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Walt Disney Company 10-Q 2012 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 1,792,360,533 shares of common stock outstanding as of January 31, 2012.
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
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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 ended December 31, 2011 are not necessarily indicative of the results that may be expected for the year ending September 29, 2012. 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 2011 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 12 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 be 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. Although the Company has less than a 50% direct ownership interest in Disneyland Paris, Hong Kong Disneyland Resort and Shanghai Disney Resort, they are VIEs, and given the nature of the Company’s relationships with these entities, which include management agreements, the Company has consolidated Disneyland Paris, Hong Kong Disneyland Resort and Shanghai Disney Resort 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.
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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:
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
Seven TV On November 18, 2011, the Company acquired a 49% ownership interest in Seven TV, a broadcast television network in Russia for $300 million. Seven TV was converted to an ad-supported, free-to-air Disney Channel in Russia. The Company accounts for its interest in Seven TV as an equity method investment. 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%. Pursuant to a shareholder agreement, UTV’s founder had a four-year option 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. Under this agreement, the Company did 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 was 48%. In January 2010, UTV issued additional shares 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). 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”). Pursuant to a delisting offer process, on February 2, 2012, the Company purchased publicly held shares and all of the shares held by the founder of UTV for $375 million. Upon completion, the Company’s interest in UTV increased to 93% and will result in the consolidation of the UTV Group in the Company’s financial statements in the second quarter of fiscal 2012. In addition, the four-year option held by the founder and limitations on the Company’s rights to vote certain shares subject to the option were eliminated. Upon consolidation, the Company expects to recognize a non-cash pre-tax gain on its currently held interest in the UTV Group of approximately $200 million based on a preliminary estimate of the fair value of the Company’s currently held interest. In accordance with Indian securities regulations, the Company expects to delist the UTV shares in the second quarter of fiscal 2012. Upon delisting and for a one year period, the Company can be required to purchase any outstanding UTV shares at the election of each remaining UTV shareholder for 1,100 Indian rupees per share for a cost of approximately $85 million for the additional shares.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
Goodwill The changes in the carrying amount of goodwill for the quarter ended December 31, 2011, are as follows:
The carrying amount of goodwill at December 31, 2011 and October 1, 2011 includes accumulated impairments of $29 million at Interactive Media.
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.
During the quarter ended December 31, 2011, the Company’s borrowing activity was as follows:
The Company has a 51% effective ownership interest in the operations of Disneyland Paris, a 47% ownership interest in the operations of Hong Kong Disneyland Resort and a 43% ownership interest in the operations of Shanghai Disney Resort (collectively the “International Theme Parks”), all of which are consolidated in 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)
The following tables present summarized balance sheet information for the Company as of December 31, 2011 and October 1, 2011, reflecting the impact of consolidating the balance sheets of the International Theme Parks.
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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 quarter ended December 31, 2011, reflecting the impact of consolidating the income statements of the International Theme Parks.
The following table presents summarized cash flow statement information of the Company for the quarter ended December 31, 2011, reflecting the impact of consolidating the cash flow statements of the International Theme Parks.
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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 components of net periodic benefit cost are as follows:
During the quarter ended December 31, 2011, the Company did not make any material contributions to its pension and postretirement medical plans. The Company expects pension and postretirement medical plan contributions in fiscal 2012 of approximately $325 million to $375 million. Final minimum funding requirements for fiscal 2012 will be determined based on our January 1, 2012 funding actuarial valuation which will be available in late fiscal 2012.
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, is as follows:
On November 30, 2011, the Company declared a $0.60 per share dividend ($1.1 billion) related to fiscal 2011 for shareholders of record on December 16, 2011, which was paid on January 18, 2012. The Company paid a $0.40 per share dividend ($756 million) during the second quarter of fiscal 2011 related to fiscal 2010. During the quarter ended December 31, 2011, the Company repurchased 23 million shares of its common stock for $800 million. As of December 31, 2011, the Company had remaining authorization in place to repurchase 282 million additional shares. The repurchase program does not have an expiration date.
