Call Start: 17:00
Call End: 17:56
The Walt Disney Company (DIS)
Q2 2014 Earnings Conference Call
May 6, 2014 5:00 PM ET
Lowell Singer - SVP, IR
Bob Iger - Chairman and CEO
Jay Rasulo - SEVP and CFO
Michael Nathanson - MoffettNathanson
Alexia Quadrani - JPMorgan
Jessica Reif Cohen - Bank of America Merrill Lynch
David Bank - RBC Capital Markets
Benjamin Swinburne - Morgan Stanley
Todd Juenger - Sanford Bernstein
Anthony DiClemente - Nomura
Jason Bazinet - Citibank
David Miller - Topeka Capital Markets
Mike Morris - Guggenheim Securities
Hello, and welcome to the Q2 2014 Walt Disney Company Earnings Conference Call. My name is Eric, I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded.
I will now turn the call over to Lowell Singer, Senior Vice President of Investor Relations. Mr. Singer, you may begin.
Good afternoon, everyone and welcome to The Walt Disney Company's second quarter 2014 earnings call. Our press release was issued almost 45 minutes ago. It's available on our Web site at www.disney.com/investors. Today's call is also being webcast and the website and a transcript will be available on our Web site.
Joining me in Burbank for today's call are Bob Iger, Disney's Chairman and Chief Executive Officer and Jay Rasulo, Senior Executive Vice President and Chief Financial Officer. Bob will lead off followed by Jay and then of course we will be happy to take some questions.
So, with that, let me turn the call over to Bob and we will get started.
Thanks, Lowell, and good afternoon, everyone. We're extremely pleased with our performance in Q2, with revenues up 10%, net income up 27%, and adjusted EPS up 41% to $1.11, the highest in the history of our Company. Once again, all of our business segments achieved double-digit increases or more in operating income.
Our continued strong performance reflects the strength of our brands and the quality of our content. Our extraordinary creative success and our unique ability to leverage it across the entire Company. The unprecedented global success of Disney Animation's phenomenal Frozen continues and it's now the world's highest grossing animated film of all time. The best-selling title ever released on Blu-ray and digital. The demand for Frozen merchandise remains extremely high and the soundtrack was the number one album in the U.S. again last week. And as previously announced, Frozen is headed to Broadway.
Captain America: The Winter Soldier has far surpassed the first Captain America in total global box office, which obviously bodes well for our Avengers franchise. We’ve had enormous success releasing Marvel movies on the first weekend of May, including the two biggest domestic openings of all time. And we’ll continue this tradition with the Avengers Age of Ultron next year and Captain America 3 in 2016. Avengers Age of Ultron is currently shooting an early footage and looks great.
This August 1st, we’re looking forward to introducing the world to more fantastic Marvel storytelling, with a great cast of new characters in Guardians of the Galaxy, which we screened last week and we believe it has strong franchise potential. Also on the Marvel front, we just announced the Disney Interactive’s Infinity 2, will feature The Avengers, as well as other Marvel and Disney characters when it’s released in the fall. Since the first version of the game launched last August, more than 3 million Disney Infinity starter packs have been sold and it was the best-selling interactive gaming toy of 2013 in the U.S.
We made some news last week, when we announced the cast for Star Wars Episode VII, which includes some very familiar faces, as well as some exciting new talent. And the reaction has been tremendous. I was at Pinewood Studios with J. J. Abrams a couple of weeks ago, unlike more confident than ever that Episode VII will be the extraordinary movie Star Wars fans have been waiting for.
Our Parks and Resorts had another record quarter and we have completed the rollout of MyMagic+ to all guests, which Jay will get into in a few minutes. Guest reaction has been very positive and we believe the new program is delivering nicely on its promise of improving guest experience. Internationally, Hong Kong Disneyland set new attendance and occupancy records in Q2 and construction on Shanghai Disney Resort continues to go well. There are an estimated 330 million potential guests within a three-hour travel radius of our Shanghai Resort, and by the time, we open the gates in late 2015, China’s travel market is expected to be 34% bigger than it was in 2012. And the number of upper middle-class and affluent households is expected to grow by 18% a year for most of the next decade. These trends factored into our recent decision with our partners in Shanghai to accelerate expansion with an additional $800 million investment.
Turning to Media Networks, both our cable and broadcast businesses had a solid quarter. We showcased the strength and long-term potential of ESPN at our Investor Day last month. It’s an incredible brand that continues to drive tremendous value for us, and we've got a lot of reasons to be excited about what's coming up, including a great NBA post-season culminating with the finals on ABC, the World Cup from Brazil, a very promising Monday Night Football schedule, and ESPN's first foray into the NFL post-season.
Finally, I would like to share a few thoughts about our acquisition of the top online video network Maker Studios. We are excited about entering the short form video space in a much more asserted manner to boost the presence of our brands and franchises in this increasingly valuable and fast growing arena. Maker's production talent and leadership will create exciting new opportunities to drive value from our content and create new content as well. By any measure, we had great success in Q2, creatively, financially and strategically. In addition to our unique ability to leverage content across the entire Company to create maximum value, our unparallel portfolio of incredibly strong brands is a clear strategic advantage that we expect will be evident in our results for years to come.
And now, I'm going to turn this call over to Jay, so he can walk you through the details of our results in the second quarter. Jay?
