Disney Speakers: Bob Igercdn.media.ir.thewaltdisneycompany.com/2006/q3/q3-fy06...global reach and provides far more significant opportunities for ancillary businesses. In addition

Page 1

Q3 FY06 Earnings Call

AUGUST 9 , 2006 Disney Speakers:

Bob IgerPresident and Chief Executive Officer

Tom Staggs Senior Executive Vice President and Chief Financial Officer

moderated by,

Wendy Webb Senior Vice President, Investor Relations and Shareholder Services

Q3 FY06 Earnings Conference Call & Webcast August 9, 2006

Page 2

P R E S E N T A T I O N

Operator Good day, ladies and gentlemen. Thank you for standing by and welcome to the Walt Disney third-quarter 2006 earnings conference call. My name is Carlo and I will be your coordinator for today's presentation. At this time, all of our participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's prepared remarks. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's conference, Ms. Wendy Webb, Senior Vice President of Investor Relations and Shareholder Services. Ma'am, you may proceed.

Wendy Webb – SVP, Investor Relations and Shareholder Services, The Walt Disney Company Thank you. Good morning, and thanks for joining us. A quick note that for your convenience our Investor Relations website will provide not only a replay of this call but also MP3 download capability and an archived written transcript of today's remarks. Here with us in Burbank this morning are Bob Iger, Disney's President and Chief Executive Officer and Tom Staggs, Senior Executive Vice President and Chief Financial Officer. Bob will lead off followed by Tom. Then we will open up the call to you for Q&A. We will do our best to conclude the call before 9:15 AM Eastern time. So let's get started. Bob?

Bob Iger - President and CEO, The Walt Disney Company

Thank you, Wendy, and good morning. I am pleased to report that the strength of our earnings reflects solid performance across all of our segments. While Tom will provide greater detail shortly, I'd like to briefly offer a couple of observations and some thoughts about where we see the Company going in the future. On the last several earnings calls, we've discussed our continuing efforts to invest in the quality of our brands and content to best position Disney to deliver growth and shareholder value over the long term. Our current success is a direct outgrowth of this focus. Our results also demonstrate Disney's unique ability to capitalize on great content across multiple


Page 3

businesses, platforms and markets. Some highlights – Disney/ Pixar's Cars is a great example of this ability. It's the number one animated movie of the year and ranks as the number two domestic movie of the year in total box office receipts. Cars also was a major factor in our consumer products growth this quarter with our broadest merchandise presence of any property since The Lion King. Cars is currently the number one boys property in the marketplace across all categories. And at present we are putting our plans in place for aggressive programs for the holiday season to coincide with the film's release on DVD. And down the road, you shouldn't be surprised to see a Cars based attraction at one or more of our theme parks around the world. We see enormous potential for this entertainment property and believe its enduring appeal, particularly among young boys, can generate significant returns for the Company over the long term. The Chronicles of Narnia has also proven to be an extremely important franchise for the Company on a global scale. Due to the universal appeal of The Lion, the Witch and the Wardrobe, Narnia is tracking to be the number one DVD title of the year in the U.S., with strong sales in international markets as well. Disney Channel's High School Musical continues to set performance records across multiple categories, including Billboard's best-selling record of the year. In fact, we're seeing considerable strength in all video and music categories worldwide from this franchise and this title is now our biggest TV-based DVD title. And lastly, though not a major factor in this quarter's results, Disney's enormously successful franchise Pirates of the Caribbean - Dead Man's Chest, which opened in theaters in July, is the number one movie of the year, crossing the $790 million mark in global box office receipts, including capturing the number one spot overseas for the fifth consecutive weekend. Pirates has come to represent perhaps our biggest cross-platform franchise ever. While allocating capital in the direction of creating high-quality entertainment experiences is our number one priority, we also are keenly focused on how to apply technology to both enhance the consumer experience and to use it as a tool to reach more people more often.


Page 4

Digital technology is transforming the production and distribution of media and entertainment content while globalization is opening new markets, unlocking new economic opportunity for us. With the rise in new distribution platforms worldwide, we're launching new services to better meet the needs of our consumers, as well as introducing new business models to diversify our revenue streams. These activities point to what is critical to all of our efforts, our focus on consumers. With consumers continually gaining greater control over the consumption of media, we're committed to distributing our content on a well-timed well-priced basis, on platforms that offer a great consumer experience and an appropriate environment for our content. We believe that changes in technology and demographics create new business opportunities for content owners and creators, many of which exist outside of traditional media and entertainment channels. So we see enormous potential for video-based Internet and mobile delivery content and intend to exploit new business opportunities to our advantage. We're just launching Disney Mobile, the first comprehensive domestic mobile phone service specifically designed for families. The initial product reviews have been extremely positive for our unique product, including being named Editor's Choice by PC Magazine. With the opportunity we identified in the family segment of the market, we're optimistic that our national marketing, advertising and retail plans that begin this month will drive great interest among parents, tweens and young teens in our service. Earlier this year, we launched Mobile ESPN, and while we are pleased with the quality and utility of this mobile content service, sales have been slower to develop than we had hoped. As a result, we made some broad changes in our marketing, selling and handset strategy to better position Mobile ESPN among targeted consumer groups. We think there is a great opportunity to extend ESPN branded content to mobile platforms as a way of connecting with our consumers whenever and wherever they are. Over the long term, we will continue to exploit multiple business models in the mobile space to drive revenue and affinity among our core users. Our commitment to extend the ESPN experience across multiple platforms is a key element of our strategy. The strength of our multimedia platform approach has been clearly demonstrated in the success we are experiencing in the cable upfront, where we are seeing strong demand in general with ESPN and sports, with revenue and CPMs up while the majority of cable is flat to down relative to the prior year.


