disney speaker: tom staggs,cdn.media.ir.thewaltdisneycompany.com/2006/events/tos-ae...well, pixar is...

Atlantic Equities Conference Call

OCTOBER 2 , 2006

Disney Speaker:

Tom Staggs, Senior Executive Vice-President and CFO,

The Walt Disney Company

moderated by, Hamilton Faber

P R E S E N T A T I O N Hamilton Faber – Analyst, Atlantic Equities We are very pleased to be hosting today's call with Tom Staggs, Disney's Chief Financial Officer. Disney has been one of the best performing media names so far this year and the company shares have risen by more than 28%. Atlantic Equities has an overweight recommendation on the company on the basis of: 1) excellent visibility from ESPN, 2) continued margin expansion at theme parks, 3) a strong syndication pipeline, 4) expected forthcoming DVD titles and strength from those, and 5) the company's leadership in adopting new digital distribution.

General Discussion with Hamilton Faber of Atlantic Equities

October 2, 2006

Before we go into the call, please bear in mind that the company is actually currently in its quiet period. As such, Tom will not be able to address near term trends or, indeed, the closed quarter. The format of today's call will be a question and answer session and, to that end, Operator, please, could you now provide callers with the instructions for asking a question. Operator [OPERATOR INSTRUCTIONS] Hamilton Faber – Analyst, Atlantic Equities I think what I will do is I will kick off with the first few questions, if that's okay. Tom, a little less than a year ago, when Bob took over as CEO, you outlined three main areas of focus – 1) crafting and nurturing branded content; 2) leveraging technology; and 3) globalization. I wonder if you could explain how you've executed these priorities into financial results and what your strategic priorities are going forward. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Thanks, Hamilton, and thanks for having us today. What you've seen going on, per some of the opening comments you made, is that we have continued, as you suggested, to focus on these three areas that we think are the central growth drivers for the company. Now, that's borne of the view as to what we're seeing going on in the environment. There's a rapid pace of change in media entertainment and what that technological change adds up to, more than anything else, really, is increasing choice for consumers. Consumers have much better access to the content and programs they want. They can get it when they want it and they can consume it how they want it on an expanding array of devices.


October 2, 2006

So we, for some time, have felt that the most important things for our company to focus on are making sure that we are creating the best possible content under the strongest possible brand and that we are doing it in a way that leverages this technological development so that we are on a broad array of platforms. The emphasis on strong content is probably obvious. As consumers get more choice, the best content is accessed more often because it's more available. And the emphasis on brands is equally important, because in this world where there's so much consumer choice, it's important to have brands that stand for something and convey a clear message to consumers and help them make their choices in terms of consuming entertainment. The globalization point you raised is equally important. The [inaudible] of our potential markets around the world is dramatic at this point and our ability, again, to reach consumers, and now we're talking about consumers in all parts of the world, is increasing and we think that bodes well for the long-term growth of the company. So a lot of the steps that we're taking to make sure that we are increasing our presence globally may not have a very big effect on our financial results today, but down the road, I think they're going to be very big, indeed. Our priorities as we go forward, then, are going to really remain the same. We're going to continue to invest in branded creative content and we're going to try to make sure that we continue to nurture a business model that I think is somewhat unique in the industry, and that is we have an integrated set of businesses that allow us to leverage creative successes across a broad array of different businesses and outlets. And if you look at sort of the strong results that we're having in 2006, I think that's evident now. I think most people know we had the number one and number two movies of the year domestically, but if you look at how we've taken those properties, Cars, as an example, which was very successful, that has enjoyed the broadest and most successful merchandise presence within our consumer products division of any property we've had since Lion King. We have the DVD release coming out on November 7 and suspect that that will be quite successful, as well. Of course, there's a Cars videogame based on that, and I could do the same thing with Pirates.


October 2, 2006

But it just is interesting that something that had smaller initial aspirations, High School Musical, has become just as much a phenomenon and been leveraged just as dramatically across different businesses as a company. This year, about 40 million people watched the show on television so far, and it's now the fastest-selling television DVD release of the year. It's a New York Times bestseller. It's the biggest selling album of the year. The point is that we try to make sure that we're running our business on an integrated basis and when we have creative successes, we are able to multiply those creative successes across the board. And the other important thing is that as a company, we're trying to make sure that we're positioned to attract and retain the best possible talent, especially creative talent, in the business. And earlier this year, as you know, we did the Pixar acquisition and I think that's indicative of our desire to make sure that the strong and creative talent is actually applying right here at our company, so that we can keep this cycle going. So 2006, I should note we're pleased to see, is going to be another year of double-digit growth, the fourth straight for us on an apples-to-apples basis and we continue to see growth in our cash flow and growth in our returns on investment capital. So the strategy seems to be working. Hamilton Faber – Analyst, Atlantic Equities You mentioned the Pixar acquisition, which, obviously, clearly, bolstered up the creative and content side of your business. Could you give an update as to how the integration has gone so far and how the incoming executives have potentially helped your own animation efforts, as well? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, we've really been quite pleased and, if anything, I think the integration would be ahead of our expectations. We really -- it's an extraordinarily talented group of people up there at Pixar, led by John Lasseter and Ed Catmull, and I think that that acquisition has not only brought that talent to the company, but it's invigorated the animation


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group here and other creative groups around the company, and so we're really pleased in that regard. It seems to us that what we hope to have happen in terms of a creative catalyst from that acquisition is absolutely what we're getting from it and I think the output will reflect that over time. Hamilton Faber – Analyst, Atlantic Equities Okay. And in terms of the impact that they've actually had on existing Disney pictures, have they had a chance to change the way anything is done so far at your animation studios? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, Pixar is really extraordinarily good at managing the creative process and I think that a lot of those best practices are being brought into Disney feature animation. And so it's very much a director-driven culture. That is, I guess the best way to translate is that it's an idea-driven culture and the focus is fundamentally on the product. As you may have noticed, we were careful to note that when people asked, at the time of the acquisition, what the release schedule would look like, we've got a sense of where we'd like to be, but the fact is that we are going to make sure that it's projects and the strength of the projects that dictate our release schedule, more than anything else, and making sure that we're making great product is, obviously, paramount. And so I think that that director-driven culture is something that they've reoriented the feature animation group toward and that the best practices, over time, and some of the technology that they've developed, will find its way into the Disney releases. Hamilton Faber – Analyst, Atlantic Equities Great. And, Tom, just moving to, I guess, the second leg of the strategy that Bob outlined on technology, we've had some fairly impressive numbers coming out of your ABC.com trial.


October 2, 2006

And I wondered whether you could just kind of give a rundown for investors over here, who may not know the story quite so well, as to exactly how that has fared and, basically, how you kind of see that going forward. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Right. Well, for those of you who don't know, during this past spring, May and June, we put the ABC.com broadband player out and during that period of time, we had requests for episodes that totaled about 5.7 million, which is pretty impressive. But we also did a survey during that trial period and found that something like 80% of the people had a positive view of their viewing experience. Nearly 90% said they'd recommend the site to others. We had an interesting demographic. The average age for people that used the site was 29 years old. Remember the average age for people watching television is just over 40, I believe. So it's, obviously, a younger audience. More than half the audience were college graduates and it was nearly evenly split between men and women, or males and females. We had some kids watching, too, the younger shows. And the biggest reason that people said that they had initiated a view was that they missed an episode on television. So that bolstered our view and our observation that this wasn't cannibalistic. In fact, we think that there's a good likelihood that what this did was keep the programs more available and keep people involved in the shows more deeply, and so we were really pleased. The other thing that's important, though, is that we did have advertising sponsorship. We had single-sponsor advertisers, but 87% of users surveyed were able to recall the advertisers. Now, that is well over double what the recall is for television. So it was really a strong, strong result all the way around. We're getting ready to sort of take a look at what we're seeing this season and, as you may know, the ABC season is off to a strong start. We're going to stream 7 shows this season, including some of the most popular ones, Lost, Grey's Anatomy, and Desperate


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Housewives, but we're also adding Ugly Betty, Six Degrees, The Knights of Prosperity, which has yet to premiere, and The Nine. So I think we're excited to see where this takes us. Hamilton Faber – Analyst, Atlantic Equities Yes. It seems that this game has gone very well so far. And just looking at the other leg of digital distribution that you've been examining, your iTunes relationship, there's been quite a lot of press speculation about potential feedback from Wal-Mart since you signed up to offer your films on iTunes. Could you give us an idea of what pushback you have had from Wal-Mart and where you see that part of the business going? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, I think -- in fact, Wal-Mart has made a public statement on this that they absolutely believe in the exploitation of new technology. I'm sure they're watching with interest, but we haven't received pushback from them. I think it's important to note that even though the movie downloads are somewhat new for us, we've got some experience that comes from television, as we just discussed. Now, last year, the most requested show for download on ABC.com was Lost and it was, far and away, number one. And we just came out with the DVD for Lost just a few weeks ago and the second season of Lost on DVD, which was available on ABC.com, is off to an even stronger start than the first season's DVD was last year. And so, again, the evidence is that it's an alternative form of viewership, but it doesn't seem to be substituting. If we talk about the movies for a second, we're off to a strong start there, but, again, it's a somewhat different product. I think it's going to be used for different purposes. I'd be surprised, especially in the early going, in the next few years, if that turns out to be something that cuts into DVD sales. I think it's largely going to be additive. And so


