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Walt Disney Company 10-Q 2011 Documents found in this filing: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
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).
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 1,890,153,714 shares of common stock outstanding as of May 3, 2011.
PART I. FINANCIAL INFORMATION Item 1: Financial Statements THE WALT DISNEY COMPANY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited; in millions, except per share data)
See Notes to Condensed Consolidated Financial Statements
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THE WALT DISNEY COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited; in millions, except per share data)
See Notes to Condensed Consolidated Financial Statements
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THE WALT DISNEY COMPANY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited; in millions)
See Notes to Condensed Consolidated Financial Statements
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THE WALT DISNEY COMPANY CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (unaudited; in millions)
See Notes to Condensed Consolidated Financial Statements 5
THE WALT DISNEY COMPANY CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (cont’d) (unaudited; in millions)
See Notes to Condensed Consolidated Financial Statements
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
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 six months ended April 2, 2011 are not necessarily indicative of the results that may be expected for the year ending October 1, 2011. 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 2010 Annual Report on Form 10-K. 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 Company enters into relationships or investments with other entities, and in certain instances, the entity in which the Company has a relationship or investment may qualify as a variable interest entity (“VIE”). A VIE is consolidated in the financial statements if the Company has the power to direct activities that most significantly impact the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Euro Disney and Hong Kong Disneyland are VIEs, and given the nature of the Company’s relationships with these entities, which include management agreements, the Company has consolidated Euro Disney and Hong Kong Disneyland in its financial statements. 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.
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. Beginning with the first quarter of fiscal 2011, the Company made changes to certain transfer pricing arrangements between its business units. The most significant change was to the allocation of home video revenue and distribution costs between the Media Networks and Studio Entertainment segments for home video titles produced by the Media Networks segment and distributed by the Studio Entertainment segment. These changes will generally result in higher revenues, expenses and operating income at our Media Networks segment with offsetting declines at our Studio Entertainment segment.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
A reconciliation of segment operating income to income before income taxes is as follows:
Playdom On August 27, 2010, the Company acquired Playdom, Inc. (Playdom), a company that develops online social games. This acquisition is designed to strengthen the Company’s digital gaming portfolio and provide access to a new customer base. Total consideration was approximately $563 million, subject to certain conditions and adjustments, of which approximately $115 million will be paid subject to vesting
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
conditions and recognized as post-close compensation expense. Additional consideration of up to $200 million may be paid if Playdom achieves predefined revenue and earnings targets for calendar year 2012. The Company has recognized the fair value (determined by a probability weighting of the potential payouts) of the additional consideration as a liability and subsequent fair value changes, measured quarterly, up to the ultimate amount paid, will be recognized in earnings. The Company is in the process of finalizing the valuation of the assets acquired and liabilities assumed. Goodwill The changes in the carrying amount of goodwill for the six months ended April 2, 2011, are as follows:
The carrying amount of goodwill at April 2, 2011 and October 2, 2010 includes accumulated impairments of $29 million at Interactive Media. The Disney Stores Japan On March 31, 2010, the Company acquired all of the outstanding shares of Retail Networks Company Limited (The Disney Stores 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 Statements of Income.
Miramax On December 3, 2010, the Company sold Miramax Film NY, LLC (Miramax) for $663 million. Net proceeds which reflect closing adjustments, the settlement of related claims and obligations and Miramax’s cash balance at closing were $532 million, resulting in a pre-tax gain of $64 million, which is reported in “Other income” in the fiscal 2011 Condensed Consolidated Statement of Income. The book value of Miramax included $217 million of allocated goodwill that is not deductible for tax purposes. Accordingly, tax expense recorded in connection with the transaction was approximately $103 million resulting in a loss of $39 million after tax. Other Dispositions 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 Statements 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.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
During the six months ended April 2, 2011, the Company’s borrowing activity was as follows:
In February 2011, the Company entered into a new four-year $2.25 billion bank facility with a syndicate of lenders. This facility, in combination with an existing facility that matures in 2013, is used to support commercial paper borrowings. The new facility allows the Company to issue up to $800 million of letters of credit. The bank facilities allow for borrowings at LIBOR-based rates plus a spread depending on the credit default swap spread applicable to the Company’s debt, subject to a cap and a floor that vary with the Company’s public debt rating. The spread above LIBOR can range from 0.33% to 4.50%.
