion driven by an increase of $651 million in worldwide theatrical distribution, including our participation in Iron Man 2, partially offset by a decrease of $163 million in worldwide home entertainment.

The revenue growth in worldwide theatrical distribution was primarily due to the strong performance of current period titles. Significant current period titles included Alice in Wonderland and Iron Man 2 in domestic and international markets and Toy Story 3 domestically while the prior-year period included Up domestically.

The decrease in worldwide home entertainment was primarily due to lower net effective sales prices and decreased television series DVD unit sales internationally and a decline in unit sales of new releases domestically. Key current period titles included Up, Snow White Diamond Release and Tinker Bell And The Lost Treasure while the prior-year period included WALL-E, The Chronicles of Narnia: Prince Caspian and High School Musical 3: Senior Year.

Costs and Expenses

Costs and expenses were essentially flat at $4.5 billion as a decrease in worldwide home entertainment was offset by an increase in worldwide theatrical distribution and higher film cost write-downs.

Lower costs and expenses in worldwide home entertainment were primarily due to decreased distribution and marketing expenses resulting from cost reduction initiatives and lower unit sales. The increase in worldwide theatrical distribution was primarily due to higher production cost amortization driven by stronger performing titles including Alice in Wonderland and Iron Man 2, and higher participation costs driven by Alice in Wonderland in the current period.

 

33


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Segment Operating Income

Segment operating income increased $401 million to $589 million due to higher results in worldwide theatrical distribution and domestic home entertainment.

Restructuring and impairment charges

The Company recorded charges totaling $127 million for the current nine months and $2 million in the prior year nine-month period. The current-year nine month charges were primarily related to the write-off of capitalized costs related to abandoned film projects, the closure of a production facility and, severance and related costs which are reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Consumer Products

Revenues

Revenues for the nine months increased 9%, or $169 million, to $1.9 billion, primarily due to increases of $79 million at Publishing, $66 million at Retail, and $12 million at Merchandise Licensing.

The increase at Publishing was driven by the acquisition of Marvel and sales of Percy Jackson titles. Higher revenues at Retail were driven by the acquisition of the Disney Store Japan and higher comparable store sales at the Disney Store North America. Merchandise Licensing revenue growth was driven by the strong performance of Toy Story merchandise and revenues from Marvel properties, partially offset by a higher revenue share with the Studio Entertainment segment and lower performance of High School Musical and Hannah Montana merchandise.

Costs and Expenses

Costs and expenses increased 10%, or $134 million primarily due to higher cost of sales at Publishing driven by Marvel and an increase at Retail due to the acquisition of the Disney Store Japan and unfavorable foreign currency impacts in Europe.

Segment Operating Income

Segment operating income increased 8%, or $35 million, to $493 million, primarily due to increases at Retail and Publishing.

Restructuring and impairment charges

The Company recorded charges totaling $2 million in the current nine months and $9 million in the prior-year nine-month period for severance and related costs which were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

Interactive Media

Revenues

Interactive Media revenues for the nine months increased 3%, or $18 million, to $573 million reflecting an increase of $41 million at Disney Online, partially offset by a decrease of $34 million at Disney Interactive Studios.

The increase at Disney Online was driven by higher Club Penguin subscription revenues and increased advertising sales. At Disney Interactive Studios, the decrease was primarily due to a sales mix shift from new video game releases to catalog titles which have a lower sales price. Significant releases for the current nine months included Toy Story 3, Split Second and Sing It 2, while the prior year included High School Musical 3, Sing It, Bolt and Club Penguin.

 

34


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Costs and Expenses

Costs and expenses decreased 5%, or $36 million, to $703 million driven by a decrease at Disney Interactive Studios, partially offset by an increase at Disney Online driven by higher product development costs.

The decrease at Disney Interactive Studios was primarily due to lower cost of sales driven by a higher sales mix of lower cost catalog titles and an overall decrease in sales volume. Additionally, certain prior year titles had higher per unit costs due to bundled accessories.

Operating Loss

Segment operating loss decreased 28% to $130 million due to an improvement at Disney Interactive Studios.

Restructuring and impairment charges

The Company recorded charges totaling $29 million in the prior-year nine-month period primarily for goodwill impairment which was reported in “Restructuring and impairment charges” in the Consolidated Statements of Income.