Page 5

Key drivers of our success are ESPN's Monday Night Football and college football, including ABC's Saturday Night Football, where advertisers are committing significant budgets to our multimedia platforms. Based on our current projections, our multimedia strategy for our sports content will drive an increase in our non-TV sales by well over 50% as compared to prior year. At ABC, our multi-platform approach to content distribution also has led to increased ad revenue opportunities. With considerable growth in broadband penetration, ABC.com is now an ongoing important new platform for ABC viewers as they now have the opportunity to watch programs they may have missed on network TV. Providing viewers with this on-demand service speaks to both our willingness to embrace new technology platforms and our goal to diversify our revenue streams. Advertisers are looking at the success of delivering programming via ABC.com as a means of forming a deeper relationship with consumers while we are better serving our viewers with our flexible service. According to our research from our two-month trial, users who downloaded 5.7 million episodes on the service had an 87% recall of the advertising viewed, more than triple the average advertiser recall for normal TV ads. Furthermore, the average age of our users on line is 29 years old, a target audience that advertisers covet. We believe these strong results will encourage advertisers to innovate with us around this new platform and we believe the new source of revenue can contribute meaningfully to our bottom line over the long run. Turning to international markets, last month, The Lion King stage play opened at the Shanghai Grand Theater, bringing our award-winning musical to China for the first time and great Disney-branded content to that market in an entirely new way. Also in Asia, two weeks ago, we acquired the children's television channel, Hungama TV, a 24-hour Hindi language entertainment channel for kids in India, to promote our long-term strategy to build the Disney brand and our businesses in this important region of the world. Next month in Hong Kong marks an important milestone for the Walt Disney Company, the one-year anniversary of the opening of Hong Kong Disneyland. Tom Staggs and I, along with the Head of our Parks and Resorts, Jay Rasulo, just toured the new attractions that opened this summer. These attractions are generating a great


Page 6

response from our guests and are contributing to increased attendance at the park. Our team in Hong Kong is focused on bolstering that momentum as we continue to refine our marketing and sales approach to this new market. Having said that, the quality of our overall product and the high consumer satisfaction levels we're generating are encouraging and bode well for the long-term potential of Hong Kong Disneyland. Hong Kong Disneyland remains an important building block of our strategy to build Disney in this region of the world. Our emphasis on the Disney brand is common across our businesses. Recently, we announced a strategic shift at Walt Disney Studios, reflecting our long-term plan to produce more films under the Disney banner. Going forward, Walt Disney Studios will produce and distribute approximately 10 Disney live-action and animated films a year and maybe two to three Touchstone films a year, representing a more focused approach. The depth and breath of great Disney movies range from Pirates of the Caribbean to Cars to Chronicles of Narnia. Our new approach makes particular sense when you consider the above-market returns we have been able to earn on Disney-branded films. Furthermore, we believe this strategic shift ultimately will benefit the entire company as the universal appeal of titles under the Disney brand expands our global reach and provides far more significant opportunities for ancillary businesses. In addition to this strategic shift towards Disney-branded films, we are also consolidating global movie marketing and distribution, which is an important step as we continue to adapt to the changing marketplace. With this new strategy and global infrastructure in place, we have adapted our organization to best position this business for ongoing success. We are enjoying strong current financial results across our businesses. As our strategic priorities are put into action, long-term financial performance will be the ultimate measure of our success. Through our creative capabilities, strategic direction, the strength of our senior management team and our willingness to evolve or change our business models or structures to best serve our consumers, we believe we are on track to deliver sustainable and valuable long-term growth. At the same time, we will not shy away from investment opportunities that require capital investment or dampen earnings per share in the short run, if we believe these initiatives will deliver attractive returns on our investment.


Page 7

The Pixar acquisition is a great example of this type of investment. We are just a few months past the closing of the deal, but the creative resources, energy and enthusiasm generated by this combination is even greater than we expected. We are also investing in the video games business and will increase this investment next year. We are doing so with a focus on Disney-branded titles with an eye toward capitalizing on and creating core franchises for the Company. We are also investing and further developing our Web presence across our major brands. With over $1.2 billion in Internet revenues projected this year, which includes our theme park packages, our businesses are becoming increasingly significant. In addition, we believe there is a substantial upside from the Internet for rich branded content like ours and we intend to capture that upside. In fiscal 2007, we will launch a wholly redesigned Disney.com that will capitalize on the unique strength of the Disney brand and content. This is in addition to our robust entertainment offerings from our other vertical sites, ESPN 360 and ABC.com. So across our entire portfolio, we will emphasize entertainment, commerce and community. We also will continue to invest in our core Disney-branded content for television and other platforms around the world. We see increased development of high-quality branded content to markets outside the United States as an important long-term brand and profit building opportunity for us. Creative and brand strength, the application of technology and globalization are the central elements of our strategy. We've made creative excellence and the focus on consumers the primary tenants of our approach and that orientation will help us adapt and innovate to the benefit of our shareholders for the long term, just as we have demonstrated with our quarterly results today. So now I'll turn the call over to Tom to offer more specifics on our performance, particularly with regard to our strong financial results. Tom? Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company The results we've posted for the quarter and the year to date are obviously gratifying. As Bob mentioned, they demonstrate the strength of our coordinated approach to leveraging content across our lines of business. They also evidence our conviction that creative excellence and financial discipline are compatible and complementary objectives for our Company.


Page 8

We're now three-quarters of the way through our 2006 fiscal year and are well on our way to delivering our fourth straight year of double-digit earnings growth. In fact, in those first three quarters, we earned approximately the same in net income as we did for all of last year. We also expect that strong earnings will help us deliver our highest level of free cash flow in the Company's history. And the increases we're seeing are broad-based. At Parks and Resorts, consolidated revenue in Q3 grew by 11%, operating income increased 26% and we improved margins by more than 200 basis points. Walt Disney World attendance increased by 7% with growth across all guest segments, led by roughly 10% growth in both resident and international attendance. Per capita spending came in just above last year. A number of factors contributed to our success in the quarter, including the strong guest response to our newest Florida attraction, Expedition Everest, continued positive reaction to Disney's Magical Express and Magic Your Way and the timing of the Easter holiday. Our Florida hotel occupancy increased by 5 percentage points to 92% and per room spending was up 8%. Disneyland Resort’s attendance was up slightly for the quarter and we saw continued strength in guest spending, which increased by high single digits. These increases were in spite of the challenging comparisons to the successful launch of the 50th Anniversary Celebration last year. At our West Coast hotels, occupancies were over 96% and per-room spending increased by 7%. Looking ahead, our room reservations for the September quarter at our domestic resorts are running high single digit percentages ahead of last year. However, for Q4, we will be comping against the strong quarter we had last year, especially at Disneyland Resort. At this point, and barring unforeseen events, we expect that overall attendance at our domestic parks will come in at or around the levels we saw in Q4 of last year. Attendance was also up strongly at Disneyland Resort Paris, helped by the Easter shift. We also saw a favorable response in the quarter to new local marketing programs and to the opening of the new Buzz Lightyear Laser Blast attraction in April.


Page 9

In Media Networks, cable operating profit was up 15% this past quarter, driven by higher affiliate revenue due in large measure to increased rates at ESPN. We also recognized higher deferred affiliate revenues, resulting in a net benefit of approximately $65 million for the quarter versus last year. In Q4, we expect to recognize approximately $85 million more in deferred revenue than we did in Q4 of last year. ESPN finished Q3 with ratings up double digits in all key demos, with the NBA playoffs, Major League Baseball, World Cup Soccer, and SportsCenter driving increased viewership. At ESPN2, coverage of The World Cup drove double-digit ratings increases, making June the most viewed month ever for that network. ESPN successfully leveraged World Cup coverage across all of its platforms, generating significant traffic for each of them. As we look ahead to Q4 for ESPN, it's worth noting that we start the new Monday Night Football contract in September and we expect that roughly 25% of the first year's amortization will fall into Q4. At our other cable nets, we're continuing to invest in programming that is building our brands and our distribution opportunities. This is especially evident at the Disney Channel, where hits like Hannah Montana, The Suite Life of Zack and Cody, and of course High School Musical drove strong double-digit increases in ratings across all key demos. The phenomenal popularity of High School Musical has enabled us to take advantage of both established and new distribution technologies, not only in Media Networks, but across the Company. DVD sales of High School Musical passed the 2 million mark in Q3, soundtrack sales are strong, as Bob mentioned, and the title is number one in its 12th week on the New York Times Paperback Best Seller list. On the Broadcasting side, we saw strong top-line growth at the network, and in Q3, ABC again saw scatter CPMs that were double-digit percentages above last year's upfront. For Q4 to date, scatter prices are high single-digit percentages above those upfront levels. Broadcasting operating profit was down overall, however, due to higher programming costs at the network driven by our dramas, greater investment in pilots at the TV studio and increased investment in new digital initiatives, including Disney Mobile.


Page 10

Our Television Station group had a solid June quarter, with Q3 ad sales up mid single digits. So far this quarter, station pacings are roughly in line with last year. Ad sales at our radio group were down mid single digits in Q3, reflecting a soft radio marketplace. We're seeing similar pacings so far in Q4. Looking forward at the network, our enthusiasm for ABC's fall schedule has been reinforced by advertisers' reactions during the recent upfront. ABC achieved the highest increase in CPMs of any network, with overall CPM growth of 3 to 4% and total primetime commitments of $2.3 billion. If we can further improve our ratings momentum off of last year, we think our prospects in the scatter market are very promising. We also held back our new media opportunities, such as MyABC.com in order to sell them in the scatter market, which should serve us well as the year unfolds. Studio Entertainment proved to be our best year-over-year performer for the quarter. DVD sales were strong with worldwide DVD units growing 9% to over 69 million units, led by The Chronicles of Narnia, which sold over 18 million units. Home video also benefited from lower distribution costs and fewer returns. We generated very solid box office results from our theatrical slate this quarter, led by Cars, and we benefited from less expensive Miramax titles versus the prior year. Our success at the Studio directly influences results in Consumer Products and that was certainly the case this quarter. Licensing operating income was up by more than 35%, due in large measure to the performance of Cars and Pirates merchandise. This leveraging of successful film titles in other segments is an important factor in the shift to Disney-branded films. At Buena Vista Games, we were successful with a number of Disney-branded licensed and self-produced titles, including Pirates of the Caribbean, Narnia and Cars, although our increased investment and title development dampened results somewhat as we invest for future growth in this business. Our fundamental goal is to allocate our capital in areas where we think we can generate attractive growth and returns for our shareholders. At the same time, we continue to evaluate our existing portfolio of assets. With this in mind, we recently entered into an


Page 11

agreement to sell our non-controlling 50% interest in Us Weekly for roughly $300 million and we expect that deal to close this fall. The magazine has been managed superbly by Jann Wenner and his team and as a result, the roughly $40 million investment we made in this asset in 2001 has generated an outstanding return. We are also continuing to return capital to our shareholders in the form of both dividends and share repurchase. During the third quarter, we repurchased approximately 80 million Disney shares for a little under $2.4 billion. Taking into account the shares we purchased since the end of the quarter through the market close yesterday, we have bought in nearly 220 million shares this fiscal year at a cost of roughly $6.2 billion. Looking ahead to fiscal 2007, the Q1 home video release of both Cars and Pirates 2 will be important determinants of studio results, as will the theatrical release of Pirates 3 next May and Ratatouille later in the summer. In October, we launched the Where Dreams Come True marketing campaign for our theme parks around the world, which we think can continue to drive demand for Disney Vacations coming off our highly successful 50th Anniversary Celebration. At ABC, the performance of our new schedule will play an important part in our efforts to continue the resurgence of this business. And of course, at both ABC and our cable nets, the strength of the ad market could be an important swing factor. In Consumer Products, we will invest significantly over the next 12 to 24 months to ramp up our product and design capabilities and merchandise licensing, in order to further our efforts in direct-to-retail and other key account initiatives. And as Bob mentioned briefly, we will continue to invest in new digital and international initiatives across the Company. We're pleased with the trends we're seeing across the Company and we think they reflect our efforts to adapt to changes in the media business, best serve our customers and invest wisely for future growth, while closely managing our existing businesses. Even as we innovate for the future, our primary goals remain unchanged and straightforward, to provide outstanding and differentiated content to consumers around the world while delivering increased value for our Company's owners. With that, we'd be happy to take a few questions.


Page 12

Wendy Webb – SVP, Investor Relations and Shareholder Services, The Walt Disney Company

Thanks, Tom. We're ready to take the first question, operator.

Q & A

Operator (OPERATOR INSTRUCTIONS). Anthony Noto, Goldman Sachs.

Anthony Noto – Analyst, Goldman Sachs

Bob and Tom, Bob, you had mentioned that the Company achieved $1.2 billion of Internet revenue and that included bookings for the parks. I was wondering if you could give us that number without the parks and in your view, how well do you think you monetize all the engagement you have with users through any digital distribution channel, whether it's the Internet or mobile, vis-a-vis where it can be long term. And then Tom, you mentioned a number of factors that would impact 2007 and be important for us to consider. Do you still feel comfortable with double-digit operating income growth in 2007? Thank you. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company For the first question on the Internet revenues, the theme park packages are a little over half of that number. So we're north of $500 million of Internet revenues, excluding the theme park packages. But obviously that's a big part of the business.


In terms of how well we are, in effect, monetizing our connection with our consumers on these new media platforms, it's just the tip of the iceberg, as I see it. We are really focused on creating environments that are more conducive to both the consumers and to advertisers -- Disney.com, ESPN, ABC.


Page 13

I mentioned in my remarks that we're working on a relaunch of Disney.com and actually it's very, very extensive. We expect that sometime toward the end of this calendar year, we will relaunch that site, with extremely compelling opportunities on the video side, on the commerce side, on the community side, and that will be the first of what I think will be a number of significant steps to better monetize our presence with our consumers or our ability to, in effect, exploit the experience on a Company-wide basis. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company You asked about 2007. We're not giving guidance on 2007 specifically; in fact, in general, we're not big fans of specific guidance year by year. But you wanted to talk a little bit about the swing factors. We're obviously in the middle of the budget season right now here, and, so, we're in the middle of having 2007 take shape in terms of where we specifically think it will come out. But I think that in broad measure, given sort of the way that the market reacts to guidance, our opinion is this -- we're best talking about swing factors and letting you all come up with your best estimate of where things will come out.


Tom mentioned a number of those factors in his remarks and I certainly support Tom's comments about guidance. If you are thinking about Disney in fiscal '07, you obviously have to consider the fact that we've got Cars and Pirates DVDs coming out, two of the most successful movies of the year, maybe the number one and number two most successful movies of the year, with great opportunities.

You also have continued aggressive merchandise platforms for both of those properties, that should last well into '07, particularly with the release of Pirates 3, which comes out on Memorial Day weekend.

On the ABC front, they had quite a decent upfront in an overall marketplace that was just okay. They ended up selling roughly flat to last year in terms of total dollars with some CPM increases. They used less inventory to do so, so they certainly have the inventory to capitalize on scatter. They also have great upscale demographics and they did not sell their digital packages to ABC Streaming, specifically because they felt there was real demand there and it would help drive scatter.


Page 14

We had a good development season at ABC. They have some strong returning shows. Desperate Housewives in particular is going to be in better shape than it was last year. So that's another factor.

At the parks, we've talked a lot about the impact of the 50th, but in general, the parks have some momentum, primarily because they've got great product. What we have introduced into the marketplace in the last couple of years has been very strong and this Year of a Million Dreams has gotten great response on the Internet.

And then lastly, Consumer Products, while we are investment spending on the video game side and to strengthen our overall licensing efforts, they have some great opportunities, as I said at the beginning, with Cars and Pirates and licensing in general. So I think that's what you have to think about when you think about Disney for '07.