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 April 2, 2011, reflecting the impact of consolidating the balance sheets of Euro Disney and Hong Kong Disneyland.
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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 income statement information of the Company for the six months ended April 2, 2011, reflecting the impact of consolidating the income statements of Euro Disney and Hong Kong Disneyland.
The following table presents summarized cash flow statement information of the Company for the six months ended April 2, 2011, reflecting the impact of consolidating the cash flow statements of Euro Disney and Hong Kong Disneyland.
On April 8, 2011, the Company and its partner in China announced that the Chinese central government in Beijing had approved an agreement to build and operate a Disney resort in the Pudong district of Shanghai (Shanghai Disney Resort) that will be operated through a joint venture between the Company and its Chinese partner. Shanghai Disney Resort is scheduled to open in approximately five years. There will be a phased investment in the project totaling approximately $3.7 billion over the construction period (24.5 billion yuan) to build the theme park and an additional $0.7 billion (4.5 billion yuan) to build other properties for the resort, including two hotels and a retail, dining and entertainment area. The Company will finance 43%
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
of the initial investment in accordance with its equity ownership percentage. The Company anticipates consolidating Shanghai Disney Resort for financial statement reporting purposes due to the Company’s involvement in the management of the resort.
The components of net periodic benefit cost are as follows:
During the six months ended April 2, 2011, the Company made contributions to its pension and postretirement medical plans totaling $169 million, which included discretionary contributions above the minimum requirements. The Company expects additional pension and postretirement medical plan contributions in fiscal 2011 of approximately $280 million which are expected to include discretionary contributions above the minimum requirements. Final minimum funding requirements for fiscal 2011 will be determined based on a January 1, 2011 funding actuarial valuation which will be available late in fiscal 2011.
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:
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
On December 1, 2010, the Company declared a $0.40 per share dividend ($756 million) related to fiscal 2010 for shareholders of record on December 13, 2010, which was paid on January 18, 2011. The Company paid a $0.35 per share dividend ($653 million) during the second quarter of fiscal 2010 related to fiscal 2009. During the six months ended April 2, 2011, the Company repurchased 42 million shares of its common stock for approximately $1.6 billion. On March 22, 2011, the Company’s Board of Directors increased the repurchase authorization to a total of 400 million shares as of that date. As of April 2, 2011, the Company had remaining authorization in place to repurchase approximately 398 million additional shares. The repurchase program does not have an expiration date. The Company received proceeds of $1.0 billion and $748 million from the exercise of 38 million and 32 million employee stock options during the first six months of fiscal 2011 and 2010, respectively. The par value of the Company’s outstanding common stock totaled approximately $27 million. Accumulated other comprehensive income (loss), net of tax, is as follows:
The amount of compensation expense related to stock options, stock appreciation rights and restricted stock units (RSUs) is as follows:
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
Unrecognized compensation cost related to unvested stock options/rights and RSUs totaled approximately $281 million and $828 million, respectively, as of April 2, 2011. In January 2011, the Company made equity compensation grants, which included its regular annual grant, consisting of 10.4 million stock options and 12.5 million RSUs, of which 0.4 million RSUs included market and/or performance conditions. In March 2011, shareholders of the Company approved the 2011 Stock Incentive Plan, which increased the number of shares authorized to be awarded as grants by 64 million shares. The weighted average grant date fair values of options issued during the six months ended April 2, 2011, and April 3, 2010, were $10.96 and $9.42, respectively.