October 2, 2006

we are pleased with where things are headed in that direction, but we're also comfortable with the response from our distribution partners, like Wal-Mart, who I think they, too, are trying to make sure that they're making content and products available to consumers in the most convenient way. So we'll keep our eye on it, but it looks good so far. Hamilton Faber – Analyst, Atlantic Equities There was a comment in Variety quite recently which suggested that other studios wouldn't sign up to iTunes unless there was some sort of more solid relationship or settlement with Wal-Mart, which might actually be Wal-Mart taking a cut, potentially, of the iTunes fees. But I guess you've moved ahead of that already. Do you have a particular view on that strategy? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, in some ways, we're pleased to have the opportunity to be able to be the first on iTunes, because if you go to iTunes right now, you'll see a bunch of Disney movies promoted. So I guess that's the place to be for the moment. But I certainly can't comment on what the other studios are going to do. That's a negotiation between Apple and the other studios. Again, our experience with Wal-Mart has been good and so my guess is that -- but I don't have any inside knowledge -- my guess is, over time, you'll see a broader range of movies available for download on iTunes and, frankly, on other platforms. Hamilton Faber – Analyst, Atlantic Equities Great. Now, moving along to, I guess, the other side of technology in terms of the threats from DVRs. DVR penetration continues to rise and we still, I guess, have the prospect of a network DVR coming from Cablevision and if that gets through, potentially, you might see copycat action from Comcast and Time Warner.


October 2, 2006

And then within the recent upfront, there were attempts to include DVR ratings within subtotal ratings, which didn't seem to work. What is your strategy with respect to DVRs and how do you see that playing out? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company

Well, first of all, the issue of DVRs is one that, obviously, isn't brand new and we've given it a fair amount of thought. But if you take a step back from it, what we're talking about is potential changes in the way people consume television. At the same time, we think that, over time, as you look out, say, the next 10 years or so, we think that overall viewership of television will actually increase. Now, most of that will come probably in the means of time-shifted television viewership, but we think that overall average hours of television viewed per week could be up, probably the next 10 years, by as much as 10% or so. And so the audience will be there and it is incumbent upon us to make sure that we're evolving our advertising and other business models in a way that captures the value of that audience, but I think that is something that, in part, probably working with the folks who were supplying the PVR technology and capability, in working with them and in being innovative, that we are still going to be seeing advertising as a very robust part of the equation. Content distribution revenues right now, if you take the total overall, are probably about 60% advertising and 40% direct pay, if you will. I think that equation may shift a little bit and maybe it'll be more like 50/50, but advertising is still going to be an extremely important part of that expanded marketplace. So, again, the most important thing we can do is to continue to make the great content that people want to see and then make sure that we are adapting our business models to take advantage of the fact that we've got an audience, which, on the whole, is likely to expand. Hamilton Faber – Analyst, Atlantic Equities Great, that makes a lot of sense.


October 2, 2006

Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company You asked about the ratings. I should touch on that. Hamilton Faber – Analyst, Atlantic Equities Yes. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company I think that what's implicit in what I just said is that time shift and viewership will become a more important part of the overall television consumption. I wouldn't necessarily view this year's upfront as the final word on that issue. I think that over time, it's in our interest and in advertisers' interest to measure and take advantage of the viewership that happens post the initial airing. Hamilton Faber – Analyst, Atlantic Equities Thanks for that. Operator, just for people who want to join the call late, could you sort of reiterate the question asking instructions, please? Operator [OPERATOR INSTRUCTIONS] Hamilton Faber – Analyst, Atlantic Equities Great. Well, I'll carry on in the meantime. Tom, you mentioned your new season and how that's come off to a good start. And perhaps you could give a quick rundown of which shows are working well and, also, perhaps, talk about the decision to move Grey's Anatomy, which I believe is your


October 2, 2006

number one show at the moment, from Sunday to Thursday night and how that seems to have played out. And just while we're talking about the broadcasting unit, if you could give an idea of what the sort of key swing factors are that investors should bear in mind for growth of the division in 2007. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure, happy to do it. The season is off to a great start. I only hesitate to say that because, obviously, it's early and we're as pleased as we could be so far. Moving Grey's Anatomy to Thursday night, I think, was a bold move by the folks at ABC and it seems to be one that's paying off. Grey's is the number one show. Sunday nights held up extremely well with the strength of Desperate Housewives. The new shows are being strongly sampled. Dancing with the Stars has come on strong again this year. And we won the first week and we won it pretty solidly. I think it's important to know that Lost has not yet premiered. That happens on Wednesday night. So we're looking forward to that. I don't have the final numbers for this week yet, but I think we were poised to be right up there, perhaps in first place again in the second week, and we'll wait and see the final numbers on that. But I think that the move that the ABC folks have made and the programming they've put on the air, that all appears to be working. Again, it's early and I think that it's important that it continue, because, frankly, to your second point, ratings for the ABC network are going to be probably the most important swing factor, followed by the advertising market overall. And it's too early to make any real calls on the advertising market at this point in time, but I think that that's showing signs of coming through. And so I think that the ABC network is well positioned. For media networks as a whole, we've seen nice growth in our ratings across our various outlets, including ESPN, which is the most important piece of the pie there.