Thanks. We'll take the next question, please.

Operator William Drewry, Credit Suisse.

William Drewry – Analyst, Credit Suisse

Thanks, a couple questions. Just on that last theme there in terms of '07, I think that in spite of fantastic earnings from you all, the market for investor worry is focused as much as anything on theme parks, I guess the thought being that you have really tough comps next year. Maybe Bob or Tom, could you just expand a little bit more on that? How much leverage in the model is there as we go into next year in terms of pricing leverage if attendance is flat, as you talked about for the fourth quarter. Do you need attendance growth to really drive a good bottom-line there, or will flat attendance be good enough in terms of being able to drive better pricing from rooms and food and beverage? That was one question. A second question was, Bob, just wondering as you grow out your Internet business and you look at how you get there, do you all ever think about or consider a big


Page 15

Internet partner, a Yahoo! or a Google to really get on one of these horses to ride in terms of building out the traffic that you can drive through these concept sites. Thanks. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company So just a couple of thoughts on parks. The parks model is, I think as you were pointing out, a model that has a fair amount of leverage, incremental attendees for a fair amount of profitability to the bottom line. Having said that, I think one of the most important factors that we will be looking at next year will be consumer confidence, consumer spending in the economy. And I don't want to make predictions about that -- you all can do that. But, to the extent that those factors cooperate, we really like the way the theme parks are positioned overall. They're a unique experience; they stand alone in terms of a theme park brand in the mind of the consumer. And as I said, I think we're really quite well-positioned. I think that what we do on pricing, what we do on packaging, what we do on marketing, will be impacted by what we see in the economy. But in my mind, that is -- and I don't fault anyone for it -- a relatively short-term focus. We think the theme parks are extremely well-positioned with a great competitive advantage out into the future. And so when I think of the theme parks out three, five, seven, ten years, we continue to see a business that we think will generate significant free cash flow for the Company, attractive growth opportunities, to the extent we see a growing economy, and a business that we can sustain that competitive edge and earn great returns. So I guess that would be the most I would say on the theme parks. We like the marketing program, promotion that they're getting underway in October. I think that it resonates very well with consumers and wishes and dreams are central to what people think about our theme parks and we're hopeful that call to action really works with people.


One other point on that, Bill, before I answer the second part of your question. When we raise prices, particularly for the single day ticket, it tends to get a fair amount of attention, as the price increase that we just announced at Walt Disney World did. In reality, a relatively small percentage of the people who go to Walt Disney World buy a


Page 16

single-day ticket. What we're really trying to do is to guide behavior into a more multi-day ticket approach and multi-day stay. So you can now buy multi-day access to Walt Disney World whether you're a local resident or a non-local resident, for somewhere in the neighborhood of $30 to $40 a day. So what we're really trying to do is -- and Magic Your Way really accomplished a lot of this -- is we're trying to extend length of stay, attract more people to stay longer than for the single day and it's been relatively successful. That is really what our focus is rather than simple price increases. On the Internet side, you asked about whether we would consider partnerships with Yahoo! and Google. In reality, we have a number of initiatives with both. We have had a number of discussions with both. We have discussed broad, sweeping partnerships with one of the big aggregators or portals. But for the most part, those discussions have ultimately resulted in the conclusion on both parts that it doesn't necessarily make sense. One of the big issues that we have when we enter into these discussions is, who controls the advertising and who owns the customer. We believe because of the strength of our brands and the strength of our creativity that we have opportunities to do both, that we don't necessarily have to share with any third parties either our advertising revenue or our relationship with the customer. And while we believe that there are opportunistic ways that we could get involved with all the portals in sort of specific or more narrow ways, I don't think you should really think that we're going to end up in a broad, sweeping partnership with one because our opportunities without them are pretty significant.



Operator Lowell Singer, Cowen and Co.


Page 17

Lowell Singer – Analyst, Sanders Morris Harris

Bob, I think you had made a comment earlier about video game investment going up next year. I'm wondering if you can quantify that and can you just give us some sense as to how you guys are thinking about the video game business over the long term, how you arrived at the build versus buy decision and ultimately how big you think that business can be.


We're not going to get specific in terms of how much our investment will go up. One of the things that we're managing here in terms of increased investment is our own creative capabilities. So simply increasing investment is not what we're really interested in, unless we really believe we've got the ability to create at a high level. In terms of what we are thinking overall, you have to focus on the fact that about 80% of our output will be Disney branded and about 80% of that will be derivative of product that has already been created for other businesses or other platforms at the Company. So, we intend to mine fully our known entities and our strong brand. What we really see in that business is an opportunity to grow significantly in the kids and tweens direction, as opposed to what I'll call the core gamer direction. In terms of license versus build, I don't think you'll see 100% build because there are still some interesting opportunities to license, in part to take advantage of some of the creative capabilities elsewhere that we don't have. That said, when you have a successful game, you're far better off if you built it yourself than if you've licensed it. So, I think a significant portion of what we do in the video games business will be internally created and fully owned and controlled. But we don't rule out the possibility of continuing to be in business with third parties on a licensing basis. We're also going to continue to look for opportunities to buy talent, and to buy developers. We have done some of that in the last couple of years. We're continuing to look carefully at that. There's been a fair amount of vertical integration in that direction and there are fewer developers available, which is probably one of the few things that could get in the way of us building ourselves at a faster pace. Again, it goes back to


Page 18

what I said at the beginning, which is managing our investment to in some form conform to what our creative capabilities are. And again, looking for franchise opportunities.



Operator Doug Mitchelson, Deutsche Bank.

Doug Mitchelson – Analyst, Deutsche Bank

Nice numbers. First, I was wondering, given a few articles yesterday, whether past options/ grant practices with Pixar would have any material impact on your Company. I just can't imagine that it would but if you have any comment, that would be helpful. Second, in the vein of hope for the best but plan for the worst, have you prepared the cost structure of the parks in case of a slowdown in attendance given the structural uncertainty in the consumer economy? And specifically for the September quarter, if you think attendance will be around flat, what does cost growth look like for the domestic parks? Thanks. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company Thanks, Doug. It's obviously inappropriate for us to comment on Pixar's stock option grants, which were awarded before the Disney acquisition. But having said that, and to your point, we aren't aware of any basis under which stock options that were issued by Pixar would have a material impact on our financials. Obviously, we amortize stock options, but other than that. With regard to the cost structure of the parks, there is a fair amount of flexibility in the cost structure of the parks. I would say that when we're talking about a fiscal fourth quarter, that tends to be a relatively high attendance quarter for us. We had a very good quarter last year and when we think of attendance being flat this year, I think that


Page 19

corresponds with a strong level of attendance. So that's not a situation where I would be overtly pushing the parks to slash costs. I think that they seek to operate efficiently and do a good job of that. They will, to the extent that they think the situation warrants, react as they have in the past, to take action on the cost side, but you know, the long-term is best served in making sure that even if they do that, the Disney experience and Disney promise to consumers comes through. So I think they've got a good sense of how to balance that. It is a cost base that as we continue to grow attendance and we think over time, you're going to see low single digit growth in attendance over the long haul with the parks, we do get leverage out of that and I think there is an opportunity there.


Tom, you made a good point at the beginning. We had record attendance at domestic parks last Christmas season, and duplicating that this year would be a feat that we would be very pleased with. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company

Exactly.


Thank you. Next question, please.

Operator Jessica Reif Cohen, Merrill Lynch.

Jessica Reif Cohen– Analyst, Merrill Lynch

Two questions. Bob, you said that ESPN Mobile was disappointing. What do you need to see to make the decision to continue to invest or cut your losses? And can you give us a range of investment losses for fiscal '06 and expectations for '07?


Page 20

The second question relates to that Internet revenue, the $500 million plus of non-theme park revenue. Tom, can you break down the revenue by advertising subscription and content and tell us if there is any bottom-line contribution? Thanks.


To your first question, I was fairly specific in the last quarterly earnings announcement about ESPN Mobile and I will repeat some of the things that I said. We launched this about -- it's only about six months old. And there are issues that we had to deal with in terms of our retail strategy, our overall marketing approach, our pricing approach, as well as the quality of the handset. So there were a number of issues that clearly were a factor in the rather disappointing sales. We addressed all of them. We have increased our retail outlets by about 500. We've just introduced a new handset, which is RAZR-like in nature, Samsung manufactured; I think it's called an ACE. We've completely changed our marketing and we have reduced our pricing. Our investment in '06 was approximately $150 million.1 We're not going to get specific at all about '07. What we know is that ESPN works on the platform in that the product itself and the experience for the consumer is quite positive. And so ESPN's presence in mobile platforms is a given into the future. Under what circumstance or in what model, it's really too soon to tell. We're going to continue to evaluate this very carefully. And I'm not going to get specific in terms of the timing of a decision or what factors we have to see, but I will say again that the results, at least initially, even though it's only been six months, were disappointing and we're monitoring this carefully. _________________________________________

1 This amount represents the Company's total investment in MVNO initiatives in fiscal 2006, including Mobile ESPN and Disney Mobile.


Page 21

Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company Jessica, you asked about Internet revenue breakdown. It's about a third, a third, a third, between advertising, paid content and commerce.


Thank you, next question, please.

Operator Kathy Styponias, Prudential.

Kathy Styponias – Analyst, Prudential

A question on your studio strategy. How the strategy pans out, obviously, is going to depend upon the cost of the films that you put out as well as how well they do in the box office. But I was wondering, Tom, if you can give us a sense of, given the cost reductions that you have announced, specifically the headcount, would it be fair to assume that reduces your cost structure at the studio by about 100 million? And then the second question I had is you guys did a great job of articulating what factors we should take into consideration for ABC next year on the top line. I was wondering if you can talk a little bit about the cost side in terms of what we should expect in programming cost increases, especially in light of the fact that you no longer have Monday Night Football on the schedule. Thanks. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company Sure, Kathy. With regard to the studio strategy, it is safe to assume that we will have a lower cost base. As you know, many of the costs of the studio are capitalized into the films and then they come through the film. So I'm not speaking of timing, but your estimate of $100 million is in the right ballpark for what we think the net effect will be in that regard.


Page 22

With regard to ABC primetime costs, I think the best way to look at it is that we expect to be roughly flat with regard to cost per prime time hour. And I say that because Monday Night Football did skew it some. So if you take Monday Night Football out of the mix, the overall number is down somewhat. But if you think about cost per primetime hour that we're programming with entertainment programming, that's relatively flat year over year based on our current estimate of where the schedule will come out.


Thank you. We'll take the next question, please.

Operator Imran Khan, JPMorgan.