Thanks Bob and good afternoon everyone. We had a great first half of fiscal 2014. In fact, it's the best first half in the Company's history. Our second quarter results once again reflect the significant benefit we derived from our strategy of investing in high-quality content.
As Bob mentioned, adjusted earnings per share for the second quarter were up 41% to $1.11. Each segment delivered meaningful increases in operating income and in the case of the Studio, operating income was up over 300% to $475 million, representing one of the Studio's best quarters ever. During the quarter, the growth in operating income at the Studio was due primarily to the domestic home video release of Frozen and the film's strong theatrical performance overseas, where it has generated approximately $770 million in international box office to-date. Higher operating income from television distribution also contributed to growth in the quarter.
Media Networks delivered higher operating income in the second quarter due to growth at both cable and broadcasting. At cable, growth in operating income was driven by ESPN, domestic Disney Channels and higher equity income from our investment in A&E Television Networks.
Growth in ESPN's operating income was due to higher affiliate revenue and lower programming and production costs, partially offset by lower ad revenue. ESPN continues to benefit in the quarter from the absence of losses at our ESPN UK business, which was sold in the fourth quarter last year. Programming cost with ESPN were lower than in the prior year as contractual rate increases for college basketball were more than offset by the absence of costs for UK sports rights.
During the second quarter, ESPN deferred $80 million less in affiliate revenue than in Q2 of last year, due primarily to the signing of a new affiliate contract. As we look to the third quarter, we expect ESPN to recognize approximately $190 million less in previously deferred affiliate revenue compared to the prior year. I'll remind you these changes have no impact on full year results.
Ad revenue at ESPN declined low single-digits in the second quarter due to a decrease in units sold and lower ratings, partially offset by higher rates. The marketplace was not particularly robust in the second quarter. So far this quarter ESPN ad sales are pacing up mid single-digits, driven by demand for the World Cup. The broadcast of those matches gets underway in late Q3 and runs through the first two weeks of Q4.
Domestic cable affiliate revenue growth was up low double-digits in the quarter, which was aided by the timing of program covenants. Adjusted for the timing of deferred revenue at ESPN, growth in domestic cable affiliate revenue was up high single-digits. Broadcasting operating income was up in the quarter driven by higher affiliate revenue and lower expenses, partially offset by lower advertising revenue. Ad revenue at the ABC Network was down in the quarter due to lower ratings, partially offset by higher rates. Quarter-to-date, scatter pricing at the network is running mid-single digits above upfront levels.
At Parks and Resorts, our Q2 results reflect strong underlying trends in the business. Total revenue was up 8% and operating income was up 19%, as a result of continued strength.
Results at our international operations were comparable to the prior year, as growth at Hong Kong Disneyland was offset by a decline at Disneyland Paris. Total segment margins were up 120 basis points in the second quarter and were adversely impacted by about 200 basis points due to new initiatives.
The second quarter also included one less week of the Easter holiday compared to last year. Adjusted for the timing of the Easter holiday, operating income would have been up an estimated 31%. Growth in operating income at on our domestic operations was driven by higher guest spending at Walt Disney World and higher attendance at Disneyland Resort, partially offset by higher costs, primarily related to the continued rollout of MyMagic+.
We made MyMagic+ available to all on property guests during the first fiscal quarter and to all other guests at the beginning of the third quarter. We are pleased with some of the changes in guest behavior and park dynamics we are already seeing.
Guest adoption of our MyMagic+ pre-visit planning tools is encouraging. Roughly three quarters of our Resort guests are using them to plan their visit. Just one month after making pre-arrival planning of FastPass+ available to our day guests more than 25% of them are pre-engaging with us.
Historically guests who preplan spend more time at our Parks, so we like these early trends. MyMagic+ has also increased the engagement with FastPass+ by 40% relative to the legacy FASTPASS system, and allowed us to increase the number of guests we can accommodate during peak periods.
Our research indicates that these benefits are driving higher overall levels of guest satisfaction. During the second quarter, per capita spending at our domestic Parks was up 4% on higher ticket prices, food and beverage and merchandise spending. Attendance at our domestic Parks was up 3% setting a second quarter attendance record. Per room spending in our domestic hotels was up 3% and occupancy was up 6 percentage points to 86%. So far this quarter, domestic Resort reservations are pacing up 3% compared to prior year levels, while book rates are up 6%.
At Consumer Products, operating income increased 37% and margins were higher by almost 500 basis points, reflecting continued strength in our merchandise licensing business and retail. Growth in licensing was driven by higher revenue for Disney Channel, Mickey and Minnie, and Planes properties. On a comparable basis, earned licensing revenue in the second quarter was up 8% versus last year. That's three consecutive quarters of mid to high-single-digit growth in earned revenue, which is pretty impressive.
Results at Disney Interactive were significantly better than we anticipated when we reported Q1 results due to the continued success of Disney Infinity. We had another profitable quarter, which makes it three consecutive quarters of profitability, a first for the segment.
In addition to success of Disney Infinity, growth in our Japan mobile business also contributed to higher operating income albeit to a lesser extent. We continue to repurchase our stock during the second quarter and we are still on pace to repurchase between $6 billion and $8 billion for fiscal 2014. During Q2, we repurchased 19.9 million shares for about $1.5 billion. Fiscal year-to-date, we have repurchased 58.2 million shares for $4.3 billion.
With that, we're now ready to take your questions.
Okay, thanks Jay. Eric, we are ready to open it up for questions.
Earnings Call Part 2: