10-Q 1 fy2017_q1x10qxdoc.htm FORM 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended
 
Commission File Number 1-11605
December 31, 2016
 
 
 
twdcimagea01a01a01a01a04.jpg
 
 
 
 
 
Incorporated in Delaware
 
I.R.S. Employer Identification
 
 
No. 95-4545390
500 South Buena Vista Street, Burbank, California 91521
(818) 560-1000
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).
Large accelerated filer
 
x
 
Accelerated filer
 
¨
 
 
 
 
 
Non-accelerated filer (do not check if smaller reporting company)
 
¨
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x
There were 1,581,248,242 shares of common stock outstanding as of February 1, 2017.




PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
THE WALT DISNEY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited; in millions, except per share data)
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Revenues:
 
 
 
Services
$
12,406

 
$
12,622

Products
2,378

 
2,622

Total revenues
14,784

 
15,244

Costs and expenses:
 
 
 
Cost of services (exclusive of depreciation and amortization)
(7,020
)
 
(7,056
)
Cost of products (exclusive of depreciation and amortization)
(1,386
)
 
(1,567
)
Selling, general, administrative and other
(1,985
)
 
(2,025
)
Depreciation and amortization
(687
)
 
(607
)
Total costs and expenses
(11,078
)
 
(11,255
)
Restructuring and impairment charges

 
(81
)
Interest expense, net
(99
)
 
(24
)
Equity in the income of investees
118

 
474

Income before income taxes
3,725

 
4,358

Income taxes
(1,237
)
 
(1,448
)
Net income
2,488

 
2,910

Less: Net income attributable to noncontrolling interests
(9
)
 
(30
)
Net income attributable to The Walt Disney Company (Disney)
$
2,479

 
$
2,880

 
 
 
 
Earnings per share attributable to Disney:
 
 
 
Diluted
$
1.55

 
$
1.73

 
 
 
 
Basic
$
1.56

 
$
1.74

 
 
 
 
Weighted average number of common and common equivalent shares outstanding:
 
 
 
Diluted
1,603

 
1,668

 
 
 
 
Basic
1,592

 
1,654

 
 
 
 
Dividends declared per share
$
0.78

 
$
0.71

See Notes to Condensed Consolidated Financial Statements

2



THE WALT DISNEY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited; in millions)
 
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Net income
$
2,488

 
$
2,910

Other comprehensive income/(loss), net of tax:
 
 
 
Market value adjustments for investments
(11
)
 
(3
)
Market value adjustments for hedges
280

 
(25
)
Pension and postretirement medical plan adjustments
46

 
42

Foreign currency translation and other
(290
)
 
(113
)
Other comprehensive income/(loss)
25

 
(99
)
Comprehensive income
2,513

 
2,811

Less: Net income attributable to noncontrolling interests
(9
)
 
(30
)
Less: Other comprehensive loss attributable to noncontrolling interests
99

 
51

Comprehensive income attributable to Disney
$
2,603

 
$
2,832

See Notes to Condensed Consolidated Financial Statements





3


THE WALT DISNEY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited; in millions, except per share data)
 
December 31,
2016
 
October 1,
2016
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
3,736

 
$
4,610

Receivables
9,878

 
9,065

Inventories
1,299

 
1,390

Television costs and advances
821

 
1,208

Other current assets
931

 
693

Total current assets
16,665

 
16,966

Film and television costs
6,572

 
6,339

Investments
4,220

 
4,280

Parks, resorts and other property
 
 
 
Attractions, buildings and equipment
49,912

 
50,270

Accumulated depreciation
(26,996
)
 
(26,849
)
 
22,916

 
23,421

Projects in progress
2,902

 
2,684

Land
1,236

 
1,244

 
27,054

 
27,349

Intangible assets, net
6,892

 
6,949

Goodwill
27,793

 
27,810

Other assets
2,380

 
2,340

Total assets
$
91,576

 
$
92,033

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable and other accrued liabilities
$
9,979

 
$
9,130

Current portion of borrowings
5,698

 
3,687

Unearned royalties and other advances
3,640

 
4,025

Total current liabilities
19,317

 
16,842

Borrowings
14,792

 
16,483

Deferred income taxes
3,888

 
3,679

Other long-term liabilities
6,402

 
7,706

Commitments and contingencies (Note 10)


 


Equity
 
 
 
Preferred stock, $.01 par value, Authorized – 100 million shares, Issued – none

 

Common stock, $.01 par value,
Authorized – 4.6 billion shares, Issued – 2.9 billion shares
35,906

 
35,859

Retained earnings
67,327

 
66,088

Accumulated other comprehensive loss
(3,855
)
 
(3,979
)
 
99,378

 
97,968

Treasury stock, at cost, 1.3 billion shares
(56,168
)
 
(54,703
)
Total Disney Shareholders’ equity
43,210

 
43,265

Noncontrolling interests
3,967

 
4,058

Total equity
47,177

 
47,323

Total liabilities and equity
$
91,576

 
$
92,033

See Notes to Condensed Consolidated Financial Statements

4



THE WALT DISNEY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
OPERATING ACTIVITIES
 
 
 
Net income
$
2,488

 
$
2,910

Depreciation and amortization
687

 
607

Deferred income taxes
(76
)
 
551

Equity in the income of investees
(118
)

(474
)
Cash distributions received from equity investees
203

 
206

Net change in film and television costs and advances
440

 
705

Equity-based compensation
97

 
106

Other
187

 
211

Changes in operating assets and liabilities:
 
 
 
Receivables
(1,160
)
 
(2,358
)
Inventories
102

 
134

Other assets
126

 
91

Accounts payable and other accrued liabilities
(2,763
)
 
(891
)
Income taxes
1,047

 
658

Cash provided by operations
1,260

 
2,456

 
 
 
 
INVESTING ACTIVITIES
 
 
 
Investments in parks, resorts and other property
(1,040
)
 
(1,406
)
Acquisitions

 
(400
)
Other
5

 
8

Cash used in investing activities
(1,035
)
 
(1,798
)
 
 
 
 
FINANCING ACTIVITIES
 
 
 
Commercial paper borrowings, net
732

 
1,907

Borrowings
42

 
382

Reduction of borrowings
(194
)
 
(564
)
Repurchases of common stock
(1,465
)
 
(2,352
)
Proceeds from exercise of stock options
65

 
52

Other
(167
)
 
13

Cash used in financing activities
(987
)
 
(562
)
 
 
 
 
Impact of exchange rates on cash and cash equivalents
(112
)
 
(64
)
 
 
 
 
Change in cash and cash equivalents
(874
)
 
32

Cash and cash equivalents, beginning of period
4,610

 
4,269

Cash and cash equivalents, end of period
$
3,736

 
$
4,301

See Notes to Condensed Consolidated Financial Statements

5



THE WALT DISNEY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(unaudited; in millions)
 
 
Quarter Ended
 
December 31, 2016
 
January 2, 2016
 
Disney
Shareholders
 
Non-
controlling
Interests
 
Total
Equity
 
Disney
Shareholders
 
Non-
controlling
Interests
 
Total
Equity
Beginning balance
$
43,265

 
$
4,058

 
$
47,323

 
$
44,525

 
$
4,130

 
$
48,655

Comprehensive income/(loss)
2,603

 
(90
)
 
2,513

 
2,832

 
(21
)
 
2,811

Equity compensation activity
48

 

 
48

 
128

 

 
128

Dividends
(1,237
)
 

 
(1,237
)
 
(1,168
)
 

 
(1,168
)
Common stock repurchases
(1,465
)
 

 
(1,465
)
 
(2,352
)
 

 
(2,352
)
Distributions and other
(4
)
 
(1
)
 
(5
)
 
(7
)
 
131

 
124

Ending balance
$
43,210

 
$
3,967

 
$
47,177

 
$
43,958

 
$
4,240

 
$
48,198

See Notes to Condensed Consolidated Financial Statements



6



THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)
 
1.
Principles of Consolidation
These Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. We believe that we have included all normal recurring adjustments necessary for a fair presentation of the results for the interim period. Operating results for the quarter ended December 31, 2016 are not necessarily indicative of the results that may be expected for the year ending September 30, 2017. Certain reclassifications have been made in the prior-year financial statements to conform to the current-year presentation.
These financial statements should be read in conjunction with the Company’s 2016 Annual Report on Form 10-K.
The Company enters into relationships or investments with other entities that may be a variable interest entity (VIE). A VIE is consolidated in the financial statements if the Company has the power to direct activities that most significantly impact the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE (as defined by ASC 810-10-25-38). Disneyland Paris, Hong Kong Disneyland Resort and Shanghai Disney Resort (collectively the International Theme Parks) are VIEs. Company subsidiaries (the Management Companies) have management agreements with the International Theme Parks, which provide the Management Companies, subject to certain protective rights of joint venture partners, with the ability to direct the day-to-day operating activities and the development of business strategies that we believe most significantly impact the economic performance of the International Theme Parks. In addition, the Management Companies receive management fees under these arrangements that we believe could be significant to the International Theme Parks. Therefore, the Company has consolidated the International Theme Parks in its financial statements.
The terms “Company,” “we,” “us,” and “our” are used in this report to refer collectively to the parent company and the subsidiaries through which our various businesses are actually conducted.
 