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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 par value of the Company’s outstanding common stock totaled approximately $28 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:
Unrecognized compensation cost related to unvested stock options/rights and RSUs totaled approximately $153 million and $539 million, respectively, as of December 31, 2011. The weighted average grant date fair values of options issued during the quarters ended December 31, 2011, and January 1, 2011 were $9.42 and $10.13, respectively. In January 2012, the Company made equity compensation grants, which included its regular annual grant, consisting of 9.8 million stock options and 8.6 million RSUs, of which 0.5 million RSUs included market and performance conditions.
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
Legal Matters Celador International Ltd. v. American Broadcasting Companies, Inc. 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 pro rata 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 is vigorously pursuing 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 December 31, 2011, the remaining debt service obligation guaranteed by the Company was $359 million, of which $87 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 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, net of an immaterial allowance for credit losses, was $0.8 billion as of December 31, 2011. The activity in the current period related to the allowance for credit losses was not material.
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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 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, net of a related allowance for credit losses of approximately 5%, was approximately $0.5 billion as of December 31, 2011. The activity in the period related to the allowance for credit losses was not material. Income Taxes During the quarter, the Company settled certain tax matters with various jurisdictions. As a result of these settlements, the Company reduced its unrecognized tax benefits by $64 million. In the next twelve months, it is reasonably possible that our unrecognized tax benefits could change due to resolutions of open tax matters. These resolutions would reduce our unrecognized tax benefits by approximately $52 million.
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 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 quarter of fiscal 2012. 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, available-for-sale investments, derivative contracts and accounts payable approximated the carrying values. The estimated fair values of the Company’s total borrowings (current and noncurrent) subject to fair value disclosures, determined based on broker quotes or quoted market prices or interest rates for the same or similar instruments are $14.7 billion and $14.2 billion at December 31, 2011 and October 1, 2011, 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 December 31, 2011, the outstanding principal amount for sold mortgage receivables was $220 million, and the carrying value of the Company’s residual interest, which is recorded in other long-term assets, was $35 million.
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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 repurchases defaulted mortgage receivables at their outstanding balance. The Company did not make material repurchases in the quarters ended December 31, 2011 or January 1, 2011. 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.
The Company manages its exposure to various risks of 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 gross fair value of the Company’s derivative positions as of December 31, 2011:
The following table summarizes the gross fair value of the Company’s derivative positions as of October 1, 2011:
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
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. As of December 31, 2011 and October 1, 2011, the total notional amount of the Company’s pay-floating interest rate swaps was $2.2 billion and $1.2 billion, respectively. The following table summarizes adjustments related to fair value hedges included in net interest expense in the Condensed 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 December 31, 2011 nor at October 1, 2011. 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, Japanese yen, Canadian dollar and British pound. 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 December 31, 2011 and October 1, 2011, the notional amounts of the Company’s net foreign exchange cash flow hedges were $3.7 billion and $3.6 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 quarters ended December 31, 2011 and January 1, 2011 were not material. Net deferred gains recorded in AOCI
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THE WALT DISNEY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited; tabular dollars in millions, except for per share data)
for contracts that will mature in the next twelve months totaled $46 million. The following table summarizes the pre-tax adjustments to AOCI for foreign exchange cash flow hedges.
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 amounts of these foreign exchange contracts at December 31, 2011 and October 1, 2011 were $2.7 billion and $2.6 billion, respectively. During the quarters ended December 31, 2011 and January 1, 2011, the Company recognized a net gain of $54 million and $20 million, respectively, in costs and expenses on these foreign exchange contracts which offset a net loss of $66 million and $25 million on the related economic exposures for the quarters ended December 31, 2011 and January 1, 2011, 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 December 31, 2011 nor at October 1, 2011. Risk Management – Other 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 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 amounts of these contracts at December 31, 2011 and October 1, 2011 were $176 million and $184 million, respectively. The gains or losses recognized in income for the quarters ended December 31, 2011 and January 1, 2011 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 $103 million and $114 million on December 31, 2011 and October 1, 2011, respectively.
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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 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 18% for the quarter reflecting improved operating results and a decrease in weighted average shares outstanding. Improved segment operating results were driven by increased fees from Multi-channel Video Service Providers (MVSP) (Affiliate Fees) including a benefit from a decrease in revenue deferrals related to annual program commitments, higher guest spending and attendance at our domestic parks and resorts, and improved results in our worldwide theatrical business, partially offset by increased operating expenses at our domestic parks and resorts and lower political advertising revenues at our owned television stations.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
The Company recorded $6 million of restructuring and impairment charges in the current quarter. In the prior-year quarter, 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 the prior year items.
Restructuring and impairment charges in the prior-year quarter included an impairment related to assets that had tax basis in excess of the book value resulting in a $31 million tax benefit on the restructuring and impairment charges. The book value of Miramax included allocated goodwill totaling $217 million which is not tax deductible. Accordingly, the taxable gain on the sales of these businesses exceeded the $75 million book gain resulting in the tax expense of $107 million. SEASONALITY The Company’s businesses are subject to the effects of seasonality. Consequently, the operating results for the quarter ended December 31, 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. 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.
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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:
The following table reconciles segment operating income to income before income taxes:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Depreciation expense is as follows:
Amortization of intangible assets is as follows:
Media Networks Operating results for the Media Networks segment are as follows:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Revenues The 11% increase in affiliate revenue was driven by increases of 5% from contractual rates and 4% from a change in the provisions related to annual programming commitments in an MVSP contract at Cable Networks. Lower advertising revenues were due to an increase of $20 million at Cable Networks from $1,095 million to $1,115 million and a decrease of $74 million at Broadcasting from $1,166 million to $1,092 million. The increase at Cable Networks included a 5% increase due to higher rates and a 1% increase due to higher units sold, partially offset by a 5% decrease due to lower ratings. Advertising revenues also reflected a shift in the timing of the Rose and Fiesta Bowls and certain NBA games, relative to our fiscal period end, at ESPN. The decrease at Broadcasting reflected a 5% decrease in local television advertising revenues. Advertising revenues at the ABC Television Network were essentially flat as higher advertising rates were offset by decreased ratings and units sold. The decline in other revenues reflected lower DVD sales of ABC Studios productions driven by Lost and Scrubs. Costs and Expenses Operating expenses include a decrease in programming and production costs of $52 million from $2,727 million to $2,675 million. At Cable Networks, programming and production costs were essentially flat as higher sports rights costs due to contractual rate increases for key contracts and higher programming and production costs at the worldwide Disney Channels were offset by the timing shift related to college bowl and NBA games. At Broadcasting, programming and production costs decreased $54 million driven by lower DVD sales and the absence of The Oprah Winfrey Show at our local television stations. The increase in selling, general, administrative and other costs and expenses was driven by higher marketing costs for new series launches at the ABC Television Network. Segment Operating Income Segment operating income increased 12%, or $127 million, to $1.2 billion. The increase was primarily due to increases at ESPN and the worldwide Disney Channels, partially offset by a decrease at the owned television stations. The following table provides supplemental revenue and segment operating income detail for the Media Networks segment:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Parks and Resorts Operating results for the Parks and Resorts segment are as follows:
Revenues Parks and Resorts revenues increased 10%, or $287 million, to $3.2 billion due to an increase of $254 million at our domestic operations and an increase of $33 million at our international operations. Revenue growth of 11% at our domestic operations reflected a 6% increase from higher average guest spending and a 5% increase due to volume driven by passenger cruise ship days from our newest cruise ship, the Disney Dream, which was launched in January 2011 and higher theme park attendance. Higher guest spending was primarily due to higher average ticket prices, food and beverage and daily hotel room rates. Revenue growth of 5% at our international operations reflected a 3% increase from higher attendance and a 3% increase due to higher average guest spending, partially offset by a 2% decrease due to the absence of real estate sales at Disneyland Paris which occurred in the prior-year quarter.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
The following table presents supplemental park and hotel statistics:
Costs and Expenses Operating expenses include operating labor which increased by $78 million from $865 million to $943 million driven by labor cost inflation across our parks and resorts businesses and higher employee benefits costs at Walt Disney World Resort. Operating expenses also include cost of sales which increased $3 million from $311 million to $314 million driven by volume, partially offset by the absence of the costs related to prior-year real estate sales at Disneyland Paris. Operating expenses also increased due to a full period of operations of the Disney Dream which launched at the end of January 2011, costs for our new hotel and vacation club resort in Hawaii, Aulani, a Disney Resort & Spa, enhancement costs including investments in systems infrastructure at Walt Disney World Resort, and new guest offerings at Disney California Adventure. The increase in selling, general, administrative and other costs and expenses was driven by higher marketing costs at our domestic parks and resorts and labor cost inflation. Segment Operating Income Segment operating income increased 18%, or $85 million, to $553 million due to increases at our domestic parks and resorts and Disney Cruise Line.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Studio Entertainment Operating results for the Studio Entertainment segment are as follows:
