Disney’s Q4 and fiscal ’05 Earnings Call

Disney's Q4 and fiscal '05 Earnings Call

NOVEMBER 17, 2005

Disney Speakers:

Bob Iger

President and Chief Operating Officer and CEO-Elect, The Walt Disney Company

Tom Staggs

Chief Financial Officer, The Walt Disney Company

Moderated by,

Wendy Webb

Sr. Vice President, Investor Relations and Shareholder Services, The Walt Disney Company

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Q4 and Fiscal '05 Earnings Call November 17, 2005

Operator

Good day ladies and gentlemen. Thank you for standing by, and welcome to the Walt Disney Company's fourth quarter 2005 earnings conference call. My name is Carlo, and I will be your coordinator for today's presentation. At this time, all participants are in a listenonly mode. We will be facilitating a question and answer session towards the end of today's prepared remarks. [OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the presentation over to your host for today's conference, Wendy Webb, Senior Vice President of Investor Relations and Shareholder Services. Please proceed.

Wendy Webb - Walt Disney - SVP, IR, Shareholder Services

Thank you. Good afternoon and thanks for joining us. On the call with us today are Bob Iger, President and Chief Executive Officer, and Chief Financial Officer, Tom Staggs. Bob will lead off followed by Tom. Then we will open up the call to you for Q&A. We'll try our best to conclude the call before 5:30 p.m., Eastern Time. So let's get started. Bob?

Bob Iger - Walt Disney - President, CEO

Thanks, Wendy. I'm pleased to report that we achieved our goal of delivering double-digit EPS growth for the year, despite the challenges we faced in the studio in the fourth quarter. Our continued strong performance this year reflects how well-positioned the Company is for the future.

I've been in my new role at Disney for just under two months, and during this time have been listening with great interest to the debate among various constituencies, about old media versus new media. What this debate highlights, is the simple fact that the world is changing, due in large part to advances in digital technology that have led to an explosion in media, resulting in increases in content, distribution, and communication. This is a global phenomenon, as we are seeing the growth of mass media infrastructure in both developed and emerging markets.

Competition for the consumer remains fierce, as consumers with a limited amount of leisure time have significantly greater choice. Distribution methods and new more sophisticated consumer electronics devices are multiplying, offering consumers far more flexibility, customization, and control over how, when, and where they consume content.

With this dynamic in mind, we established three strategic priorities to meet the challenges of this era, to best position Disney to reach our goal of delivering long-term growth, and increased shareholder value. And they are once again, driving creativity and innovation, applying technology, and global expansion. I would like to reinforce them, as they tie closely to our current performance, and will continue to serve as our roadmap for the future.

Nothing is more important to us than creativity. It's central to our growth over the long-term. Great creative content, whether a TV series, movie or theme park attraction is powering us today, and will continue to drive us into the future. It is essential that our creative efforts remain vibrant, relevant, and to a large extent branded, most notably Disney and ESPN, as we believe demand for branded content will grow in a universe of choice. To that end, all of us are extremely pleased with the early results of feature animation's first all CGI film, 'Chicken Little.'

However, we recognize that this early success is only a first step. Animation is, and will remain, at the heart and soul of Disney. It provides the basis for cultivating enduring characters and franchises that extend across our businesses. As such, developing high quality Disney animated films is our number one creative pursuit, and thus investing in this business is essential.

Our focus on creativity also includes attracting great talent, partnering with great talent, and creating differentiated content designed specifically for new media platforms. Delivering high quality content will enable us to occupy new technological space, and allow to us cross geographical borders. Our growing publishing business at Starwave Mobile, our recent acquisition of Living Mobile, and ESPN's 360 broadband product are just a few strong examples of our creative efforts in this direction.

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Q4 and Fiscal '05 Earnings Call November 17, 2005

The application of technology is another priority. As new distribution platforms and consumer electronics devices penetrate our markets, we expect a voracious appetite for content, and in particular high quality branded content. No new platform, whether it is a consumer electronics device or a multi-channel system, can penetrate a market and retain customers without offering great content. This creates enormous opportunities for The Walt Disney Company.

We firmly believe in a platform agnostic approach to distribution, as well as capturing a first mover position under the right circumstances. We believe that the strength of our brands and content drives our first mover opportunities and in turn affords our brands and content premiere positioning, pricing, instrumental marketing support, and platforms that promote strong brands to drive interest in their service.

Our recent deal with Apple for both ABC and Disney Channel programming, is a great example of our approach. We have a long line of potential distribution partners interested in our content. While we undoubtedly will strike new deals, deals have to offer the right economics, acceptable consumer proposition, strong protection for our IP, and an otherwise favorable environment for our content, which is what Apple provided. We will not make deals for purposes of making headlines. Instead we are focused on getting our product into the marketplace on a well timed, well protected, and well priced basis.

Apple recently announced it sold 1 million video downloads in less than 20 days since the launch of its video service, noting that 'Desperate Housewives' and 'Lost' were among the top downloads, which is fitting proof that demand exists, and that consumers are willing to use new, legitimate distribution methods and devices to access content in new ways. Technology also powers creativity and innovation. Across our Company, we are using technology to improve our product, and remain on the leading edge of entertainment offerings.