OTHER FINANCIAL INFORMATION

Corporate and Unallocated Shared Expenses

Corporate and unallocated shared expenses are as follows:

 

      Quarter Ended   

    % Change    
Better/
(Worse)

   Nine months Ended        % Change    
Better/
(Worse)
(in millions)      July 3,  
2010
     June 27,  
2009
        July 3,  
2010
     June 27,  
2009
  

Corporate and unallocated shared expenses

     $ 119          $ 96        (24)  %          $ 282          $ 268        (5)  %    

The increase in corporate and unallocated shared expenses for the quarter was driven by higher compensation related costs.

Net Interest Expense

Net interest expense is as follows:

 

     Quarter Ended        % Change    
Better/
(Worse)
   Nine months Ended        % Change    
Better/
(Worse)
(in millions)      July 3,  
2010
     June 27,  
2009
        July 3,  
2010
     June 27,  
2009
  

Interest expense

     $ (103)          $ (134)        23   %          $ (368)          $ (452)        19   %    

Interest and investment income

     14           59         (76)  %          46           110         (58)  %    
                                 

Net interest expense

     $ (89)          $ (75)        (19)  %          $ (322)          $ (342)        6    %    
                                 

The decrease in interest expense for the quarter was primarily due to lower average debt balances. For the nine months, the decrease in interest expense reflected lower average debt balances and lower effective interest rates, partially offset by expense related to the early redemption of a film financing borrowing.

 

35


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

The decrease in interest and investment income for the quarter and nine months was primarily due to a gain on the sale of an investment in the prior-year third quarter. The nine months also decreased due to lower effective interest rates.

Income Taxes

The effective income tax rate is as follows:

 

     Quarter Ended        Change    
Better/
(Worse)
   Nine months Ended        Change    
Better/
(Worse)
       July 3,  
2010
     June 27,  
2009
        July 3,  
2010
     June 27,  
2009
  

Effective Income Tax Rate

     35.6  %          37.8  %          2.2  ppt          35.5  %        36.6  %          1.1  ppt    

The decrease in the effective income tax rate for the current-year quarter was driven by favorable adjustments related to certain prior-year income tax matters.

For the nine months, the decrease in the effective income tax rate was primarily due to favorable adjustments related to certain prior-year income tax matters, partially offset by a $72 million charge related to the health care reform legislation enacted in March 2010. Under this legislation the Company’s deductions for retiree prescription drug benefits will be reduced by the amount of Medicare Part D drug subsidies received beginning in fiscal year 2014. Under applicable accounting rules, the Company is required to reduce in the period of enactment its existing deferred tax asset, which was established for the future deductibility of retiree prescription drug benefit costs, to reflect the lost deductions.

Noncontrolling Interests

Net income attributable to noncontrolling interests is as follows:

 

     Quarter Ended        % Change    
Better/
(Worse)
   Nine months Ended        % Change    
Better/
(Worse)
(in millions)      July 3,  
2010
     June 27,  
2009
        July 3,  
2010
     June 27,  
2009
  

Net income attributable to noncontrolling interests

     $ 174          $ 77        (>100)  %          $ 219          $ 123        (78)  %    

The increase in net income attributable to noncontrolling interests for both the quarter and nine months was primarily due to higher operating results at ESPN. The net income attributable to noncontrolling interests is determined based on income after royalties, financing costs and income taxes.

 

36


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

FINANCIAL CONDITION

The change in cash and cash equivalents is as follows:

 

     Nine months Ended    Change
    Better/(Worse)    
(in millions)        July 3,    
2010
       June 27,    
2009
  

Cash provided by operations

     $ 4,372          $ 3,581       $ 791    

Cash used in investing activities

     (3,463)         (1,110)      (2,353)   

Cash used in financing activities

     (1,375)         (2,344)      969    
                    

(Decrease)/increase in cash and cash equivalents

     $ (466)           $ 127       $ (593)   
                    

Operating Activities

The increase in cash provided by operations was driven by higher segment operating results.

Film and Television Costs

The Company’s Studio Entertainment and Media Networks segments incur costs to acquire and produce film and television 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 Company’s broadcast and 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 Company’s film and television production and programming activity for the nine months ended July 3, 2010 and June 27, 2009 are as follows:

 

     Nine months Ended
(in millions)        July 3,    
2010
       June 27,    
2009

Beginning balances:

     

Production and programming assets

     $ 5,756          $ 5,935    

Programming liabilities

     (1,040)         (1,108)   
             
     4,716          4,827    
             

Spending:

     

Film and television production

     2,518          2,562    

Broadcast programming

     3,375          2,905    
             
     5,893          5,467    
             

Amortization:

     

Film and television production

     (2,710)         (2,414)   

Broadcast programming

     (3,214)         (2,773)   
             
     (5,924)         (5,187)   
             

Change in film and television production and programming costs

     (31)         280    

Other non-cash activity

     108          (129)   

Ending balances:

     

Production and programming assets

     5,556          5,872    

Programming liabilities

     (763)         (894)   
             
     $ 4,793          $ 4,978    
             

 

37


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Investing Activities

Cash used by investing activities during the nine months ended July 3, 2010 of $3.5 billion included $2.3 billion for the cash portion of the Marvel Entertainment, Inc. acquisition (see Note 3 to the Condensed Consolidated Financial Statements for further details) and $1.3 billion of investments in parks, resorts and other property, partially offset by proceeds totaling $170 million from the sales of investments in pay television services in Europe and the sale of the rights and assets related to the Power Rangers property.

During the nine months ended July 3, 2010 and June 27, 2009, investments in parks, resorts and other properties were as follows:

 

     Nine months Ended
(in millions)          July 3,      
2010
       June 27,    
2009

Media Networks

     

Cable Networks

     $ 60          $ 98    

Broadcasting

     52          87    
             

Total Media Networks

     112          185    
             

Parks and Resorts

     

Domestic

     851          674    

International

     148          75    
             

Total Parks and Resorts

     999          749    
             

Studio Entertainment

     65          110    

Consumer Products

     41          22    

Interactive Media

     13          15    

Corporate

     83          46    
             

Total investment in parks, resorts and other property

     $ 1,313          $ 1,127    
             

The increase in capital expenditures for the nine months reflected higher construction progress payments on two new cruise ships, the expansion at Disney’s California Adventure and Hong Kong Disneyland, and the construction of a Disney Vacation Club Resort in Hawaii, partially offset by the construction of broadcast and film production facilities in the prior-year nine month period.

Financing Activities

Cash used by financing activities during the nine months ended July 3, 2010 of $1.4 billion reflected repurchases of common stock and dividend payments, partially offset by proceeds from stock option exercises and net borrowings. The decrease in cash used in financing activities from the prior-year nine-month period was driven by higher proceeds from stock option exercises and net borrowings in the current nine months compared to a net reduction in borrowings and the purchase of additional interests in Jetix Europe N.V. (Jetix) in the prior-year period. These decreases were partially offset by higher repurchases of common stock.

 

38


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

During the nine months ended July 3, 2010, the Company’s borrowing activity was as follows:

 

         October 3,    
2009
       Additions            Payments        Other
    Activity    
       July 3,    
2010

Commercial paper borrowings

     $ —            $ 794          $ —           $ —           $ 794    

U.S. medium-term notes

     7,618          —          (50)         3           7,571    

European medium-term notes

     347          —          (88)         5           264    

Other foreign currency denominated debt

     904          —          —           22           926    

Film financing

     350          —          (350)         —           —    

Other

     614          —          —           15           629    

Euro Disney borrowings(1)

     2,344          —          (91)         (307)          1,946    

Hong Kong Disneyland borrowings

     524          —          —           (27)          497    
                                  

Total

     $ 12,701          $ 794          $ (579)         $ (289)          $   12,627    
                                  

 

(1)

The other activity is primarily the impact of foreign currency translation as a result of the strengthening of the U.S. dollar against the Euro.

The Company’s bank facilities as of July 3, 2010 were as follows:

 

(in millions)          Committed      
Capacity
         Capacity      
Used
   Unused
       Capacity      

Bank facilities expiring February 2011

   $ 2,225        $ 235        $ 1,990    

Bank facilities expiring February 2013

     2,250          —          2,250    
                    

Total

   $ 4,475        $ 235        $ 4,240    
                    

These bank facilities allow for borrowings at LIBOR-based rates plus a spread, which depends on the Company’s public debt rating and can range from 0.18% to 4.50%. As of July 3, 2010, 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 February 2011, which if utilized, reduces available borrowings under this facility. As of July 3, 2010, $235 million of letters of credit had been issued under this facility.

The Company may use commercial paper borrowings up to the amount of its 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.

On December 2, 2009, the Company declared a $653 million dividend ($0.35 per share) related to fiscal 2009 for shareholders of record on December 14, 2009, which was paid on January 19, 2010. On December 3, 2008, the Company declared a $648 million dividend ($0.35 per share) related to fiscal 2008 for shareholders of record on December 15, 2008, which was paid on January 20, 2009.

During the nine months ended July 3, 2010, the Company repurchased 45 million shares of its common stock for approximately $1.5 billion. As of July 3, 2010, the Company had remaining authorization in place to repurchase approximately 134 million additional shares. The repurchase program does not have an expiration date.