2.
Segment Information
The operating segments reported below are the segments of the Company for which separate financial information is available and for which segment results are evaluated regularly by the Chief Executive Officer in deciding how to allocate resources and in assessing performance.
Segment operating results reflect earnings before corporate and unallocated shared expenses, restructuring and impairment charges, interest expense, income taxes and noncontrolling interests. Segment operating income includes equity in the income of investees. Corporate and unallocated shared expenses principally consist of corporate functions, executive management and certain unallocated administrative support functions.
Equity in the income of investees is included in segment operating income as follows: 
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Media Networks
$
119

 
$
142

Parks and Resorts
(2
)
 

Consumer Products & Interactive Media
1

 

Equity in the income of investees included in segment operating income
118

 
142

Vice Gain

 
332

Total equity in the income of investees
$
118

 
$
474

During the quarter ended January 2, 2016, the Company recognized its share of a net gain recorded by A+E Television Networks (A+E), a joint venture owned 50% by the Company, in connection with A+E’s acquisition of an interest in Vice Group Holding, Inc. (Vice) (Vice Gain). The Company’s $332 million share of the Vice Gain is recorded in “Equity in the income of investees” in the Condensed Consolidated Statement of Income but is not included in segment operating income. See Note 3 for further discussion of the transaction.

7

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


Segment revenues and segment operating income are as follows:
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Revenues (1):
 
 
 
Media Networks
$
6,233


$
6,332

Parks and Resorts
4,555


4,281

Studio Entertainment
2,520


2,721

Consumer Products & Interactive Media
1,476


1,910

 
$
14,784

 
$
15,244

Segment operating income (1):
 
 
 
Media Networks
$
1,362

 
$
1,412

Parks and Resorts
1,110

 
981

Studio Entertainment
842

 
1,014

Consumer Products & Interactive Media
642

 
860

 
$
3,956

 
$
4,267

(1) Studio Entertainment segment revenues and operating income include an allocation of Consumer Products & Interactive Media revenues, which is meant to reflect royalties on sales of merchandise based on certain film properties. The increase to Studio Entertainment revenues and operating income and corresponding decrease to Consumer Products & Interactive Media revenues and operating income totaled $181 million and $262 million for the quarters ended December 31, 2016 and January 2, 2016, respectively.
A reconciliation of segment operating income to income before income taxes is as follows:
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Segment operating income
$
3,956

 
$
4,267

Corporate and unallocated shared expenses
(132
)
 
(136
)
Restructuring and impairment charges

 
(81
)
Interest expense, net
(99
)
 
(24
)
Vice Gain

 
332

Income before income taxes
$
3,725

 
$
4,358


3.
Acquisitions
Vice/A+E
Vice is a media company targeting a millennial audience through news and pop culture content and creative brand integration. During the first quarter of fiscal 2016, A+E acquired an 8% interest in Vice in exchange for a 49.9% interest in one of A+E’s cable channels, H2, which has been rebranded as Viceland and programmed with Vice content. As a result of this exchange, A+E recognized a net non-cash gain based on the estimated fair value of H2. The Company’s share of the Vice Gain totaled $332 million and was recorded in “Equity in the income of investees” in the Condensed Consolidated Statement of Income in the first quarter of fiscal 2016. At December 31, 2016, A+E had a 20% interest in Vice.
In addition, during the first quarter of fiscal 2016, the Company acquired an 11% interest in Vice for $400 million of cash.
The Company accounts for its interests in A+E and Vice as equity method investments.
BAMTech
In August 2016, the Company acquired a 15% interest in BAMTech, an entity which holds Major League Baseball’s streaming technology and content delivery businesses, for $450 million. In January 2017, the Company acquired an additional 18% interest for $557 million. In addition, the Company has an option to increase its ownership to 66% by acquiring additional shares at fair market value from Major League Baseball between August 2020 and August 2023. The Company accounts for its interest in BAMTech as an equity method investment.

8

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)



4.
Borrowings
During the quarter ended December 31, 2016, the Company’s borrowing activity was as follows: 
 
October 1,
2016
 
Borrowings
 
Payments
 
Other
Activity
 
December 31,
2016
Commercial paper with original maturities less than three months(1)
$
777

 
$

 
$
(117
)
 
$
1

 
$
661

Commercial paper with original maturities greater than three months
744

 
1,594

 
(745
)
 
2

 
1,595

U.S. medium-term notes
16,827

 

 

 
5

 
16,832

International Theme Parks borrowings
1,087

 
13

 

 
(27
)
 
1,073

Foreign currency denominated debt and other(2)
735

 
29

 
(194
)
 
(241
)
 
329

Total
$
20,170

 
$
1,636

 
$
(1,056
)
 
$
(260
)
 
$
20,490

(1) 
Borrowings and payments are reported net.
(2) 
The other activity is primarily market value adjustments for debt with qualifying hedges.
The Company has bank facilities with a syndicate of lenders to support commercial paper borrowings as follows:
 
Committed
Capacity
 
Capacity
Used
 
Unused
Capacity
Facility expiring March 2017
$
1,500

 
$

 
$
1,500

Facility expiring March 2019
2,250

 

 
2,250

Facility expiring March 2021
2,250

 

 
2,250

Total
$
6,000

 
$

 
$
6,000

All of the above bank facilities allow for borrowings at LIBOR-based rates plus a spread depending on the credit default swap spread applicable to the Company’s debt, subject to a cap and floor that vary with the Company’s debt rating assigned by Moody’s Investors Service and Standard and Poor’s. The spread above LIBOR can range from 0.23% to 1.63%. The Company also has the ability to issue up to $800 million of letters of credit under the facility expiring in March 2019, which if utilized, reduces available borrowings under this facility. As of December 31, 2016, the Company has $172 million of outstanding letters of credit, of which none were issued under this facility. The facilities specifically exclude certain entities, including the International Theme Parks, from any representations, covenants, or events of default and contain only one financial covenant relating to interest coverage, which the Company met on December 31, 2016 by a significant margin.
Interest expense, net
Interest and investment income and interest expense are reported net in the Condensed Consolidated Statements of Income and consist of the following (net of capitalized interest):
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Interest expense
$
(121
)
 
$
(66
)
Interest and investment income
22

 
42

Interest expense, net
$
(99
)
 
$
(24
)
Interest and investment income includes gains and losses on the sale of publicly and non-publicly traded investments, investment impairments and interest earned on cash and cash equivalents and certain receivables.


9

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


5.
International Theme Park Investments
The Company has an 81% effective ownership interest in the operations of Disneyland Paris, a 47% ownership interest in the operations of Hong Kong Disneyland Resort and a 43% ownership interest in the operations of Shanghai Disney Resort. The International Theme Parks are VIEs consolidated in the Company’s financial statements. See Note 1 for the Company’s policy on consolidating VIEs.
The following table summarizes the carrying amounts of the International Theme Parks’ assets and liabilities included in the Company’s Condensed Consolidated Balance Sheets as of December 31, 2016 and October 1, 2016:
 
International Theme Parks
 
December 31, 2016
 
October 1, 2016
Cash and cash equivalents
$
717

 
$
1,008

Other current assets
343

 
331

Total current assets
1,060

 
1,339

Parks, resorts and other property
8,960

 
9,270

Other assets
89

 
88

Total assets
$
10,109

 
$
10,697

 
 
 
 
Current liabilities
$
1,265

 
$
1,499

Borrowings - long-term
1,073

 
1,087

Other long-term liabilities
267

 
256

Total liabilities
$
2,605

 
$
2,842

The following table summarizes the International Theme Parks’ revenues and costs and expenses included in the Company’s Condensed Consolidated Statement of Income for the quarter ended December 31, 2016:
 
December 31, 2016
Revenues
$
737

Costs and expenses
(760
)
International Theme Parks royalty and management fees of $32 million recognized for the quarter ended December 31, 2016 are eliminated in consolidation but are considered in calculating earnings allocated to noncontrolling interests.
For the quarter ended December 31, 2016, International Theme Parks’ cash flows included in the Company’s Condensed Consolidated Statement of Cash Flows are $113 million generated from operating activities, $304 million used in investing activities and $13 million generated from financing activities.
Disneyland Paris    
The Company has term loans to Disneyland Paris with outstanding balances totaling €1.0 billion at December 31, 2016 bearing interest at a 4% fixed rate and maturing in 2024. In addition, the Company has provided Disneyland Paris a €0.4 billion line of credit bearing interest at EURIBOR plus 2% and maturing in 2023. At December 31, 2016, €155 million is outstanding under the line of credit. The amounts of the loans and line of credit are eliminated upon consolidation.
The Company has waived royalties and management fees for the fourth quarter of fiscal 2016 through the third quarter of fiscal 2018.
Hong Kong Disneyland Resort
At December 31, 2016, the Government of the Hong Kong Special Administrative Region (HKSAR) and the Company had 53% and 47% equity interests in Hong Kong Disneyland Resort, respectively.
As part of financing the construction of a third hotel, the Company and HKSAR have provided loans with outstanding balances of $136 million and $91 million, respectively, which bear interest at a rate of three month HIBOR plus 2% and mature in September 2025. The amount of the Company’s loan is eliminated upon consolidation.

10

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


Shanghai Disney Resort
Shanghai Disney Resort is owned through two joint venture companies, in which Shanghai Shendi (Group) Co., Ltd (Shendi) owns 57% and the Company owns 43%. A management company, in which the Company has a 70% interest and Shendi a 30% interest, is responsible for operating Shanghai Disney Resort.
The Company has provided Shanghai Disney Resort with long-term loans totaling $762 million, bearing interest at rates up to 8%. In addition, the Company has an outstanding balance of $288 million due from Shanghai Disney Resort related to development and pre-opening costs of the resort and outstanding royalties and management fees. The Company has also provided Shanghai Disney Resort with a $157 million line of credit bearing interest at 8%. There is no outstanding balance under the line of credit at December 31, 2016. The amounts of the loan and line of credit are eliminated upon consolidation.
Shendi has provided Shanghai Disney Resort with term loans totaling 6.5 billion yuan (approximately $0.9 billion), bearing interest at rates up to 8% and maturing in 2036; however, early repayment is permitted. Shendi has also provided Shanghai Disney Resort with a 1.4 billion yuan (approximately $197 million) line of credit bearing interest at 8%. There is no outstanding balance under the line of credit at December 31, 2016.

6.
Pension and Other Benefit Programs
The components of net periodic benefit cost are as follows: 
 
Pension Plans
 
Postretirement Medical Plans
 
Quarter Ended
 
Quarter Ended
 
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Service costs
$
91

 
$
80

 
$
3

 
$
3

Interest costs
112

 
115

 
14

 
15

Expected return on plan assets
(219
)
 
(188
)
 
(12
)
 
(11
)
Amortization of prior-year service costs
3

 
3

 

 

Recognized net actuarial loss
101

 
61

 
4

 
2

Net periodic benefit cost
$
88

 
$
71

 
$
9

 
$
9

During the quarter ended December 31, 2016, the Company made $1.3 billion of contributions to its pension and postretirement medical plans. The Company currently does not expect to make any additional material contributions to its pension and postretirement medical plans during the remainder of fiscal 2017. However, final funding amounts for fiscal 2017 will be assessed based on our January 1, 2017 funding actuarial valuation, which we expect to receive during the fourth quarter of fiscal 2017.

7.
Earnings Per Share
Diluted earnings per share amounts are based upon the weighted average number of common and common equivalent shares outstanding during the period and are calculated using the treasury stock method for equity-based compensation awards (Awards). A reconciliation of the weighted average number of common and common equivalent shares outstanding and the number of Awards excluded from the diluted earnings per share calculation, as they were anti-dilutive, are as follows: 
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Shares (in millions):
 
 
 
Weighted average number of common and common equivalent shares outstanding (basic)
1,592

 
1,654

Weighted average dilutive impact of Awards
11

 
14

Weighted average number of common and common equivalent shares outstanding (diluted)
1,603

 
1,668

Awards excluded from diluted earnings per share
16

 
4

 

11

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


8.
Equity
The Company paid the following dividends in fiscal 2017 and 2016:
Per Share
 
Total Paid
 
Payment Timing
 
Related to Fiscal Period
$0.78
$1.2 billion
Second Quarter of Fiscal 2017
Second Half 2016
$0.71
$1.1 billion
Fourth Quarter of Fiscal 2016
First Half 2016
$0.71
$1.2 billion
Second Quarter of Fiscal 2016
Second Half 2015
During the quarter ended December 31, 2016, the Company repurchased 15 million shares of its common stock for $1.5 billion. As of December 31, 2016, the Company had remaining authorization in place to repurchase approximately 267 million additional shares. The repurchase program does not have an expiration date.
The following table summarizes the changes in each component of accumulated other comprehensive income (loss) (AOCI) including our proportional share of equity method investee amounts, which is generally net of 37% estimated tax:
 
 
 
 
 
Unrecognized
Pension and 
Postretirement
Medical 
Expense
 
Foreign
Currency
Translation
and Other
(1)
 
AOCI
 
Market Value Adjustments
 
 
Investments
 
Cash Flow Hedges
 
Balance at October 1, 2016
$
26

 
$
(25
)
 
$
(3,651
)
 
$
(329
)
 
$
(3,979
)
Quarter Ended December 31, 2016:
 
 
 
 
 
 
 
 
 
Unrealized gains (losses) arising
  during the period
(11
)
 
324

 
(22
)
 
(191
)
 
100

Reclassifications of realized net (gains) losses to net income

 
(44
)
 
68

 

 
24

Balance at December 31, 2016
$
15

 
$
255

 
$
(3,605
)
 
$
(520
)
 
$
(3,855
)
 
 
 
 
 
 
 
 
 
 
Balance at October 3, 2015
$
13

 
$
334

 
$
(2,497
)
 
$
(271
)
 
$
(2,421
)
Quarter Ended January 2, 2016:
 
 
 
 
 
 
 
 
 
Unrealized gains (losses) arising
  during the period
(3
)
 
41

 

 
(62
)
 
(24
)
Reclassifications of realized net (gains) losses to net income

 
(66
)
 
42

 

 
(24
)
Balance at January 2, 2016
$
10

 
$
309

 
$
(2,455
)
 
$
(333
)
 
$
(2,469
)
(1) 
Foreign Currency Translation and Other is net of an average 22% estimated tax at December 31, 2016 as the Company has not recognized deferred tax assets for some of our foreign entities.
Details about AOCI components reclassified to net income are as follows:
Gains/(losses) in net income:
 
Affected line item in the
  Condensed Consolidated
  Statements of Income:
 
Quarter Ended
 
 
December 31,
2016
 
January 2,
2016
Cash flow hedges
 
Primarily revenue
 
$
70

 
$
105

Estimated tax
 
Income taxes
 
(26
)
 
(39
)
 
 
 
 
44

 
66

 
 
 
 
 
 
 
Pension and postretirement
  medical expense
 
Costs and expenses
 
(108
)
 
(67
)
Estimated tax
 
Income taxes
 
40

 
25

 
 
 
 
(68
)
 
(42
)
 
 
 
 
 
 
 
Total reclassifications for the period
 
 
 
$
(24
)
 
$
24


12

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


At December 31, 2016 and October 1, 2016, the Company held available-for-sale investments in unrecognized gain positions totaling $29 million and $49 million, respectively, and no investments in significant unrecognized loss positions.