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 Company has stipulated with the plaintiff to an award of prejudgment interest of $50 million, which amount will be reduced prorata should the Court of Appeals reduce the damages amount. On December 21, 2010, the Company’s alternative motions for a new trial and for judgment as a matter of law were denied. 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 on appeal, notice of which was filed by the Company on January 14, 2011. On or about January 28, 2011, plaintiff filed a notice of cross-appeal. The Company has determined that it does not have a probable loss under the applicable accounting standard relating to probability of loss for recording a reserve with respect to this litigation and therefore has not recorded a reserve. 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 any 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 April 2, 2011, the remaining debt service obligation guaranteed by the Company was $362 million, of which $90 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. 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
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
the terms of the agreement, ESPN and the other joint-venture partner have jointly guaranteed the programming rights obligation of approximately $0.7 billion over the remaining term of the agreement. Long-Term Receivables and the Allowance for Credit Losses The Company has accounts receivable with original maturities greater than one year in duration principally related to the Company’s sale of program rights in the television syndication markets within the Media Networks segment and the Company’s vacation ownership units within the Parks and Resorts segment. Allowances for credit losses are established against these receivables as necessary. The Company estimates the allowance for credit losses related to receivables for the sale of syndicated programming based upon a number of factors, including historical experience, and an ongoing review of the financial condition of individual companies with which we do business. The balance of syndication receivables recorded in other non-current assets was approximately $0.7 billion, net of an immaterial allowance for credit losses as of April 2, 2011. The activity in the current period related to the allowance for credit losses was also not material. The Company estimates the allowance for credit losses related to receivables for sales of its vacation ownership units based primarily on historical collection experience. Projections of uncollectible amounts are also based on consideration of the economic environment and the age of receivables. The balance of mortgage receivables recorded in other non-current assets was approximately $0.4 billion, net of a related allowance for credit losses of approximately 8%, as of April 2, 2011. The activity in the period related to the allowance for credit losses was not material. Income Taxes During the six months ended April 2, 2011, the Company settled certain tax matters and as a result reduced its unrecognized tax benefits by $70 million. In the next twelve months, it is reasonably possible that our unrecognized tax benefits could change due to resolutions of certain open tax matters which would reduce our unrecognized tax benefits by $39 million.
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 adopted the provisions of this guidance at the beginning of fiscal year 2011, and the adoption did not have a material impact on the Company’s financial statements. Transfers and Servicing of Financial Assets In June 2009, the FASB issued guidance on transfers and servicing of financial assets to eliminate the concept of a qualifying special-purpose entity, change the requirements for off balance sheet accounting for financial assets including limiting the circumstances where off balance sheet treatment for a portion of a financial asset is allowable, and require additional disclosures. The Company adopted the provisions of this guidance at the beginning of fiscal year 2011, and the adoption did not have a material impact on the Company’s financial statements.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
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 a VIE’s economic performance and shares in the significant risks and rewards of the VIE. The guidance on VIE’s requires companies to continually reassess VIEs to determine if consolidation is appropriate and requires additional disclosures. The Company adopted the provisions of this guidance at the beginning of fiscal year 2011, and the adoption did not have a material impact on the Company’s financial statements.
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 three categories:
The Company’s assets and liabilities measured at fair value on a recurring basis are summarized by level in the following tables:
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
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 primarily of interest rate and foreign currency financial instrument contracts, 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, prepayments, and defaults. There were no material changes in the residual interests in the first six months of fiscal 2011. 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, cash equivalents, receivables, and accounts payable approximated the carrying values. The estimated fair values of the Company’s total borrowings (current and noncurrent), primarily determined based on broker quotes, quoted market prices, interest rates for the same or similar instruments are $12.7 billion and $13.7 billion at April 2, 2011 and October 2, 2010, respectively. 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 continues to service the sold receivables and has a residual interest in those receivables. As of April 2, 2011, the outstanding principal amount for sold mortgage receivables was $271 million, and the carrying value of the Company’s residual interest, which is recorded in other long-term assets, was $42 million. The Company repurchases defaulted mortgage receivables at their outstanding balance. The Company did not make material repurchases in the six months ended April 2, 2011 or April 3, 2010. The Company generally has been able to sell the repurchased vacation ownership units for amounts that exceed the amounts at which they were repurchased. 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.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
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 April 2, 2011:
The following table summarizes the fair value of the Company’s derivative positions as of October 2, 2010:
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 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.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
As of both April 2, 2011 and October 2, 2010, the total notional amount of the Company’s pay-floating interest rate swaps was $1.5 billion. The following table summarizes adjustments related to fair value hedges included in net interest expense in the Consolidated Statements of Income.
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 April 2, 2011 nor at October 2, 2010. 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. 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 four 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 April 2, 2011 and October 2, 2010, the notional amounts of the Company’s net foreign exchange cash flow hedges were $3.8 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 six months ended April 2, 2011 and April 3, 2010 were not material. Net deferred losses recorded in AOCI for contracts that will mature in the next twelve months totaled $112 million. The following table summarizes the pre-tax adjustments to AOCI for foreign exchange cash flow hedges.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
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 April 2, 2011 and October 2, 2010 was $2.7 billion and $2.2 billion, respectively. During the quarters ended April 2, 2011 and April 3, 2010, the Company recognized a net loss of $91 million and a net gain of $57 million, respectively, in costs and expenses on these foreign exchange contracts which offset a net gain of $81 million and a net loss of $114 million on the related economic exposures for the three months ended April 2, 2011 and April 3, 2010, respectively. During the six months ended April 2, 2011 and April 3, 2010, the Company recognized a net loss of $64 million and a net gain of $52 million, respectively, in costs and expenses on these foreign exchange contracts which offset a net gain of $56 million and a net loss of $104 million on the related economic exposures for the six months ended April 2, 2011 and April 3, 2010, respectively. 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 April 2, 2011 nor at October 2, 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, commodity swap contracts and credit default swaps, 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 April 2, 2011 and October 2, 2010 was $201 million and $218 million, respectively. For the six months ended April 2, 2011 and April 3, 2010, the gain and loss on these contracts recognized in income were not material. 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 that vary with Disney’s credit rating. If the Company’s credit ratings were to fall below investment grade, such counterparties would also 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 derivative instruments with credit-risk-related contingent features in a net liability position by counterparty were $283 million and $306 million on April 2, 2011 and October 2, 2010, respectively.
The Company recorded $12 million of restructuring and impairment charges in the current six months. In the prior-year six months, the Company recorded $176 million of restructuring and impairment charges related to organizational and cost structure initiatives primarily at our Studio Entertainment and Media Networks segments. Impairment charges were $96 million, of which $57 million were recorded in the second quarter of the prior year, and consisted of write-offs of capitalized costs primarily related to abandoned film projects and the closure of a studio production facility. Restructuring charges were $80 million, of which $14 million were recorded in the second quarter of the prior year, and reflected primarily severance and related costs.
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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 Six-Month Results Other Financial Information Financial Condition Commitments and Contingencies Other Matters Market Risk OVERVIEW Our summary consolidated results are presented below:
Quarter Results Diluted earnings per share (EPS) increased 2% for the quarter driven by improved operating results. Improved operating results reflected higher advertising revenues and increased fees from Multi-channel Video Service Providers (MVSP) (Affiliate Fees) at ESPN and increased guest spending at our domestic parks and resorts. These increases were partially offset by higher programming costs at ESPN, increased operating expenses at our domestic parks and resorts, lower unit sales at our worldwide home entertainment business, lower results at our theatrical business reflecting the performance of Mars Needs Moms in the current quarter and the inclusion of results for Playdom in the current quarter, which included the impact of acquisition accounting.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)
The prior-year quarter included restructuring and impairment charges of $71 million, a gain on the sale of an investment in a pay television service in Europe of $48 million, and an accounting gain related to the acquisition of the Disney Stores in Japan of $22 million, which collectively had no impact on EPS. Six-Month Results Diluted EPS increased 25% for the six months driven by improved operating results. Improved operating results reflected higher advertising revenues at ESPN and the owned television stations, increased Affiliate Fees, increased guest spending and volumes at our domestic and international parks and resorts and higher licensing revenue due to the strength of Toy Story and Marvel merchandise. These increases were partially offset by higher programming costs at ESPN, increased operating expenses at our domestic parks and resorts and the inclusion of results for Playdom in the current six months, which included the impact of acquisition accounting. In the current six months, the Company recorded $12 million of restructuring and impairment charges and gains on the sale of Miramax and BASS totaling $75 million. The table below shows the pretax and after tax impact of these items.