Our relationship with consumers is all-important, and we are committed to delivering the best consumer experience possible. 'Chicken Little' in digital 3D, ABC, and ESPN's wide array of programming in high-def, and our attraction 'Expedition Everest' that opens in Walt Disney World this spring, are excellent examples. Based on the positive consumer reaction to 'Chicken Little' in 3D, we now plan to release 'Meet the Robinsons' in 3D format in fiscal '07.

Applying technology to enhance our content and extend its distribution enables us to get closer to our increasingly more sophisticated consumers worldwide. Based on consumer demand, it is essential that we continuously reevaluate traditional business models and adapt accordingly. Our investments in ESPN Mobile and Disney Mobile are key examples of how we are placing bets on branded content and wireless services, to drive both a stronger connection with our consumers, as well as long-term returns. This is one of the smartest things we can do as a Company, to be thoroughly in touch with our customers, in-tune with our markets, and on top of emerging trends.

Global expansion is the third prong of our strategic priorities. While globalization remains a challenge, we have tremendous opportunities to better penetrate international markets, both developed and emerging. In emerging markets where disposable income is rising and mass communications infrastructure is growing, we plan to aggressively expand our businesses. With the opening of Hong Kong Disneyland in September, we now have an important driver for all Disney businesses in the region.

During its first two months of operation, the resort has achieved among the highest guest satisfaction scores we have ever seen, which points to the quality of our product, its word of mouth marketing potential, and it's outlook over the long-term. It is imperative that we continue to make strides to better reach, address and represent the diverse global markets we serve. As we expand our businesses and brands into emerging markets, we are making strategic investments in local content.

For instance, we are currently developing original Disney-branded movies in China and plan to do the same in India. Financial performance will be the ultimate measure of our success as our strategic priorities are put into action. We intend to be disciplined in our approach to our current cost structure and our investments.

This investment approach extends not only to our internal development, but also to how we approach acquisitions. As we have stated in the past, we do not feel the need to acquire assets just to get bigger, or simply to wade into new space. We are prepared to move wisely and quickly in order to respond to rapid changes in the marketplace. In order to do so, we are placing greater authority while emphasizing accountability at the business unit level.

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Q4 and Fiscal '05 Earnings Call November 17, 2005

I'm very realistic about the challenges that lie ahead for our Company, and I'm extremely enthusiastic about our creative capabilities, strategic direction, the strength of our senior management team, and our willingness to adapt or change our businesses or structure to best serve our consumers and marketplace conditions. Adapting to new business conditions within an established company is never easy, but here at Disney it is a real priority.

We are making creative excellence and consumer focus our primary focal points, and that orientation will help us adapt and innovate to the benefit of our shareholders. As we embark on the new fiscal year, we have considerable momentum across our businesses, thanks to continued success in Primetime at ABC, our tremendous portfolio of premiere sports programming across ESPN's now multi-media platforms, strong continued results for our worldwide 50th Anniversary celebration at our theme parks and resorts, and an exciting array of merchandise from Disney's Consumer Products division, ranging from our princess collection to video games.

At the studio we are encouraged by the early box office results of 'Chicken Little' and believe we have great films on the horizon this year, including the first installment of the 'Chronicles of Narnia: The Lion, the Witch, and the Wardrobe', Pixar's 'Cars' and 'Pirates of the Caribbean: Dead Man's Chest.' I want to ensure that Disney is admired for its performance, admired for the quality and integrity of its products and people, and admired because we are modern, innovative, willing to take risks, and not bound by old rules or outdated habits. We must be user friendly for those who work for us, those who partner with us, and those who buy our products and invest in our stock.

Now I am going to turn the call over to Tom Staggs, our CFO, to provide more details on the quarter and the year. Tom?

Tom Staggs - Walt Disney - CFO

Thank you, Bob. We continue to look at three key financial metrics in assessing our Company's overall performance and to gauge how well our strategic initiatives are translating to delivering value to our shareholders. These metrics are earnings per share, return on invested capital, and free cash flow. For 2005 we delivered double-digit growth in EPS for the third year in a row. We improved our return on invested capital, again, for the third year in a row, and we delivered over $2.4 billion in free cash flow, after consolidation of our less than wholly-owned international parks.

Media Networks has contributed greatly to our momentum quarter after quarter, and stands out as the biggest driver of our company's strong performance again this year. Perhaps the most gratifying aspect of Media Networks contribution has been ABC's resurgence, fueled by the success of shows like 'Desperate Housewives', 'Lost' and 'Gray's Anatomy.' As we projected, the network reached profitability this year, and we are on our way to delivering further substantial improvement as positive trends continue into Q1 of 2006.

ABC's Adults 18-49 ratings are up another 5% over last season, and we are seeing strength in the ad market with scatter pricing for ABC running high single-digit percentages above upfront levels. At our television stations, Q4 advertising sales were up by roughly 2%, and advertising at our radio operations was up about 1%. So far this quarter pacings for TV stations and radio continue at about those same levels.

In addition to improvement in our ad-based businesses, syndication sales of 'My Wife and Kids' boosted broadcasting operating profit by over $60 million in Q4. And, as Bob discussed, we continue to explore the potential for our shows on other platforms. This fall we have released last season's episodes of 'Desperate Housewives,' 'Alias' and 'Lost' on DVD, and I'm pleased to note that 'Lost' is ontrack to sell 1.2 million units, making it the best-selling TV Drama on DVD for 2005.

We have a number of successful shows that we should be able to offer through syndication including 'According to Jim' and 'Scrubs' in 2006, 'Desperate Housewives' and 'Lost' in 2008, and 'Gray's Anatomy' in 2009. We'll also explore further opportunities for ancillary platforms for these titles as well. Based on current ratings and assuming consistent marketplace trends, these shows combined with the shows we've already sold, could add well over $1 billion in operating income to us over the next five years across both traditional and new media platforms. Disney's commitment to investing in high quality family entertainment is also generating gains in viewership at the Disney Channel, which is delivering strong primetime and total day ratings improvement across all its key demos.

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Q4 and Fiscal '05 Earnings Call November 17, 2005

Similarly, we are continuing to bolster the programming at ABC Family with a wide variety of original reality shows, movies, and scripted series. Although this investment dampens near term results, we believe our new shows provide the kind of quality, familyoriented content that draws and holds the audiences that attract advertisers. This was evident in Q4, as ABC Family again delivered double-digit growth in both ad and affiliate revenue.

But the key driver of growth in cable once again was ESPN. ESPN recorded double-digit increases in revenue and operating profit for both the quarter and the year, even as we invested in new ventures like Mobile ESPN, ESPNU, and ESPN Deportes. Our fourth quarter was helped somewhat by the timing of revenue deferrals and recognition. We have entered into significant multi-platform programming deals for ESPN including Monday Night Football, Major League Baseball, and World Cup Soccer.

We expect that this compelling programming will further enhance ESPN's relationship with fans, not only in the context of traditional media, but also across new media platforms, including broadband and wireless. ESPN is positioning itself to deliver as sports fans look for enhanced and more convenient access to the best in live event coverage, sports news and information, fantasy updates, and more. While we are obviously investing in extending ESPN's position as the leading sports media brand across all platforms, we are also confident in our ability to deliver strong growth well into the future.

We have the majority of our sports costs locked in through long-term rights deals. Similarly, we have subscriber rates locked in, or soon to be locked in, through long-term affiliate deals. As a result much of ESPN's economic model for the next several years is relatively predictable. Of course, ESPN's growth going forward could be impacted by the ad market and depends in part on the success of our new platforms and program initiatives.

However, given the health we are seeing in sports advertising and ESPN's proven ability to deliver against key demographics, we feel comfortable with our ability to deliver double-digit average annual profit growth through 2009.

At our theme parks, we have also invested to reinforce the significant competitive advantage we have in this business. The growth in our results provides evidence of our growing return on that investment.

At Disneyland Resorts, our 50th anniversary celebration is resonating strongly with our guests and is a good example of how we can get leverage out of our existing asset base, through innovative marketing campaigns and less capital-intensive entertainment experiences. Attendance at Disneyland for Q4 grew by 15% versus last year. With each guest segment up double digits. West Coast occupancies increased by roughly 7 percentage points to almost 97%.

At Walt Disney World we also saw positive trends. Total Walt Disney World attendance grew by more than 10% for the quarter, led by resident and international visitation. We experienced only a small number of cancellations as a result of this year's Hurricanes Katrina, Rita, and Wilma. Walt Disney World occupancies rose to 77%.

Per room spending and per capita spending for our domestic parks rose by 4% and 3% respectively, led by strength at Disneyland. Looking ahead, rooms on the books at our domestic parks for Q1, are trending above prior year by mid single-digit percentages.

Two years ago, we laid out our goal of returning to 20% margins for our parks operations by the end of 2008. Providing progress updates on this margin goal on an apples-to-apples basis, has become a bit complicated, given that we are now required to consolidate our partially owned parks internationally, and we have begun the expensing of employee stock options. Excluding the effect of consolidating our international parks and the impact of stock option expense, margins for theme parks for the year increased by 220 basis points to 17.3%.

As long as the travel and tourism market remains healthy, we continue to expect to meet our margin target through a combination of higher volumes, higher asset utilization, productivity gains, and tight cost control. In addition, our high margin "flanker" businesses, such as Disney Cruise Line and Disney Vacation Club, should help us meet our goal.

Our studio results were disappointing. During our last earnings call, I highlighted several potential performance issues that could affect our studio performance in Q4. These included the release of six more Miramax films this quarter than the prior year, when Miramax results were relatively strong. In addition to the marketing and amortization costs associated with the release, a number of these titles failed to deliver at the box office. The Touchstone title 'Dark Water' also performed poorly. We are seeing very strong results from 'Flight Plan,' but released this picture late in the quarter.

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