We believe that the Company’s 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 Company’s operating cash flow and access to the capital markets can be impacted by

 

39


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

macroeconomic factors outside of its control. In addition to macroeconomic factors, the Company’s 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 Company’s performance as measured by certain credit metrics such as interest coverage and leverage ratios. As of July 3, 2010, Moody’s Investors Service’s long and short-term debt ratings for the Company were A2 and P-1, respectively, with stable outlook; Standard & Poor’s long and short-term debt ratings for the Company were A and A-1, respectively, with negative outlook; and Fitch’s long and short-term debt ratings for the Company were A and F-1, respectively, with stable outlook. The Company’s bank facilities contain only one financial covenant, relating to interest coverage, which the Company met on July 3, 2010, by a significant margin. The Company’s bank facilities also specifically exclude certain entities, such as Euro Disney and Hong Kong Disneyland, from any representations, covenants or events of default.

Euro Disney has annual covenants under its debt agreements that limit its investment and financing activities and require it to meet certain financial performance covenants. Euro Disney was in compliance with these covenants for fiscal 2009.

COMMITMENTS AND CONTINGENCIES

Legal Matters

As disclosed in Note 11 to the Condensed Consolidated Financial Statements, the Company has exposure for certain legal matters.

Guarantees

See Note 11 to the Condensed Consolidated Financial Statements for information regarding the Company’s guarantees.

Tax Matters

As disclosed in Note 10 to the Consolidated Financial Statements in the 2009 Annual Report on Form 10-K as amended on Form 8-K dated February 18, 2010, the Company has exposure for certain tax matters.

Contractual Commitments

Refer to Note 15 in the Consolidated Financial Statements in the 2009 Annual Report on Form 10-K as amended on Form 8-K dated February 18, 2010 for information regarding the Company’s contractual commitments.

OTHER 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 in the 2009 Annual Report on Form 10-K as amended on Form 8-K dated February 18, 2010.

Film and Television Revenues and Costs

We expense film and television production, participation and residual costs over the applicable product life cycle based upon the ratio of the current period’s revenues to the estimated remaining total 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 from the date

 

40


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

of the initial theatrical release. For television series, we include revenues that will be earned within ten years from delivery of the first episode, or if still in production, five years from 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 popularity of competing films at the time of release and the level of marketing effort. Upon a film’s release and determination of domestic theatrical performance, the Company’s 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 number 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 program’s rating and the strength of the advertising market. Program ratings, which are an indication of market acceptance, directly affect the Company’s 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. A significant decline in the advertising market would also negatively impact our estimates.

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 program’s 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 during the applicable seasons based on the estimated relative value of each year in the arrangement. The estimated values of each year are based on our projection of revenues over the contract period which include advertising revenue and an allocation of affiliate revenue. If the annual contractual payments related to each season approximate each season’s relative value, we expense the related contractual payment during the applicable season. If planned usage patterns or estimated relative values by year were to change significantly, amortization of our sports rights costs may be accelerated or slowed.

Costs of film and television productions are subject to regular recoverability assessments which compare the estimated fair values with the unamortized costs. 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 Company’s 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.

 

41


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

Revenue Recognition

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 in the 2009 Annual Report on Form 10-K as amended on Form 8-K dated February 18, 2010 for a summary of these revenue recognition policies.

We reduce 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, which is derived from historical usage patterns. If actual usage is different than our estimated usage, revenues may not be recognized in the periods the related services are rendered. In addition, a change in usage patterns would impact the timing of revenue recognition.

Pension and Postretirement Medical Plan Actuarial Assumptions

The Company’s 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 which we evaluate annually. Refer to the 2009 Annual Report on Form 10-K as amended on Form 8-K dated February 18, 2010 for estimated impacts of changes in these assumptions. 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. A lower discount rate increases the present value of benefit obligations and increases pension expense. The guideline for setting this rate is high-quality long-term corporate bond rates that are currently available. The Company’s discount rate is 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.

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.

Goodwill, Intangible Assets, Long-Lived Assets and Investments

The Company is required to test goodwill and other indefinite-lived intangible assets for impairment on an annual basis and between annual tests if current events or circumstances require an interim impairment assessment. Goodwill is allocated to various reporting units, which are generally an operating segment or one reporting level below the operating segment. The Company compares the fair value of each reporting unit to its carrying amount 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.

 

42


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)

 

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. We apply what we believe to be the most appropriate valuat