These restructuring and impairment charges include an impairment of assets that had tax basis significantly in excess of book value resulting in a $31 million tax benefit on the restructuring and impairment charges. In addition, the book value of Miramax included $217 million of allocated goodwill which is not tax deductible. Accordingly, the taxable gain on the sales of these businesses exceeded the $75 million book gain resulting in tax expense of $107 million. These items collectively had a $0.01 negative impact on EPS. The prior-year six months included restructuring and impairment charges, gains on the sales of investments in pay television services in Europe and an accounting gain related to the acquisition of the Disney Stores in Japan, which together had a $0.02 negative impact on EPS. SEASONALITY The Company’s businesses are subject to the effects of seasonality. Consequently, the operating results for the quarter and six months ended April 2, 2011 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.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)
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. 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:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)
The following table reconciles segment operating income to income before income taxes:
Depreciation expense is as follows:
Amortization of intangible assets is as follows:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)
Media Networks Operating results for the Media Networks segment are as follows:
Revenues The 10% increase in Affiliate Fees was driven by increases of 6% from contractual rate increases and 2% from subscriber growth at Cable Networks and an increase of 1% at Broadcasting due to new contractual provisions. Higher advertising revenues were due to increases of $185 million at Cable Networks (from $566 million to $751 million) and $36 million at Broadcasting (from $941 million to $977 million). Higher Cable Networks advertising revenue was driven by a 23% increase due to higher rates and a 7% increase due to higher units sold. The increase at Broadcasting reflected improvements of 7% due to higher network advertising rates and 1% due to higher local television advertising, partially offset by a 2% decrease due to lower primetime ratings and a decrease at sports due to a shift of the BCS National Championship game to ESPN. The increase in other revenues reflected the impact of a change in the transfer pricing arrangement between Studio Entertainment and Media Networks for distribution of Media Networks home entertainment product (see Note 2 to the Condensed Consolidated Financial Statements) and higher sales of ABC Studios productions driven by Criminal Minds and Army Wives, partially offset by the absence of Lost. Costs and Expenses Operating expenses include programming and production costs which increased $127 million from $1,718 million to $1,845 million. At Cable Networks, an increase in programming and production spending of $163 million was driven by higher sports rights costs due to the addition of college football Bowl Championship Series games. At Broadcasting, programming and production spending decreased $36 million driven by lower news production costs due to cost savings initiatives and decreased sports programming costs due to the shift of the BCS National Championship game to ESPN, partially offset by a higher cost mix of primetime programming. Operating costs also increased 1% due to higher labor costs and 1% due to the change in the transfer pricing arrangement for distribution of Media Networks home entertainment product. The increase in selling, general and administrative and other costs and expenses was driven by the absence of recoveries of previously reserved receivables which occurred in the prior-year quarter and higher marketing expenses. Equity in the Income of Investees Income from equity investees was $123 million for the current quarter compared to $153 million in the prior-year quarter. The decrease in income from equity investees was due to programming costs for the Cricket World Cup at our ESPN Star Sports joint venture. Segment Operating Income Segment operating income increased 17%, or $218 million, to $1.5 billion. The increase was primarily due to higher advertising sales, increased Affiliate Fees and higher sales of ABC Studios productions, partially offset by higher programming costs, lower equity in the income of investees,
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)
the absence of recoveries of previously reserved receivables and higher marketing costs. The following table provides supplemental revenue and segment operating income detail for the Media Networks segment:
Restructuring and impairment charges The Company recorded credits totaling $4 million and charges totaling $10 million in the current and prior-year quarters, respectively, that were reported in “Restructuring and impairment charges” in the Consolidated Statements of Income. Parks and Resorts Operating results for the Parks and Resorts segment are as follows:
Revenues Parks and Resorts revenues increased 7%, or $181 million, to $2.6 billion due to increases of $168 million at our domestic operations and $13 million at our international operations. Results at both our domestic and international parks and resorts reflected an unfavorable impact due to a shift in the timing of the Easter holiday relative to our fiscal periods. As a result, the current quarter did not include any of the two week Easter holiday, while the prior-year quarter included one week of the Easter holiday. Revenues at our domestic operations reflected a 5% increase due to higher average guest spending and a 3% increase from higher passenger cruise days driven by the launch of our new cruise ship, the Disney Dream, in January 2011. Higher guest spending was primarily due to higher average ticket prices and daily hotel room rates. Revenues at our international operations reflected a 6% volume increase due to higher attendance and hotel occupancy and a 2% increase from average guest spending. These improvements
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued)
were partially offset by a 5% decrease driven by the March 2011 earthquake and tsunami in Japan which resulted in the temporary suspension of operations at Tokyo Disney Resort. The following table presents supplemental park and hotel statistics:
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