Revenues The decrease in theatrical distribution revenue reflected fewer Disney branded titles in wide release in the current quarter. Key titles in the prior-year quarter included Tangled and Tron: Legacy while the current quarter included The Muppets. Lower home entertainment revenue reflected an 11% decrease due to a decline in unit sales, partially offset by a 6% increase due to higher net effective pricing which benefitted from a higher Blu-ray sales mix. Net effective pricing is the wholesale selling price adjusted for discounts, sales incentives and returns. The decrease in unit sales reflected the strength of Toy Story 3, Beauty and the Beast Platinum Release, A Christmas Carol and Sorcerer’s Apprentice in the prior-year quarter compared to Cars 2, The Lion King Platinum Release, Pirates of the Caribbean: On Stranger Tides and The Help in the current quarter, as well as lower sales of catalog titles. The decrease in Television distribution and other revenue reflected fewer title availabilities domestically and an adverse impact from the timing of title availability, relative to our fiscal period end, in international markets. Costs and Expenses Operating expenses included a decrease of $140 million in film cost amortization, from $509 million to $369 million. The decrease was due to fewer Disney branded titles in theatrical markets and lower film cost write-downs in the current quarter. Operating expenses also include cost of sales and distribution expenses which decreased $64 million from $390 million to $326 million primarily due to lower home entertainment unit sales. The decrease in selling, general, administrative and other expenses was primarily due to lower marketing expenses in theatrical distribution due to fewer Disney branded titles in the current quarter. The prior-year quarter included marketing for Tangled and Tron: Legacy whereas the current quarter included The Muppets. Segment Operating Income Segment operating income increased 10%, or $38 million, to $413 million primarily due to an increase in worldwide theatrical results and lower film cost write-downs, partially offset by decreases in television distribution and worldwide home entertainment results.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Consumer Products Operating results for the Consumer Products segment are as follows:
Revenues The increase in licensing and publishing revenue reflected a 2% increase from a favorable impact of foreign currency translation primarily as a result of the weakening of the U.S. dollar against the Japanese Yen. Licensing revenue growth, which was driven by Cars merchandise in the current quarter compared to Toy Story and Tangled merchandise in the prior-year quarter, was offset by a higher revenue share with the Studio Entertainment segment. Higher retail and other revenues reflected a 4% increase primarily due to higher sales at our retail business driven by new stores in North America and holiday season promotions. Costs and Expenses Operating expenses included an increase of $5 million in cost of goods sold, from $203 million to $208 million, driven by higher sales volume at our retail business. Operating expenses also included a 2% increase due to higher distribution expenses and labor costs primarily at our retail business. The increase in selling, general, administrative and other expenses was driven by higher marketing expense and promotions at our licensing business. Operating Income Segment operating income for the quarter was comparable to the prior-year quarter.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Interactive Media Operating results for the Interactive Media segment are as follows:
Revenues Lower game sales and subscriptions revenue reflected a 31% decrease due to a decline in console game unit sales and a 7% decrease due to lower net effective pricing of console games, reflecting the strong performance of Epic Mickey in the prior-year quarter and fewer releases in the current quarter consistent with our ongoing shift from console games to social and other interactive platforms. Significant current quarter titles included Disney Universe while the prior-year quarter included Toy Story 3 and Tron: Evolution in addition to Epic Mickey. The decrease was partially offset by a 9% increase due to higher social game revenue reflecting lower acquisition accounting impacts which were adverse to the prior-year quarter and improved title performance in the current quarter. Higher advertising and other revenue was driven by services and handset sales revenue at our mobile phone service in Japan due to increased subscribers and the launch of two new handsets in the current quarter. Costs and Expenses Operating expenses for the quarter included a decrease in product development costs from $76 million to $71 million driven by decreased console game development. The decrease in operating expenses also reflected a 12% decrease in cost of sales driven by lower unit sales of console games. The decrease in selling, general, administrative and other expenses was primarily due to lower marketing costs at our console game business driven by fewer releases in the current quarter. Operating Loss Segment operating loss was $28 million compared to $13 million in the prior-year quarter driven by a decrease at our console game business partially offset by improved social games results.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
OTHER FINANCIAL INFORMATION Corporate and Unallocated Shared Expenses Corporate and unallocated shared expense is as follows:
Net Interest Expense Net interest expense is as follows:
The increase in interest expense was driven by higher average debt balances. The increase in interest and investment income for the quarter was driven by a gain on the sale of an investment and lower investment impairments in the current quarter. Income Taxes The effective income tax rate is as follows:
The effective income tax rate for the quarter decreased to 32.1% from 35.4%. The prior-year quarter included a net adverse tax rate impact of 2.5 percentage points from a gain on sale of business and an impairment charge. In the prior-year quarter we recognized a gain on the sale of Miramax, and our book value of Miramax included non-deductible goodwill such that the taxable gain on the sale of Miramax resulted in tax expense that exceeded the book gain and an increase in the effective tax rate. The prior-year impairment charge related to assets that had tax basis in excess of the book value resulting in a tax benefit that exceeded the pre-tax impairment charge and a decrease in the effective tax rate. Noncontrolling Interests Net income attributable to noncontrolling interests is as follows:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Net income attributable to noncontrolling interests increased $25 million to $57 million primarily due to higher results at ESPN. Net income attributable to noncontrolling interests is determined based on income after royalties, financing costs and income taxes. FINANCIAL CONDITION The change in cash and cash equivalents is as follows:
Operating Activities Cash provided by operating activities of $1.7 billion for the current quarter increased 55% as compared to the prior-year quarter. The increase was due to higher operating cash receipts primarily due to higher collections of receivable balances at our Studio Entertainment, Parks and Resorts and Media Networks businesses, and higher revenues at Parks and Resorts, partially offset by lower revenues at Studio Entertainment. Additionally, operating cash flow benefitted from decreased cash payments driven by the timing of accounts payable disbursements at Corporate and lower marketing and distribution costs at our Studio Entertainment business, partially offset by higher cash payments at Media Networks and Parks and Resorts. The increase in cash payments at Media Networks was driven by higher investment in television programming and production, while the increase in cash payments at Parks and Resorts was driven by operating costs for our newest cruise ship, Disney Dream, costs for our new hotel and vacation club resort in Hawaii, investments in systems infrastructure and labor cost inflation. 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 quarter ended December 31, 2011 and January 1, 2011 are as follows:
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Investing Activities Investing activities consist principally of investments in parks, resorts, and other property and acquisition and divestiture activity. During the quarter ended December 31, 2011 and January 1, 2011, investments in parks, resorts and other properties were as follows:
Capital expenditures for the Parks and Resorts segment are principally for theme park and resort expansion, new rides and attractions, cruise ships, recurring capital and capital improvements. The decrease in capital expenditures was due to the final payment on the Disney Dream which occurred during our first quarter of fiscal 2011 compared to the final payment on the Disney Fantasy which will occur in the second quarter of fiscal 2012. This decrease was partially offset by higher current year expenditures for theme park and resort expansions and new guest offerings at Walt Disney World Resort and the development of Shanghai Disney Resort. Capital expenditures at Media Networks primarily reflect investments in facilities and equipment for expanding and upgrading broadcast centers, production facilities, and television station facilities. Capital expenditures at Corporate primarily reflect investments in information technology and other equipment and corporate facilities. The increase was driven by investments in corporate facilities. Other Investing Activities During the current quarter, acquisitions totaled $361 million primarily due to the acquisition of a 49% interest in Seven TV network in Russia. The prior-year quarter included proceeds from dispositions totaling $556 million primarily due to the sale of Miramax. Acquisitions in the prior year totaled $163 million due to payments related to the acquisition of Playdom, Inc.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (continued)
Financing Activities Cash used by financing activities was $130 million for the current quarter compared to cash provided by financing activities of $99 million for the prior-year quarter. The change of $229 million was primarily due to lower proceeds from exercises of stock options. During the quarter ended December 31, 2011, the Company’s borrowing activity was as follows:
The Company’s bank facilities as of December 31, 2011 were as follows:
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