October 2, 2006

And so, again, if we see a strong advertising market, I think things will go well for us there and that would be the most important swing factor. We've got some great content. ESPN, by the way, not a part of the ABC schedule, per se, but ESPN took Monday Night Football. So they moved their football from Sunday to Monday and that's gone extraordinarily well so far. The ratings of our Monday nights on ESPN this year versus last year are up substantially and it appears to be a good shift for ESPN. It's important to note, also, that it's not just a shift on television. Monday Night Football, as is true for all of ESPN, is a multimedia event. So we are seeing record numbers of page views on ESPN.com. We're streaming content throughout the day on the various outlets. So it's sort of a multimedia kind of occurrence. So we're pleased overall and hope to see things continue. Hamilton Faber – Analyst, Atlantic Equities Great. Now, Operator, I understand we have a question from the phone, please. Can we go to that? Operator Your question comes from [inaudible]. Please ask your question. Unidentified Audience Member Hi, Tom. Just regarding the parks, I understand that the Cap Ex that you invested in the late '90s and the early part of this decade was quite significant. And just on what the profile is going to be over the next few years and whether that's still going to be under the 1 billion mark. And, also, regarding the parks, your view on the consumer in terms of traveling, especially to Orlando, and given how consumers are feeling with regards to their


October 2, 2006

discretionary spending. Also, regarding the sort of terrorist type environment. And, also, the Hong Kong park and just how that's going at the moment. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure, happy to do it. With regard to capital expenditures, you're right to say that we went through a period of investment in the parks in the mid to late '90s and that was a substantial amount of investment (for the domestic parks.) That put us in a good position vis-à-vis the competition. So I think in the parks we had a strong competitive stance and an advantage in many ways going forward. That allows us to -- that expansion allows us to have a lower level of capital expenditures for the foreseeable future. For the domestic theme park business, we've talked about the fact that capital expenditures going forward we expect to be under a billion dollars per year and I think that guidance still stands and is still good. The parks are in great shape. There's obviously still a fair amount of capital that we put in every year, but I think that's important to make sure that we're continuing to deliver the guest experience that people expect from a Disney theme park vacation. Now, to speak to the consumer, we've said a couple of times this quarter that we expected 4th quarter attendance to come in roughly on par with the prior year, and that, in fact, is true. What's going on there is actually some upside in Orlando, to your question, as people continue to travel there, but this very difficult comparison at Disneyland in California, where we really had the bulk of the excitement over the 50th Anniversary Celebration for this period last year. So I think that it's, obviously, important that the consumer continue to travel. We saw a nice -- we had a nice year this year in that regard. Attendance overall for the year-to-date, based on what we reported, has been up mid single digits. And we're watching the same things that you are and I'm not going to make any bold predictions about the economy or exactly what consumer spending will do. I liked seeing consumer confidence pick up a little bit in this last monthly survey.


October 2, 2006

So I think that we feel good overall on where that stands. Unidentified Audience Member Okay. And internationally, Hong Kong, what's the -- I mean, it hasn't been the best to start with. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Hong Kong did -- it's coming in at a little over 5 million in attendance in its first year. I think that while that isn't quite up to the number that we had said, it's still a very strong number. We also saw a nice pickup in attendance throughout the summer on the strength of some new attractions that we put in. We put in Autopia, which is a popular driving attraction, and a water attraction and that sort of thing. Hong Kong is absolutely a long-term project. When we look at how it's doing in terms of guest response and the momentum that it's generated, we're actually quite pleased, and I think that Hong Kong is going to serve us well. It's, obviously, an important presence for us in that part of the world and as has happened in other places, the parks are a tremendous standard bearer for the brand and I think you'll see that be the case in Hong Kong over time, as well. Unidentified Audience Member And we understand that part of the view with the Hong Kong park is to grow the brand awareness in Asia. Have you been able to measure that in any way? And, also, are there any plans for the expansion in China? And do you have any -- I understand there's still restrictions on media in China. What's the environment like at the moment?