9.
Equity-Based Compensation
Compensation expense related to stock options, stock appreciation rights and restricted stock units (RSUs) is as follows:
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Stock options(1)
$
20

 
$
23

RSUs
77

 
83

Total equity-based compensation expense (2)
$
97

 
$
106

Equity-based compensation expense capitalized during the period
$
21

 
$
15

(1) 
Includes stock appreciation rights.
(2) 
Equity-based compensation expense is net of capitalized equity-based compensation and excludes amortization of previously capitalized equity-based compensation costs.
Unrecognized compensation cost related to unvested stock options and RSUs was $221 million and $770 million, respectively, as of December 31, 2016.
The weighted average grant date fair values of options granted during the quarters ended December 31, 2016 and January 2, 2016 were $25.78 and $31.17, respectively.
During the quarter ended December 31, 2016, the Company made equity compensation grants consisting of 4.5 million stock options and 3.6 million RSUs.

10.
Commitments and Contingencies
Legal Matters
Beef Products, Inc. v. American Broadcasting Companies, Inc. On September 13, 2012, plaintiffs filed an action in South Dakota state court against certain subsidiaries and employees of the Company and others, asserting claims for defamation arising from alleged false statements and implications, statutory and common law product disparagement, and tortious interference with existing and prospective business relationships. The claims arise out of ABC News reports published in March and April 2012 about a product, Lean Finely Textured Beef, that was included in ground beef and hamburger meat. Plaintiffs’ complaint sought actual and consequential damages in excess of $400 million (which in March 2016 they asserted could be as much as $1.9 billion), statutory damages (including treble damages) pursuant to South Dakota’s Agricultural Food Products Disparagement Act, and punitive damages. Trial is set for June 2017. At this time, the Company is not able to predict the ultimate outcome of this matter, nor can it estimate the range of possible loss.
The Company, together with, in some instances, certain of its directors and officers, is a defendant or codefendant in various other legal actions involving copyright, breach of contract and various other claims incident to the conduct of its businesses.
Management does not believe that the Company has incurred a probable material loss by reason of any of the above actions.
Contractual Guarantees
The Company has guaranteed bond issuances by the Anaheim Public Authority that were used by the City of Anaheim to finance construction of infrastructure and a public parking facility adjacent to the Disneyland Resort. Revenues from sales, occupancy and property taxes from the Disneyland Resort and non-Disney hotels are used by the City of Anaheim to repay the bonds. In the event of a debt service shortfall, the Company will be responsible to fund the shortfall. As of December 31, 2016, the remaining debt service obligation guaranteed by the Company was $316 million, of which $51 million was principal. To the extent that tax revenues exceed the debt service payments in subsequent periods, the Company would be reimbursed for any previously funded shortfalls. To date, tax revenues have exceeded the debt service payments for these bonds.

13

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


Long-Term Receivables and the Allowance for Credit Losses
The Company has accounts receivable with original maturities greater than one year related to the sale of television program rights and vacation ownership units. Allowances for credit losses are established against these receivables as necessary.
The Company estimates the allowance for credit losses related to receivables from the sale of television programs based upon a number of factors, including historical experience and the financial condition of individual companies with which we do business. The balance of television program sales receivables recorded in other non-current assets, net of an immaterial allowance for credit losses, was $0.8 billion as of December 31, 2016. The activity in the current period related to the allowance for credit losses was not material.
The Company estimates the allowance for credit losses related to receivables from sales of its vacation ownership units based primarily on historical collection experience. Estimates of uncollectible amounts also consider the economic environment and the age of receivables. The balance of mortgage receivables recorded in other non-current assets, net of a related allowance for credit losses of approximately 4%, was approximately $0.7 billion as of December 31, 2016. The activity in the current period related to the allowance for credit losses was not material.
Income Taxes
During the quarter ended December 31, 2016, the Company decreased its gross unrecognized tax benefits by $23 million to $821 million.
In the next twelve months, it is reasonably possible that our unrecognized tax benefits could change due to resolutions of open tax matters. These resolutions would reduce our unrecognized tax benefits by approximately $120 million, of which $23 million would reduce our income tax expense and effective tax rate if recognized. 

11. Fair Value Measurements
Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants and is classified in one of the following three categories:
Level 1 - Quoted prices for identical instruments in active markets
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable
The Company’s assets and liabilities measured at fair value are summarized in the following tables by fair value measurement Level: 
 
Fair Value Measurement at December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 Investments
$
55

 
$

 
$

 
$
55

Derivatives
 
 
 
 
 
 
 
Interest rate

 
16

 

 
16

Foreign exchange

 
1,025

 

 
1,025

Other

 
12

 

 
12

Liabilities
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
Interest rate

 
(149
)
 

 
(149
)
Foreign exchange

 
(339
)
 

 
(339
)
Other

 
(1
)
 

 
(1
)
Total recorded at fair value
$
55

 
$
564

 
$

 
$
619

Fair value of borrowings
$

 
$
19,597

 
$
1,389

 
$
20,986

 

14

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


 
Fair Value Measurement at October 1, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 Investments
$
85

 
$

 
$

 
$
85

Derivatives
 
 
 
 
 
 
 
Interest rate

 
132

 

 
132

Foreign exchange

 
596

 

 
596

Other

 
6

 

 
6

Liabilities
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
Interest rate

 
(13
)
 

 
(13
)
Foreign exchange

 
(510
)
 

 
(510
)
Other

 
(4
)
 

 
(4
)
Total recorded at fair value
$
85

 
$
207

 
$

 
$
292

Fair value of borrowings
$

 
$
19,500

 
$
1,579

 
$
21,079

 The fair values of Level 2 derivatives are primarily determined by internal discounted cash flow models that use observable inputs such as interest rates, yield curves and foreign currency exchange rates. Counterparty credit risk, which is mitigated by master netting agreements and collateral posting arrangements with certain counterparties, did not have a material impact on derivative fair value estimates.
Level 2 borrowings, which include commercial paper and U.S. medium-term notes, are valued based on quoted prices for similar instruments in active markets.
Level 3 borrowings, which include International Theme Park borrowings and other foreign currency denominated borrowings, are generally valued based on historical market transactions, prevailing market interest rates and the Company’s current borrowing cost and credit risk.
The Company’s financial instruments also include cash, cash equivalents, receivables and accounts payable. The carrying values of these financial instruments approximate the fair values.