Imran Khan – Analyst, JP Morgan

A couple of questions. Number one, I think, Bob, you talked about that you want to be the principal of advertising relationships and making partnerships with Internet companies doesn't make sense. I was wondering if your sales force stays well equipped to sell the Internet properties or are you planning to hire a separate sales force to sell the Internet properties, because 80% recall is pretty interesting. Secondly, Tom, you know in the past you've talked about double-digit operating profit growth for ESPN. I was wondering, do you think it will be primarily driven by revenue or do you see some cost cutting opportunities as well?


On the first question, Imran, first of all, we do have some opportunities with some of the big Internet players that we are pursuing. And I actually support that wholeheartedly. I just don't believe that you should consider us doing, or expect us to do, a broad sweeping partnership in some form.


Page 23

In terms of our sales capabilities, we think we have excellent sales capabilities to sell in this space. One of the most interesting experiences we've had is at ESPN, where the growth of multi-platform packages and sales has been rather significant. It's interesting because particularly in this upfront, it's a real factor. ESPN is finding that the strength of its brand as well as its ability to provide advertisers with multi-platform opportunities is of great value to them. So we really believe that we do have the sales capability. At ABC, the online experience was essentially to sell ads in video that was being basically made available to consumers on a different platform and the skills involved in selling those wasn't that different than the skills involved in selling traditional media. That said, we are adding to our sales staff in order to essentially contend with these opportunities, adding some expertise and essentially we're very focused on basically getting better at selling advertising on a multi-platform basis. I am confident that there is a tremendous opportunity in both online video and in mobile video. And that is going to create revenue generating opportunities that are in some cases advertiser generated, in some cases subscription generated, in other cases on a video-on-demand basis. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company With regard to ESPN, when we think about ESPN growth, it is absolutely a combination of revenue growth--we've got affiliate contracts in place for the majority of our subs and expect to complete other agreements in the not distant future--but also that we get some leverage on the cost line. Having said that, we have entered into some new rights agreements. We think they're quite valuable and will help secure ESPN for the future. But between the NFL, Major League Baseball, NASCAR, etc., and some of the other important rights that we have secured, that will have an impact on their cost structure. And George Bodenheimer and his team are very focused on leveraging their existing cost base to make sure that they're efficiently delivering profitability to the bottom line, even as we invest to build the business. So over time, once we absorb those sports costs, you'll see us focused on margin improvement from there as well. So it's both sides of the coin.


We'll take next question, please.


Page 24

Operator Aryeh Bourkoff, UBS.

Aryeh Bourkoff – Analyst, UBS

A two-part question on ESPN. Maybe if you could talk about just about what kind of ratings you are expecting from Monday Night Football and if you're putting out any sort of guarantees around that? And secondly, I would expect that given the product with Monday Night Football, that it's an opportune time to start of shore up the negotiations with Time Warner and Comcast on the affiliate deals, and sort of update on that. And what are the dates that we should keep in mind in terms of when those things actually start to expire? And then lastly, Tom, if you could give us an update on the radio sale? That would be great. Thank you.


I'm not going to get specific in terms of Monday Night Football rate increases at ESPN, except that there has been real strong interest among advertisers for Monday Night Football on ESPN. And I mentioned a few times today that their cable upfront has been -- the upfront for ESPN has been quite strong. We are in ongoing discussions with Time Warner and Comcast. You don't have to in any way worry about the expiration of contracts. In reality, we are extending what was longer-term agreements, long-term agreements, with both of them. There are a number of moving parts in this negotiation. A lot has to do with digital media and a new world that we are in and it gets pretty complicated. But the discussions have been -- continue to be productive. I sound like a broken record. I probably said that in the last couple of earnings calls. They are complicated discussions but productive discussions and not at all contentious. And Tom--on radio.


Page 25

Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company On radio, we're working through the process. My best guess is still that the deal would close by the end of the calendar year.


Thanks. We will take the next question, please.

Operator Tuna Amobi, Standard & Poor's.

Tuna Amobi– Analyst, Standard & Poor’s

One question for Bob and one for Tom. Bob, on the digital strategy, given that social networking is one of the fastest-growing segments of the Internet, it seems to me that Disney is particularly well-positioned to kind of play this space. And with your inclination to not enter into partnerships with some of the larger Internet companies, how then do you see yourself monetizing this space, given that it seems to fit quite nicely with what you're doing in video games and your target for online video and mobile video? That's question number one. And for Tom, I would just like to clarify that the $500 million Internet revenues, does that include those three shows that you had mentioned in the past, Desperate Housewives, Lost and Grey's Anatomy? And are you still looking for those shows to provide about $1 billion in operating income over the next five years? And if you can also provide for those shows, the revenue impact that you expect, would be helpful. Thank you very much.


I took -- for the first part of your question, to essentially be focused on community elements of our digital strategy. And we are aggressively adding community facets or


Page 26

elements to our three, what will be our three primary sites, Disney.com, which will include Disney Channel, ABC.com and ESPN.com. There's a significant amount of both creative and technical work being done there and ultimately advertising. ESPN, for instance, thinks it has a tremendous opportunity to create essentially community experiences for people around sports, specific sports teams, geographic regions, games, particularly online fantasy games. On the ABC side, there are already examples of community, particularly around soap operas, but they're growing their capability to create those experiences for all of their programming. And certainly on the Disney side, for family entertainment and all kinds of other opportunities, they are significant. So I think the primary focus right now in terms of what we're doing with the Internet is to increase or improve creativity in general, that includes a lot of online and mobile video, and create better opportunities for advertisers. And then the third part would be community functionality. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company With regard to -- the Internet revenues that we're talking about do include the downloads. The downloads haven't been a major revenue driver yet. I think there is a fair amount of upside there. So while they factor into the north of $500 million that we were talking about, I think there is more upside there as we go further in that business. So we're pretty excited about where that might take us. Yes, we still feel that the next five years will see about $1 billion in profitability from the syndication business, given the shows that we have out there. And so, our perspective there remains pretty robust. The Internet download business could become a major contributor to overall revenue when we think of syndication and post television window business.


Thank you. We'll take the next question, please.


Page 27

Operator David Miller, Sanders Morris Harris.

David Miller – Analyst, Sanders Morris Harris

Congratulations on the stellar results. Bob, just one simple question. Obviously, Pirates 2 and Cars will be both analog and Blu-ray DVD events in fiscal Q1 of 2007. Yet, as you know, player penetration within the Blu-ray market is obviously pretty limited at this point. Are you going to be using these titles as levers to expand the market? And do you see -- I guess I'm trying to get at what, if anything, do you see doing to help expand the market using these two titles as levers? Thanks very much.


Eventually, Cars and Pirates will obviously be released in the Blu-ray format. Although, in the initial array of movies that will be made available, which will be the fourth quarter of '06 and early first quarter of '07, they're not part of it because their releases come a little bit later. I believe that they will help. In the end, you need a few things in terms of platform penetration. You obviously need great hardware and you need great software. It's still really early, obviously, in the life of the next generation DVD, to predict, I think, in all likelihood, adoption of next gen DVD formats will be slower to market than the first generation DVD format or standard def DVD, which was obviously rather dramatic. But long term, I really believe in the value of high-definition television in general, whether you're watching it in effect out there or through a multi-channel provider or whether you're watching it on a disk that you've purchased.


We have time for just one more question, operator.


Page 28

Operator Spencer Wang, Bear Stearns. Spencer Wang – Analyst, Bear Stearns Just a question on the theme parks. Tom, you mentioned that room reservations are up high-single digits but you expect attendance to be flattish. Can you just give us some color on the disconnect there? Is that local visitation or just overall traffic into Anaheim and Orlando? Also, Tom, ESPN, you guys have talked about double-digit EBIT growth. Do you expect that in fiscal '07 given the incremental NFL amortization? Thank you. Tom Staggs – Sr. Executive Vice President and CFO, The Walt Disney Company Thank you, Spencer. With regard to the room reservations booked versus attendance, I'd make a couple of observations. One is that this quarter that we're currently in was particularly strong at Disneyland and that's where the 50th Anniversary was really getting into full swing. So if you look at the attendance there, I would expect that to be a difficult feat to match for the fourth quarter. We also had a very strong quarter at Walt Disney World. Now, room reservations on the books include new individuals, who we have attracted to market place. It also includes individuals who might be staying on property as a result of our marketing campaigns, who last year might have been staying off property. And so when we try to sort of sift through all that and figure out where that leads to overall attendance, our best guess right now is about flat with last year. You know, we've purposely shied away from giving specific yearly projections for ESPN. What we have said about ESPN, I believe, was that we expected on average double-digit growth. As Bob mentioned and I mentioned, we are not giving specific guidance for 2007 at this point in time, nor are we inclined to do so. But we feel very good about where ESPN sits and we feel good about ESPN making good on the growth promises that we've made in the past.


Page 29


Thanks, again, for joining us today. Note that a reconciliation of non-GAAP measures referred to on this call to equivalent GAAP measures can be found on our Investor Relations website. Let me also remind you that certain statements in today's press release and on this conference call may constitute forward-looking statements under the securities laws. These statements were made on the basis of management's views and assumptions regarding future events and business performance as of the time the statements were made and management does not undertake any obligation to update these statements. These statements are subject to a number of risks and uncertainties and actual results may differ materially from those expressed or implied in light of a variety of factors, including factors contained in our annual report on Form 10-K and in our other filings with the Securities and Exchange Commission. This concludes today's third-quarter conference call.

Operator Ladies and gentlemen, we thank you for your participation in today's conference. This concludes your presentation and you may now disconnect. Good day. Certain statements in this presentation may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are made on the basis of the views and assumptions of the management of The Walt Disney Company regarding future events and business performance as of the time the statements are made and it does not undertake any obligation to update these statements. Actual results may differ materially from those expressed or implied. Such differences may result from actions taken by the company, including restructuring or strategic initiatives (including capital investments or asset acquisitions or dispositions), as well as from developments beyond the company's control, including: adverse weather conditions or natural disasters; health concerns; international, political or military developments; technological developments; and changes in domestic and global economic conditions, competitive conditions and consumer preferences. Such developments may affect assumptions regarding the operations of the business of The Walt Disney Company including, among other things, the performance of the company's theatrical and home entertainment releases, expenses of providing medical and pension benefits, and demand for products and performance of some or all company businesses either directly or through their impact on those who distribute our products. Additional factors that may affect results are set forth in the Annual Report on Form 10-K of The Walt Disney Company for the year ended October 1, 2005 under the heading "Item 1A—Risk Factors“ and subsequent filings. Reconciliations of non-GAAP financial measures to equivalent GAAP financial measures are available on Disney’s Investor Relations website.

Documents

Disney Speakers: Bob Igercdn.media.ir.thewaltdisneycompany.com/2006/q3/q3-fy06...global reach and provides far more significant opportunities for ancillary businesses. In addition