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Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Yes, we have seen awareness, especially in the greater Hong Kong region, increase substantially in terms of both awareness of Disney, but, also awareness of the Disney stories and characters. We're also seeing, in that part of the world, the parks now emerge as the sort of strongest identifier with the brand, and so that seems to be going well. In terms of other theme parks in that area, we've said in the past that we are interested in expanding further, perhaps another park in mainland China, and, over time, we're hopeful that will happen. I don't want to sort of pre-stage it or make any predictions, but, of course, we've got to continue our conversation. Unidentified Audience Member Would you like the environment in China to change before you do that in terms of how they treat media companies and the restrictions that they put on you? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, it's an ongoing conversation. We would like to have more presence with Chinese consumers, but it's important that we do that in a way that is consistent with our goals, but, also, ones of the Chinese government, a set of goals the Chinese government can be comfortable with. And I think that over time we'll work through that and it'll be a big important marker for us. Unidentified Audience Member Thanks so much. On the film side of it, you obviously had a really good year this year, following last year, getting sort of the bad stuff out, and Pirates of the Caribbean II, you obviously had tremendous numbers from that. Are there concerns in the fact that that's the sort of trend that we've seen with trilogies before in the sense that you have a really good first film and on the back of that, you end up with excellent traffic to the second film and then the third one disappoints


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because the second one didn't live up to expectations. I mean, The Matrix, Back to the Future, that sort of thing. Where do you think that's going to rank in terms of how the consumers view it after they went to see it rather than the fact that they were driven to go and see it by the previous experience? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, you, obviously, saw people go to the box office, going multiple times, and consumer scores for Pirates II have been very, very strong. Unidentified Audience Member Right, okay. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company And so I feel quite good about where the franchise stands and people's affinity for that property. We see it in terms of how people are responding to consumer products. That's also a 1st fiscal quarter, 4th calendar quarter home video release for us. I suspect that will be quite strong, as well. So I think that we are well positioned with just a tremendous response and tremendous affinity by people for that franchise. And the next Pirates comes out Memorial Day weekend in the United States this coming year. I think it'll be one of the big events for us of the year. Unidentified Audience Member Other than Pirates and -- what films do you have in the pipeline for the next couple years?


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Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Another important film is the next Pixar animated film, Ratatouille, which comes later in the summer. And it's, obviously, not done yet, but we're pretty excited about it. We've got a number of films coming up this quarter. We've got a Denzel Washington film, called Déjà Vu, later in the quarter, which looks like it should be great. We opened a film at number two this weekend, The Guardian, in the United States, and it did well. So we've been through a period of transition and restructuring at the studio and I think that Dick Cook and his team, Dick Cook, who runs our studio, has been doing a great job on focusing their efforts on a smaller number of releases that are predominantly Disney branded and have potential to be franchises that resonate through the rest of the company, and, for us, that's the way to greater returns overall. And so he's downsized overhead, to a certain extent, and, again, he's got the greatest team, I think, focused on the projects that they feel the most passionate about. That doesn't mean that every film will be a hit. It's still a film. But I think the ratio of hits to misses will be strong and, certainly, it's impossible to do anything but give them great kudos for the year that they've just had. So I feel like they are on the right track and that team is doing a great job. Unidentified Audience Member Okay, all right, thank you very much. Hamilton Faber – Analyst, Atlantic Equities Thanks. Operator, can we move on to the next question, please.


October 2, 2006

Operator The next question comes from [unidentified audience member]. Please ask your question. Unidentified Audience Member Hello, hi. Just a couple of questions on something, maybe something you said earlier, but I joined the conference a bit late. The first question is about the theme parks and, in particular, I would like to understand, given the improvements in the business model, what revenue growth, organic revenue growth is needed in order to generate leverage of the SG&A expenses and expand your operating margin? And the second question is about the DVD releases of your movies and, in particular, what has been a recently good relationship between revenues at the movie theater and sales? So if you have an expectation, in particular, about Cars, which went well. It was probably a bit disappointing, especially at the beginning, at the box office. Just those two things. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Happy to do it. At the theme parks, we've talked about continuing improved margins and that is something we expect to do. Now, I'm not going to be a predictor of economic cycles, but if you look through economic cycles over time, we've seen low single digit kind of growth in attendance overall. That's something we continue to look for going forward over the longer run. Low single-digit growth in attendance, coupled with pricing that -- we will probably be at or around inflation in terms of our pricing growth if you look at the long run. Those two factors, coupled with efforts to continue to increase the people’s length of stay and, therefore, the amount of time they're spending on our property and the amount that they're spending in our resorts, we think that that is adequate to do what we have said we'll do in terms of improving margins.