12. Derivative Instruments
The Company manages its exposure to various risks relating to its ongoing business operations according to a risk management policy. The primary risks managed with derivative instruments are interest rate risk and foreign exchange risk.
The Company’s derivative positions measured at fair value are summarized in the following tables: 
 
As of December 31, 2016
 
Current
Assets
 
Other Assets
 
Other
Accrued
Liabilities
 
Other Long-
Term
Liabilities
Derivatives designated as hedges
 
 
 
 
 
 
 
Foreign exchange
$
429

 
$
298

 
$
(106
)
 
$
(103
)
Interest rate

 
16

 
(127
)
 

Other
8

 
4

 
(1
)
 

Derivatives not designated as hedges
 
 
 
 
 
 
 
Foreign exchange
259

 
39

 
(129
)
 
(1
)
Interest rate

 

 

 
(22
)
Gross fair value of derivatives
696

 
357

 
(363
)
 
(126
)
Counterparty netting
(306
)
 
(149
)
 
338

 
117

Cash collateral (received)/paid
(243
)
 
(63
)
 
1

 

Net derivative positions
$
147

 
$
145

 
$
(24
)
 
$
(9
)
 

15

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


 
As of October 1, 2016
 
Current
Assets
 
Other Assets
 
Other
Accrued
Liabilities
 
Other Long-
Term
Liabilities
Derivatives designated as hedges
 
 
 
 
 
 
 
Foreign exchange
$
278

 
$
191

 
$
(209
)
 
$
(163
)
Interest rate

 
132

 
(13
)
 

Other
3

 
3

 
(4
)
 

Derivatives not designated as hedges
 
 
 
 
 
 
 
Foreign exchange
125

 
2

 
(133
)
 
(5
)
Gross fair value of derivatives
406

 
328

 
(359
)
 
(168
)
Counterparty netting
(241
)
 
(199
)
 
316

 
124

Cash collateral (received)/paid
(77
)
 
(44
)
 
7

 

Net derivative positions
$
88

 
$
85

 
$
(36
)
 
$
(44
)
Interest Rate Risk Management
The Company is exposed to the impact of interest rate changes primarily through its borrowing activities. The Company’s objective is to mitigate the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. In accordance with its policy, the Company targets its fixed-rate debt as a percentage of its net debt between a minimum and maximum percentage. The Company primarily uses pay-floating and pay-fixed interest rate swaps to facilitate its interest rate risk management activities.
The Company designates pay-floating interest rate swaps as fair value hedges of fixed-rate borrowings effectively converting fixed-rate borrowings to variable rate borrowings indexed to LIBOR. As of December 31, 2016 and October 1, 2016, the total notional amount of the Company’s pay-floating interest rate swaps was $8.3 billion and $8.3 billion, respectively. The following table summarizes adjustments related to fair value hedges included in “Interest expense, net” in the Condensed Consolidated Statements of Income. 
 
Quarter Ended
 
December 31,
2016
 
January 2,
2016
Gain (loss) on interest rate swaps
$
(232
)
 
$
(55
)
Gain (loss) on hedged borrowings
232

 
55

In addition, the Company realized net benefits of $12 million and $23 million for the quarters ended December 31, 2016 and January 2, 2016, respectively, in “Interest expense, net” related to pay-floating interest rate swaps.
The Company may designate pay-fixed interest rate swaps as cash flow hedges of interest payments on floating-rate borrowings. Pay-fixed swaps effectively convert floating-rate borrowings to fixed-rate borrowings. The unrealized gains or losses from these cash flow hedges are deferred in AOCI and recognized in interest expense as the interest payments occur. The Company did not have pay-fixed interest rate swaps that were designated as cash flow hedges of interest payments at December 31, 2016 or at October 1, 2016 and gains and losses related to pay-fixed swaps recognized in earnings for the quarters ended December 31, 2016 and January 2, 2016 were not material.
To facilitate its interest rate risk management activities, the Company sold an option in November 2016 to enter into a future pay-floating interest rate swap indexed to LIBOR for $0.5 billion in future borrowings. The fair value of this contract as of December 31, 2016 was not material. The option is not designated as a hedge and does not qualify for hedge accounting, accordingly any changes in value will be recorded in earnings.
Foreign Exchange Risk Management
The Company transacts business globally and is subject to risks associated with changing foreign currency exchange rates. The Company’s objective is to reduce earnings and cash flow fluctuations associated with foreign currency exchange rate changes, enabling management to focus on core business issues and challenges.
The Company enters into option and forward contracts that change in value as foreign currency exchange rates change to protect the value of its existing foreign currency assets, liabilities, firm commitments and forecasted but not firmly committed foreign currency transactions. In accordance with policy, the Company hedges its forecasted foreign currency transactions for

16

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


periods generally not to exceed four years within an established minimum and maximum range of annual exposure. The gains and losses on these contracts offset changes in the U.S. dollar equivalent value of the related forecasted transaction, asset, liability or firm commitment. The principal currencies hedged are the euro, Japanese yen, Canadian dollar and British pound. Cross-currency swaps are used to effectively convert foreign currency-denominated borrowings into U.S. dollar denominated borrowings.
The Company designates foreign exchange forward and option contracts as cash flow hedges of firmly committed and forecasted foreign currency transactions. As of December 31, 2016 and October 1, 2016, the notional amounts of the Company’s net foreign exchange cash flow hedges were $5.2 billion and $5.6 billion, respectively. Mark-to-market gains and losses on these contracts are deferred in AOCI and are recognized in earnings when the hedged transactions occur, offsetting changes in the value of the foreign currency transactions. Gains and losses recognized related to ineffectiveness for the quarters ended December 31, 2016 and January 2, 2016 were not material. Net deferred gains recorded in AOCI for contracts that will mature in the next twelve months totaled $332 million.
Foreign exchange risk management contracts with respect to foreign currency denominated assets and liabilities are not designated as hedges and do not qualify for hedge accounting. The notional amounts of these foreign exchange contracts at December 31, 2016 and October 1, 2016 were $3.5 billion and $3.3 billion, respectively. The following table summarizes the net foreign exchange gains or losses recognized on foreign currency denominated assets and liabilities and the net foreign exchange gains or losses on the foreign exchange contracts we entered into to mitigate our exposure with respect to foreign currency denominated assets and liabilities for the quarters ended December 31, 2016 and January 2, 2016 by the corresponding line item in which they are recorded in the Condensed Consolidated Statements of Income.
 
Costs and Expenses
 
Interest expense, net
 
Income Tax expense
Quarter Ended:
December 31,
2016
 
January 2,
2016
 
December 31,
2016
 
January 2,
2016
 
December 31,
2016
 
January 2,
2016
Net gains (losses) on foreign currency denominated assets and liabilities
$
(233
)
 
$
(89
)
 
$
7

 
$
10

 
$
23

 
$
23

Net gains (losses) on foreign exchange risk management contracts not designated as hedges
221

 
79

 
(7
)
 
(12
)
 
(31
)
 

Net gains (losses)
$
(12
)
 
$
(10
)
 
$

 
$
(2
)
 
$
(8
)
 
$
23

Commodity Price Risk Management
The Company is subject to the volatility of commodities prices and the Company designates certain commodity forward contracts as cash flow hedges of forecasted commodity purchases. Mark-to-market gains and losses on these contracts are deferred in AOCI and are recognized in earnings when the hedged transactions occur, offsetting changes in the value of commodity purchases. The notional amount of these commodities contracts at December 31, 2016 and October 1, 2016 and related gains or losses recognized in earnings for the quarters ended December 31, 2016 and January 2, 2016 were not material.
Risk Management – Other Derivatives Not Designated as Hedges
The Company enters into certain other risk management contracts that are not designated as hedges and do not qualify for hedge accounting. These contracts, which include certain swap contracts, are intended to offset economic exposures of the Company and are carried at market value with any changes in value recorded in earnings. The notional amount and fair value of these contracts at December 31, 2016 and October 1, 2016 were not material. The related gains or losses recognized in earnings were not material for the quarters ended December 31, 2016 and January 2, 2016.
Contingent Features and Cash Collateral
The Company has master netting arrangements by counterparty with respect to certain derivative financial instrument contracts. The Company may be required to post collateral in the event that a net liability position with a counterparty exceeds limits defined by contract and that vary with the Company’s credit rating. In addition, these contracts may require a counterparty to post collateral to the Company in the event that a net receivable position with a counterparty exceeds limits defined by contract and that vary with the counterparty’s credit rating. If the Company’s or the counterparty’s credit ratings were to fall below investment grade, such counterparties or the Company would also have the right to terminate our derivative contracts, which could lead to a net payment to or from the Company for the aggregate net value by counterparty of our derivative contracts. The aggregate fair values of derivative instruments with credit-risk-related contingent features in a net liability position by counterparty were $34 million and $86 million on December 31, 2016 and October 1, 2016, respectively.
 

17

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


13. Restructuring and Impairment Charges
The Company recorded $81 million of restructuring and impairment charges in the prior-year quarter for an investment impairment and contract termination and severance costs.

14. New Accounting Pronouncements
Restricted Cash
In November 2016, the Financial Accounting Standards Board (FASB) issued guidance that requires restricted cash to be presented with cash and cash equivalents in the statement of cash flows. The guidance is required to be adopted retrospectively, and is effective beginning in the first quarter of the Company’s 2019 fiscal year (with early adoption permitted). At December 31, 2016 and October 1, 2016, the Company held restricted cash of approximately $335 million and $150 million, respectively, primarily associated with collateral received from counterparties to its derivative contracts. The Company’s restricted cash balances are presented in the Condensed Consolidated Balance Sheets as Other current assets and Other assets based on the maturity dates of the related derivatives. Under the new guidance, changes in the Company’s restricted cash will continue to be classified as either operating activities or investing activities in the Condensed Consolidated Statements of Cash Flows, depending on the nature of the activities that gave rise to the restricted cash balance.
Intra-Entity Transfers of Assets Other Than Inventory
In October 2016, the FASB issued guidance that requires the income tax consequences of an intra-entity transfer of an asset other than inventory to be recognized when the transfer occurs instead of when the asset is sold to an outside party. The new guidance is effective beginning with the first quarter of the Company’s 2019 fiscal year (with early adoption permitted as of the beginning of an annual period). The guidance is required to be adopted retrospectively by recording a cumulative-effect adjustment to retained earnings as of the beginning of the adoption period. The Company is assessing the potential impact this guidance will have on its financial statements.
Stock Compensation - Employee Share-based Payments
In March 2016, the FASB issued guidance to amend certain aspects of accounting for employee share-based awards, including accounting for income taxes related to those transactions. This guidance will require recognizing excess tax benefits and deficiencies (that result from an increase or decrease in the value of an award from grant date to the vesting date or exercise date) on share-based compensation arrangements in the tax provision, instead of in equity as under the current guidance. In addition, these amounts will be classified as an operating activity in the statement of cash flows, instead of as a financing activity. The Company reported excess tax benefits of $0.2 billion and $0.3 billion in fiscal 2016 and 2015, respectively. In addition, cash paid for shares withheld to satisfy employee taxes will be classified as a financing activity, instead of as an operating activity. Cash paid for employee taxes was $0.2 billion and $0.3 billion in fiscal 2016 and 2015, respectively. The fiscal 2016 and 2015 amounts of excess tax benefits and cash paid for employee taxes are not necessarily indicative of future amounts that may arise in years following implementation of the new accounting pronouncement.
The Company adopted the new guidance in the first quarter of fiscal 2017 as follows:
Excess tax benefits of $38 million in the current quarter were recognized as a benefit in “Income taxes” in the Condensed Consolidated Statement of Income and classified as a source in operating activities in the Condensed Consolidated Statement of Cash Flows. The guidance required prospective adoption for the statement of income and allowed for either prospective or retrospective adoption for the statement of cash flows. The Company elected to prospectively adopt the effect to the statement of cash flows and accordingly, did not restate the Condensed Consolidated Statement of Cash Flows for the quarter ended January 2, 2016.
Cash paid for shares withheld to satisfy employee taxes of $135 million for the quarter ended December 31, 2016 was classified as a use in financing activities in the Condensed Consolidated Statement of Cash Flows. The guidance required retrospective adoption; accordingly, a $94 million use was reclassified from an operating activity to a financing activity in the Condensed Consolidated Statement of Cash Flows for the quarter ended January 2, 2016.
Leases
In February 2016, the FASB issued a new lease accounting standard, which requires the present value of committed operating lease payments to be recorded as right-of-use lease assets and lease liabilities on the balance sheet. As of October 1, 2016, the Company had an estimated $3.1 billion in undiscounted future minimum lease commitments. The Company is currently assessing the impact of the new guidance on its financial statements. The guidance is required to be adopted retrospectively, and is effective beginning in the first quarter of the Company’s 2020 fiscal year (with early adoption permitted).

18

THE WALT DISNEY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited; tabular dollars in millions, except for per share data)


Revenue from Contracts with Customers
In May 2014, the FASB issued guidance that replaces the existing accounting standards for revenue recognition with a single comprehensive five-step model, eliminating industry-specific accounting rules. The core principle is to recognize revenue upon the transfer of goods or services to customers at an amount that reflects the consideration expected to be received. Since its issuance, the FASB has amended several aspects of the new guidance, including provisions that address revenue recognition associated with the licensing of intellectual property. The new guidance, including the amendments, is effective beginning with the first quarter of the Company’s 2019 fiscal year (with early adoption permitted beginning fiscal year 2018). The guidance may be adopted either by restating all years presented in the Company’s financial statements or by recording the impact of adoption as an adjustment to retained earnings at the beginning of the year of adoption. We are continuing to assess the potential impact of this guidance, including the impact on those areas currently subject to industry-specific guidance such as licensing of intellectual property. As part of our assessment, we are reviewing representative samples of customer contracts to determine the impact on revenue recognition under the new guidance. Our method of adoption will in part be based on the degree of change identified in our assessment.

19



MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

ORGANIZATION OF INFORMATION
Management’s Discussion and Analysis provides a narrative of the Company’s financial performance and condition that should be read in conjunction with the accompanying financial statements. It includes the following sections:
Consolidated Results and Non-segment Items
Seasonality
Segment Results
Tax Impact of Employee Share-Based Awards
Financial Condition
Commitments and Contingencies
Other Matters
Market Risk
CONSOLIDATED RESULTS AND NON-SEGMENT ITEMS
Our summary consolidated results are presented below: 
 
Quarter Ended
 
% Change
(in millions, except per share data)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Revenues:
 
 
 
 
 
Services
$
12,406

 
$
12,622

 
(2)
 %
Products
2,378

 
2,622

 
(9)
 %
Total revenues
14,784

 
15,244

 
(3)
 %
Costs and expenses:
 
 
 
 
 
Cost of services (exclusive of depreciation and amortization)
(7,020
)
 
(7,056
)
 
1
 %
Cost of products (exclusive of depreciation and amortization)
(1,386
)
 
(1,567
)
 
12
 %
Selling, general, administrative and other
(1,985
)
 
(2,025
)
 
2
 %
Depreciation and amortization
(687
)
 
(607
)
 
(13)
 %
Total costs and expenses
(11,078
)
 
(11,255
)
 
2
 %
Restructuring and impairment charges

 
(81
)
 
100
 %
Interest expense, net
(99
)
 
(24
)
 
>(100)
 %
Equity in the income of investees
118

 
474

 
(75)
 %
Income before income taxes
3,725

 
4,358

 
(15)
 %
Income taxes
(1,237
)
 
(1,448
)
 
15
 %
Net income
2,488

 
2,910

 
(15)
 %
Less: Net income attributable to noncontrolling interests
(9
)
 
(30
)
 
70
 %
Net income attributable to Disney
$
2,479

 
$
2,880

 
(14)
 %
Diluted earnings per share attributable to Disney
$
1.55

 
$
1.73

 
(10)
 %


20

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


Quarter Results
Revenues for the quarter decreased 3%, or $460 million, to $14.8 billion; net income attributable to Disney decreased 14%, or $401 million, to $2.5 billion; and diluted earnings per share attributable to Disney (EPS) decreased 10% from $1.73 to $1.55. The EPS decrease for the quarter was due to the Vice Gain recognized in the prior-year quarter (see Note 3 to the Condensed Consolidated Financial Statements), lower operating results and higher net interest expense, partially offset by a decrease in weighted average shares outstanding as a result of our share repurchase program. Operating results reflected declines in the sale of services and products and were adversely impacted by foreign currency translation due to the movement of the U.S. dollar against major currencies including the impact of our hedging program (FX Impact).
Revenues
Service revenues for the quarter decreased 2%, or $216 million, to $12.4 billion, due to lower licensing revenue from merchandise and games, sales of television programs, attendance at our domestic parks, advertising revenue and theatrical distribution revenues. These decreases were partially offset by the benefit of the opening of Shanghai Disney Resort in the prior-year third quarter, higher guest spending at our domestic parks and resorts and higher fees from Multi-channel Video Distributors (MVPDs) (Affiliate Fees). Service revenue reflected an approximate 1 percentage point decrease due to an unfavorable FX Impact.
Product revenues for the quarter decreased 9%, or $244 million, to $2.4 billion, due to the discontinuation of the Infinity business in the second quarter of the prior year and lower volumes at our home entertainment distribution and retail businesses. These decreases were partially offset by the benefit of the opening of Shanghai Disney Resort and higher guest spending at our domestic parks and resorts. Product revenue reflected an approximate 1 percentage point decrease due to an unfavorable FX Impact.
Costs and expenses
Cost of services for the quarter decreased 1%, or $36 million, to $7.0 billion, due to lower programming and production costs and lower film cost amortization, partially offset by the impact of the opening of Shanghai Disney Resort.
Cost of products for the quarter decreased 12%, or $181 million, to $1.4 billion, due to the discontinuation of the Infinity business and lower retail and home entertainment volumes, partially offset by the impact of the opening of Shanghai Disney Resort.
Selling, general, administrative and other costs decreased 2%, or $40 million, to $2.0 billion, due to the discontinuation of the Infinity business, partially offset by higher theatrical marketing costs. Selling, general, administrative and other costs reflected an approximate 2 percentage point benefit due to a favorable FX Impact.
Depreciation and amortization costs increased 13%, or $80 million, to $0.7 billion, due to the opening of Shanghai Disney Resort.
Restructuring and impairment charges
The Company recorded $81 million of restructuring and impairment charges in the prior-year quarter for an investment impairment and contract termination and severance costs.
Interest expense, net
Interest expense, net is as follows: 
 
Quarter Ended
 

(in millions)
December 31,
2016
 
January 2,
2016
 
% Change
Better/(Worse)
Interest expense
$
(121
)
 
$
(66
)
 
(83
)%
Interest and investment income
22

 
42

 
(48
)%
Interest expense, net
$
(99
)
 
$
(24
)
 
>(100
)%
The increase in interest expense was due to higher average debt balances, higher average interest rates and lower capitalized interest. Capitalized interest was lower due to the completion of the majority of construction at Shanghai Disney Resort in the prior-year third quarter.
The decrease in interest and investment income for the quarter was due to gains on sales of investments in the prior-year quarter.

21

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


Equity in the income of investees
Equity in the income of investees decreased $356 million to $118 million for the quarter due to the $332 million Vice
Gain ($0.13 of EPS in the prior-year quarter) (see Note 3 to the Condensed Consolidated Financial Statements).
Effective Income Tax Rate 
 
Quarter Ended
 
 
 
December 31,
2016
 
January 2,
2016
 
Change
Better/(Worse)
Effective income tax rate
33.2
%
 
33.2
%
 

ppt
The effective income tax rate for the quarter was comparable to the prior-year quarter as a favorable impact of an accounting change ($38 million) was offset by an adverse impact of a tax law change ($34 million). In the current quarter, the Company adopted new accounting guidance, which requires that excess tax benefits or tax deficiencies on employee share-based awards be included in “Income taxes” in the Condensed Consolidated Statement of Income. An excess tax benefit arises when the value of employee share-based award on the exercise or vesting date is higher than the fair value on the grant date. A tax deficiency arises when the value is lower than the fair value. These amounts were previously recorded in “Common stock” in the Condensed Consolidated Balance Sheet (see Note 14 to the Condensed Consolidated Financial Statements).
Noncontrolling Interests 
 
Quarter Ended
 
 
(in millions)
December 31,
2016
 
January 2,
2016
 
% Change
Better/(Worse) 
Net income attributable to noncontrolling interests
$
9

 
$
30

 
70
%
The decrease in net income attributable to noncontrolling interests for the quarter was primarily due to lower net income at ESPN.
Net income attributable to noncontrolling interests is determined on income after royalties and management fees, financing costs and income taxes.
SEASONALITY
The Company’s businesses are subject to the effects of seasonality. Consequently, the operating results for the quarter ended December 31, 2016 for each business segment, and for the Company as a whole, are not necessarily indicative of results to be expected for the full year.
Media Networks revenues are subject to seasonal advertising patterns, changes in viewership levels and timing of program sales. In general, advertising revenues are somewhat higher during the fall and somewhat lower during the summer months.
Parks and Resorts revenues fluctuate with changes in theme park attendance and resort occupancy resulting from the seasonal nature of vacation travel and leisure activities. Peak attendance and resort occupancy generally occur during the summer months when school vacations occur and during early-winter and spring-holiday periods.
Studio Entertainment revenues fluctuate due to the timing and performance of releases in the theatrical, home entertainment and television markets. Release dates are determined by several factors, including competition and the timing of vacation and holiday periods.
Consumer Products & Interactive Media revenues are influenced by seasonal consumer purchasing behavior, which generally results in increased revenues during the Company’s first fiscal quarter, and the timing and performance of theatrical and game releases and cable programming broadcasts.

22

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


SEGMENT RESULTS
The Company evaluates the performance of its operating segments based on segment operating income, which is shown below along with segment revenues: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Revenues:
 
 
 
 
 
Media Networks
$
6,233

 
$
6,332

 
(2)
 %
Parks and Resorts
4,555

 
4,281

 
6
 %
Studio Entertainment
2,520

 
2,721

 
(7)
 %
Consumer Products & Interactive Media
1,476

 
1,910

 
(23)
 %
 
$
14,784

 
$
15,244

 
(3)
 %
Segment operating income:
 
 
 
 
 
Media Networks
$
1,362

 
$
1,412

 
(4)
 %
Parks and Resorts
1,110

 
981

 
13
 %
Studio Entertainment
842

 
1,014

 
(17)
 %
Consumer Products & Interactive Media
642

 
860

 
(25)
 %
 
$
3,956

 
$
4,267

 
(7)
 %
 
The following table reconciles segment operating income to income before income taxes: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Segment operating income
$
3,956

 
$
4,267

 
(7)
 %
Corporate and unallocated shared expenses
(132
)
 
(136
)
 
3
 %
Restructuring and impairment charges

 
(81
)
 
100
 %
Interest expense, net
(99
)

(24
)
 
>(100)
 %
Vice Gain(1)

 
332

 
(100)
 %
Income before income taxes
$
3,725


$
4,358

 
(15)
 %
(1) See Note 3 to the Condensed Consolidated Financial Statements for a discussion of the Vice Gain.
Depreciation expense is as follows: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Media Networks
 
 
 
 
 
Cable Networks
$
36

 
$
37

 
3
 %
Broadcasting
21

 
21

 
 %
Total Media Networks
57

 
58

 
2
 %
Parks and Resorts
 
 
 
 


Domestic
328

 
318

 
(3)
 %
International
156

 
84

 
(86)
 %
Total Parks and Resorts
484

 
402

 
(20)
 %
Studio Entertainment
12

 
13

 
8
 %
Consumer Products & Interactive Media
15

 
14

 
(7)
 %
Corporate
68

 
63

 
(8)
 %
Total depreciation expense
$
636

 
$
550

 
(16)
 %

23

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


Amortization of intangible assets is as follows:
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Media Networks
$
2

 
$
5

 
60
 %
Parks and Resorts
1

 
1

 
 %
Studio Entertainment
16

 
20

 
20
 %
Consumer Products & Interactive Media
32

 
31

 
(3)
 %
Total amortization of intangible assets
$
51

 
$
57

 
11
 %

Media Networks
Operating results for the Media Networks segment are as follows: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Revenues
 
 
 
 
 
Affiliate fees
$
3,075

 
$
2,960

 
4
 %
Advertising
2,529

 
2,619

 
(3)
 %
TV/SVOD distribution and other
629

 
753

 
(16)
 %
Total revenues
6,233

 
6,332

 
(2)
 %
Operating expenses
(4,298
)
 
(4,355
)
 
1
 %
Selling, general, administrative and other
(633
)
 
(644
)
 
2
 %
Depreciation and amortization
(59
)
 
(63
)
 
6
 %
Equity in the income of investees
119

 
142

 
(16)
 %
Operating Income
$
1,362

 
$
1,412

 
(4)
 %
Revenues
The increase in affiliate fees was due to growth of 7% from higher contractual rates, partially offset by decreases of 2% from fewer subscribers and 1% from an unfavorable FX Impact.
The decrease in advertising revenues was due to a decrease of $81 million at Cable Networks, from $1,488 million to $1,407 million and a decrease of $9 million at Broadcasting, from $1,131 million to $1,122 million. The decrease at Cable Networks was due to a 5% decrease from lower impressions, partially offset by a 1% increase from higher rates, both of which were negatively impacted by the shift in timing of College Football Playoff (CFP) bowl games relative to our fiscal quarter end. Six CFP games were aired in the first quarter of the prior year, whereas three CFP games were aired in the current quarter. Lower impressions reflected a decrease in average viewership, partially offset by an increase in units delivered. Broadcasting advertising revenues reflected an 11% decrease from lower impressions and a 2% decrease from other advertising, partially offset by a 12% increase from higher rates at the ABC Television Network and the owned television stations. The decrease in impressions was due to lower average viewership and, to a lesser extent, fewer network units delivered, which reflected the impact of higher political coverage. The increase in rates at the owned television stations was due to higher political advertising.
TV/SVOD distribution and other revenue decreased $124 million, from $753 million to $629 million due to the sale of Jessica Jones in the prior-year quarter, lower sales of cable programs in the current quarter and an unfavorable FX Impact, partially offset by higher sales of ABC programs in the current quarter.
Costs and Expenses
Operating expenses include programming and production costs, which decreased $48 million, from $4,059 million to $4,011 million. At Broadcasting, programming and production costs decreased $82 million due to the impact of lower program sales and a decrease in cost write-downs for network programming. At Cable Networks, programming and production costs increased $34 million due to contractual rate increases for NBA, NFL and CFP programming, partially offset by the timing of CFP games and the impact of lower program sales.
Selling, general, administrative and other costs decreased $11 million, from $644 million to $633 million due to a favorable FX Impact.

24

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


Equity in the Income of Investees
Income from equity investees decreased $23 million, from $142 million to $119 million. Approximately half of the decrease was due to lower equity income from A+E Television Networks (A+E) and approximately half of the decrease was due to equity losses from BAMTech, which was acquired in August 2016. The decrease at A+E was due to lower advertising revenue and higher programming costs, partially offset by higher affiliate fees and lower intangible amortization. The decrease also reflected a negative impact from the conversion of the H2 channel to Viceland in November 2015. Results at Hulu were comparable to the prior-year quarter.
 Segment Operating Income
Segment operating income decreased $50 million, to $1,362 million due to a decrease at ESPN and lower income from equity investees, partially offset by increases at the ABC Television Network and the owned television stations.
The following table provides supplemental revenue and segment operating income detail for the Media Networks segment: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Revenues
 
 
 
 
 
Cable Networks
$
4,428

 
$
4,521

 
(2)
 %
Broadcasting
1,805

 
1,811

 
 %
 
$
6,233

 
$
6,332

 
(2)
 %
Segment operating income
 
 
 
 
 
Cable Networks
$
864

 
$
975

 
(11)
 %
Broadcasting
379

 
295

 
28
 %
Equity in the income of investees
119

 
142

 
(16)
 %
 
$
1,362

 
$
1,412

 
(4)
 %
Restructuring and impairment charges
The Company recorded restructuring and impairment charges of $81 million related to Media Networks in the first quarter of fiscal 2016 for an investment impairment and contract termination and severance costs.

Parks and Resorts
Operating results for the Parks and Resorts segment are as follows: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Revenues
 
 
 
 
 
Domestic
$
3,740

 
$
3,674

 
2
 %
International
815

 
607

 
34
 %
Total revenues
4,555

 
4,281

 
6
 %
Operating expenses
(2,547
)
 
(2,475
)
 
(3)
 %
Selling, general, administrative and other
(411
)
 
(422
)
 
3
 %
Depreciation and amortization
(485
)
 
(403
)
 
(20)
 %
Equity in the loss of investees
(2
)
 

 
nm
Operating Income
$
1,110

 
$
981

 
13
 %
Revenues
Parks and Resorts revenues increased 6%, or $274 million, to $4.6 billion due to increases of $208 million at our international operations and $66 million at our domestic operations. Revenues were unfavorably impacted by Hurricane Matthew at our domestic operations and a shift in the timing of the New Year’s holiday relative to our fiscal periods.

25

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


Revenue growth at our international operations reflected an increase of 33% from the opening of Shanghai Disney Resort in the prior-year third quarter and the benefit of a full period of operations at Disneyland Paris as the park was closed for four days in the prior-year quarter.
Revenue growth at our domestic operations reflected a 4% increase from higher average guest spending, partially offset by a 3% decrease from lower volumes. Guest spending growth was due to higher average ticket prices for admissions to our theme parks and sailings at our cruise line, increased food and beverage spending and higher average daily rates at our hotels. Lower volumes were due to decreases in attendance and occupied room nights. The decrease in attendance reflected the prior-year benefit of the 60th Anniversary celebration at Disneyland Resort, the impact in the current quarter from Hurricane Matthew at Walt Disney World Resort and the impact of the New Year’s holiday shift.
The following table presents supplemental park and hotel statistics: 
 
Domestic
 
International (2)
 
Total
 
Quarter Ended
 
Quarter Ended
 
Quarter Ended
 
Dec. 31,
2016
 
Jan. 2,
2016
 
Dec. 31,
2016
 
Jan. 2,
2016
 
Dec. 31,
2016
 
Jan. 2,
2016
Parks
 
 
 
 
 
 
 
 
 
 
 
Increase/(decrease)
 
 
 
 
 
 
 
 
 
 
 
Attendance
(5)
 %
 
10
%
 
50
 %
 
(7)
 %
 
6
%
 
6
%
Per Capita Guest Spending
7
 %
 
7
%
 
(3)
 %
 
5
 %
 
2
%
 
7
%
Hotels (1)
 
 
 
 
 
 
 
 
 
 
 
Occupancy
91
 %
 
92
%
 
79
 %
 
77
 %
 
88
%
 
89
%
Available Room Nights (in thousands)
2,569

 
2,608

 
731

 
620

 
3,300

 
3,228

Per Room Guest Spending

$324

 

$314

 

$289

 

$281

 

$317

 

$309

(1)
Per room guest spending consists of the average daily hotel room rate, as well as guest spending on food, beverage and merchandise at the hotels. Hotel statistics include rentals of Disney Vacation Club units.
(2)
Per capita guest spending growth rate is stated on a constant currency basis. Per room guest spending is stated at the fiscal 2016 first quarter average foreign exchange rate. The euro to U.S. dollar weighted average foreign currency exchange rate was $1.08 and $1.10 for the quarters ended December 31, 2016 and January 2, 2016, respectively.
Costs and Expenses
Operating expenses include operating labor, which increased $40 million, from $1,162 million to $1,202 million, infrastructure costs, which decreased $1 million, from $463 million to $462 million and cost of sales, which increased $8 million, from $411 million to $419 million. The increase in operating labor was primarily due to the opening of Shanghai Disney Resort and inflation, partially offset by efficiency initiatives. The increase in cost of sales was due to the opening of Shanghai Disney Resort. Infrastructure costs were flat as decreases due to efficiency initiatives and lower dry-dock expenses were offset by increased costs due to the opening of Shanghai Disney Resort and inflation. A portion of the dry-dock costs for the Disney Wonder were incurred in the current quarter whereas all of the dry-dock costs for the Disney Dream were incurred in the prior-year first quarter. Other operating expenses, which include costs for items such as supplies, commissions and entertainment offerings, increased due to the opening of Shanghai Disney Resort.
The increase in depreciation and amortization was due to the opening of Shanghai Disney Resort.
Segment Operating Income
Segment operating income increased 13%, or $129 million, to $1.1 billion due to growth at our domestic and international operations.


26

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued)


Studio Entertainment
Operating results for the Studio Entertainment segment are as follows: 
 
Quarter Ended
 
% Change
(in millions)
December 31,
2016
 
January 2,
2016
 
Better/
(Worse)
Revenues
 
 
 
 
 
Theatrical distribution
$
961

 
$
1,017

 
(6)
 %
Home entertainment