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So the parks are in a good position to continue to leverage their business model. They are quite adept and experienced at managing the costs, while still delivering on the Disney guest experience that I referenced earlier. We've got a good team there and, I think, a good set of assets in a strong competitive position. So it's kind of like what more could you ask for. I think that, over time, they will continue to be delivering well for us. And, again, that's a business where we think that we can generate in excess of a billion dollars of after-tax free cash flow for a year and the kind of growth that you and I just spoke about. With regard to DVDs, I think a lot of people have talked about next generation DVD and the impact that might have. For now, we think that that will be mostly substitute and not have a dramatic impact on the business. It's possible that as next generation DVD comes on, it will provide some positive momentum in terms of DVD pricing. For us, the relationship between box office and sell-through on DVDs has been reasonably stable over the last several quarters. I'm not going to make any predictions on what that will be. A lot of it has to do with what films are going to be out there. I think that Cars is going to be a successful home video release and I think some people have tried to paint Cars as a disappointment. I wouldn't do so at all. That was a very, very successful film. It's perhaps less than, say, Finding Nemo in terms of its worldwide box office, but it's still really strong. And as I mentioned earlier, perhaps you weren't on, Cars is actually the biggest merchandise property for us, talking about our consumer products business, that we've had since the Lion King, which was the all-time champion. So that as a property is going to have a long life here that is very successful and we're thrilled to have it. Hamilton Faber – Analyst, Atlantic Equities Thank you. Perhaps I can jump in with another question myself.


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You mentioned looking through economic cycles. Could you give an indication about how flexible your cost structure is across the company in the event of an economic downturn with flat or perhaps even some declining revenues? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure. I think that you have to look at the various businesses to get a good answer to that. For instance, in the theme parks, where, perhaps, we might see the most fluctuation in revenues based on economic cycles, although we seem to find that the underlying growth trends continue, when you look through them. Some of the costs are quite variable (merchandise, food and beverage, et cetera), but others tend to be a little bit more chunky in terms of operating hours of the park that, at a certain level, we might be able to reduce and still deliver on guest experience and number of shows per day and that sort of thing. So it is something that the parks folks have done in the past and can move on in the future. If you look at some of the other businesses, it's a little bit of a different story. The studio doesn't tend to get hit very hard in changing economic cycles. The strength of releases tends to be the most important equation in that regard. And having said that, an economic cycle doesn't have a very big impact at all on the cost base either. If you look at our cable business, there, much of the revenue is -- Disney Channel, for instance, is 100 percent subscriber fees. ESPN, more than half those revenues are from subscriber fees. So those tend to not be very exposed at all to economic cycles. The programming, to varying degrees, is -- there's some variability, but, of course, much of ESPN is based on rights fees. And then you look at the advertising model, where advertising will sometimes actually buck the trend of a consumer cycle and sometimes you'll see a downturn in advertising, depending on whether the advertisers are trying to spend into the face of a downturn.


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One of the nice parts about our company is that we tend to have businesses that have varying reactions and responses to an economic cycle. So it's a diversified set of businesses that we are able to drive through an economic cycle and do okay. Hamilton Faber – Analyst, Atlantic Equities Great, thanks for that. Just moving across to look at the -- I guess to look at the uses of free cash flow. You're one of the few media companies that actually has a dividend, reasonable dividend, which gets increased. Could you perhaps rank the uses of your free cash flow for the next few years? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure, I’m happy to do it, and it's relevant, because as a company, we have, over time, in the last several years, really increased our focus on delivering free cash flow and generating it, and I think we've become more efficient in that regard in the company and I think that we're a company that's going to generate significant free cash flow going forward. So we think a lot about the allocation of that capital. Our first priority is to reinvest that capital profitably in our businesses or in new business opportunities. I think the important word there is profitably. It's important to us that as we put new capital into businesses that we believe that, over time, we can deliver an attractive return to shareholders for that. So we don't do acquisitions just for the sake of getting bigger and we are, I hope, suitably cautious in that regard. One of the nice things about our business is that as people invest in technology, as people invest in new distribution platforms, that requires significant capital, but we are -- it's not our capital that goes into a lot of that, and, yet, we will see the benefit of some of those new platforms and those new distribution mechanisms. And so, if you will, we have the opportunity, through our content, to earn a return on a lot of capital that's going into making it easier to reach consumers.


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The capital needs of many of our businesses are quite low, if you look at the television business, broadcasting business, et cetera. It's likely, therefore, that we will have more free cash flow than we have opportunities to really invest it with great returns. And so if that is indeed the case, we would rather return that capital to shareholders through dividends or share repurchase than we would prefer to have it all over the balance sheet. That's not an efficient place for it to be and we continue to think that we'll have strong access to capital going forward, as need be. And so I think you should assume that dividends, with, hopefully, relatively consistent increases in that dividend, and share repurchase will be a part of the equation for the foreseeable future. If we see great opportunities to invest in new businesses and to put capital to work and we think there's good returns, then that'll be the first place that we go. Hamilton Faber – Analyst, Atlantic Equities I'd like to take your answer and just move to, obviously, the two areas which, I guess, you've been investing in recently, the mobile phone adventure and, also, into videogames, as well. I was looking at the first one of those. You announced earlier this week, I think it was late last week, that you would be closing down your ESPN Mobile business, in its current form, as a move toward more of a kind of content format for that business. Can you kind of give an idea of what exactly your thinking was in that process and, at the same time, perhaps comment why you think your Disney Mobile service will work, where it didn't look like the ESPN Mobile service worked in that particular format? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure. Let me take the ESPN Mobile decision first. It may seem counterintuitive, but the fact is that I would applaud ESPN for what they did with mobile and the efforts they made. They actually created an innovative and good product.


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They also did what is incumbent upon any of us as we're trying to launch a new business. They went out with their strong product and, over time, the assessment that they made was that from the standpoint of where ESPN is going overall and in terms of maximizing the opportunity out of that business that they had been inventing, they would be better off switching to a different model, more of a licensed model, which is something that they're exploring right now. So they've made the decision to stop doing it as a principal MVNO and they're looking at leveraging the strong product that they made within a licensed model. I think that we'd like every new business opportunity that we go after to work, but the fact is that not every one will work exactly as one might hope. And I think the ESPN folks should be applauded for the product they created and they should also be applauded for taking a hard look and doing exactly what we said we would do, and, that is, to the extent that we think the returns won't justify what we have to put into it or that there's a better opportunity to do it a different way, that we'll move quickly and go after that other opportunity. Now, ESPN’s MVNO and the Disney Mobile service are really two fundamentally different propositions. We remain excited about the prospects for the Disney Mobile service. This is a property that has been actually winning a lot of awards and getting kudos in the press in overall family mobile service. A lot of parents have phones in the hands of various members of the family, with varying degrees of control over how the phone is used, what it's used for, how much is spent with the phone. It provides the opportunity for parents to know where the kids with the telephones are at any given point in time. And the feedback we're getting at least is that it actually delivers on fundamental needs that parents have in terms of their mobile phone service. And we know that over the next several years, that more and more families are going to want to have phones in the hands of a broader group of members of the family, meaning younger children. So making sure that there's a product that's out there that's appropriate and serves parents' needs is something that I think is a very interesting opportunity, and I think that, here again, the Disney Mobile guys created a good product and we're excited to see where it goes.


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They've really just soft-launched it, so it's early days yet, but it looks pretty interesting. Hamilton Faber – Analyst, Atlantic Equities And, Tom, could you just -- I saw in the press release that you said on the ESPN Mobile site, that you would be, I think, reimbursing users for their handsets. Can you just talk about any sort of shutdown costs that might come with the ESPN business coming to an end in that format? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Yes, you're right. We did say that we'd continue the service through December 31 and that we'd refund folks that bought the handset. We think that's only fair in that regard. I suspect that the shutdown costs of that will be in the neighborhood of about $30 million. The large majority of that will be in 2007 and I think that, again, the more important piece is I think there's a license opportunity there that could be pretty interesting going forward. Hamilton Faber – Analyst, Atlantic Equities Great. Perhaps I could jump in with another question. Looking at the cable business, there was a recent presentation by Anne Sweeney, your Co-Chair of Media Networks, where she talked about increased investment in programming at the non-ESPN cable channels. Can you sort of elaborate on your strategy for investment in programming here and where you see margins kind of heading and what the sort of end gain would be for those cable networks? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Absolutely. Anne Sweeney, and Rich Ross runs the Disney Channel for her. I think they are doing a really great job of creating programming that is very consistent with


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what we all talked about earlier on this call, and that is programming that we think can help build the brand, is strong creatively and can resonate throughout the various businesses of the company. I mentioned High School Musical as sort of the best example, but it's by no means the only one. The shows like that, That’s So Raven, Kim Possible, High School Musical, other movies that they've made, these investments help the Disney Channel to establish a deeper relationship with their audience. And I should note, by the way, that in the 3rd calendar quarter, the Disney Channel was the number one rated channel on basic cable in prime time for the whole quarter. First time that's happened, I think, for them in their history and it's really a tribute to the programming that they've put on. But that content, if you look at some of the more recent things they put on, Little Einsteins, which has been a very successful new launch and is an extension of the Baby Einstein property, has become so important to us since that acquisition. Mickey Mouse Clubhouse, which is now an important piece of Playhouse Disney, again, very successful launch. That reintroduces Mickey to a whole new generation of kids, which is important to the Disney brand and important to the Mickey franchise overall. And then coming up later this spring, they'll be doing a show based on Winnie the Pooh, and, again, another important franchise. So you see that the strategy really is that they're trying to drive their investment dollars towards programming that has a life that is important to their initial place of airing, the Disney Channel or Toon Disney or whatever, and then goes beyond that to help drive growth in other areas, whether it's consumer products or whether it's Disney Channels around the world. And I think that they've got a real focus on that and it's exactly where we like to see those investment dollars go, because we think we can earn a very strong return on that investment over time. Hamilton Faber – Analyst, Atlantic Equities Thanks. I realized I got halfway through asking you a question earlier which I didn't follow up on, and that was on the investment in videogames. Clearly, you've been making a few acquisitions recently.


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I see you acquired a company, Climax Racing, just the other day. Could you just talk about why the videogame market makes sense for you and your competition in terms of owning versus licensing? And when do you expect to see a return on these investments? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure, I'm happy to. Thanks for bringing me back to that, because I forgot to address it earlier. The videogame business is one which I think everyone on the call probably realizes is a very big business and it's one that has seen and will continue to see strong growth. And so the initial attraction is pretty obvious. But there are other important reasons why we think of it as an opportunity for us as a publisher as opposed to just as a licensor of content. The video game business, as it becomes more and more mainstream, is also growing in terms of the core audience that we attract. So you won't see us making some of the most edgy videogames. It's not really core to what we, as a company, are focused on doing. But we do think that it's a nice place to extend some of our brands and franchises, whether it's the traditional ones that are based on Mickey, that sort of thing, or whether it's Pirates of the Caribbean, looking ahead, and the other film franchises that we created. Recall that something like -- over time, something like 80-plus percent of our film investment is going to go into Disney branded films as opposed to Touchstone films and then we've got another set that are Miramax, and we think that those will tend to create franchises that we can leverage. By being successful in the publishing business with video games, we do a couple of things. First of all, there is far higher profit potential as a successful publisher than there is just in licensing and, in fact, the contribution margin per unit sold is probably, if you're successful, could be as much as double in a published model as opposed to a licensed model.


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But, also, it's another creative engine that we think is worth developing. Over time, as I said, we can better extend franchises that are created in the studio and we can create new intellectual property around existing franchises or new ones that can be important to the company as a whole. So we think that it is an important creative center for the company and an important profit and growth opportunity, as well. Hamilton Faber – Analyst, Atlantic Equities And how long do you think it would be before you built a return -- to get the return on the investment you've made so far? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, we will ramp up investment yet again next year and in this business, we expense our product development as it's incurred and so that has an impact on the early financial returns. But I think that over the next several years, we should be hitting an inflection point where you'll start to see a lot more attractive financial dynamics out of the business, assuming that we continue to be successful. Last year, they really -- I have to give them credit, because Chronicles of Narnia was a self-published title, very important title, one of the larger videogame titles of the year, and it's indicative of what we'd like to see. They took a strong film franchise and they created a strong game property out of it. So if we continue on that course, I think you'll see nice returns over the next several years. Hamilton Faber – Analyst, Atlantic Equities Great. Could I just maybe finish out with just a couple more questions? Just looking at the way that the dollar is moving versus international currencies, could you just highlight what your hedging strategy is at present, what impact in terms of, I


October 2, 2006

guess, timing and in just general impact, a declining dollar could have on your medium and near-term results? Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Well, the way that we do our hedging is that we try to make sure that we are looking forward as best we can as to what we expect our non-dollar currency flows to be and we will try to hedge the volatility out of those flows. In other words, we don't speculate on the dollar or other currencies. We try to make sure that we are hedged. So as I sit here at the advent of 2007, we are in the neighborhood of 90 to 100% hedged versus the budget that we expect for the year. No one can forecast with perfect certainty, so there's some volatility around that. So if you see a long trend move in the dollar over time, that will show up in our financial results. Today, there's more of our cost base in the United States than there is -- the higher percentage of our cost base is in the United States than the percentage of our revenue base. Over time, we also expect to grow our non-dollar denominated businesses. And so a weakening of the dollar over time will have an impact, it's just not a dramatic impact in the near term. Hamilton Faber – Analyst, Atlantic Equities Great. And just on the radio deal that you have with Citadel, I understand that this has been on track to close by the year end, but that you still have to consider whether it's going to be a spin or a split. Perhaps you could give an idea of what considerations you'll take into account when making that decision.


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Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Sure. You're right, we haven't made the final determination on spin versus split. We think that we're going to need to look at what the market conditions are and what the relative trading strength is of the currency that we'd be getting. But, also, most importantly, we want to try to gauge how best and most efficiently we can distribute that value to our shareholders and, in some instances, a split will do that better than a spin, depending on how many folks would likely trade out or hold the new security that we'd be offering. So we're going to try to gauge that as well as we can and make a decision as we get closer to finalization of the closing. Hamilton Faber – Analyst, Atlantic Equities Great. Well, that brings us, unfortunately, to the end of our allotted hour. So that's all we have time for at the moment. But, Tom, thank you very much, indeed, for giving up your time to speak with us today. I found that very useful, indeed, and I'm sure our European investors will have, too. Tom Staggs – Senior Executive Vice President and CFO, The Walt Disney Company Thank you. It's our pleasure. Take care. Operator That ends the conference for today. Thank you for participating. You may all disconnect.


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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.

disney speaker: tom staggs,cdn.media.ir.thewaltdisneycompany.com/2006/events/tos-ae...well, pixar is...

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