Welcome to The Walt Disney Company's First Quarter 2013 Earnings Conference Call. My name is Ellen and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Mr. Lowell Singer, Senior Vice President, Investor Relations. Mr. Singer, you may begin.
Thanks, Ellen, and good afternoon, everyone. Welcome to the Walt Disney Company's First Quarter 2013 Earnings Call. Our press release was issued about 45 minutes ago. It’s available on our website at www.disney.com/investors. Today's call is being webcast and we will post the webcast and a transcript also to our website.
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'll leave plenty of time for your questions. So with that I'll turn it over to Bob and we'll get started.
Thank you, Lowell and good afternoon everyone. Coming off a record year in 2012, we had a solid first quarter and we are enthusiastic about the year ahead. Now that Lucasfilm is officially part of the Walt Disney Company, we are moving forward with the extraordinary Star Wars franchise across our portfolio of businesses and we are excited about the tremendous potential ahead starting with the Star Wars Episode 7 which we expect will be in theaters in the summer of 2015. We are pleased to have J.J. Abrams directing our first feature film in that franchise. And we have had a long and very successful with J.J., working with him on two popular ABC series, Alias, and the global phenomenon Lost. We are proud to be working with him again to take Star Wars franchise saga forward.
I would also like to confirm that we are in developed on a few standalone films that are not part of the Star Wars saga. Lawrence Kasdan who wrote Empire Strike Back and Return of the Jedi is working on one. And Simon Kinberg is working on another. And Lucasfilm will have details about these projects at a later date.
Turning to media networks. In the media networks we have now closed seven of our ten major affiliate agreements for our cable networks. Multi-channel operators clearly recognize the significant value created by our array of brands and programming from the number one sports brand ESPN, to our powerhouse portfolio of kids entertainment including Disney Channel, Disney XD, and Disney Junior, plus ABC and ABC Family.
Last year Disney channel took the top spot among kids two to 11 for the first time and continued its long winning streak as the number one network among kids and tweens in the U.S. Disney Junior programming is also doing extremely well among pre-schoolers and their families. We made Doc McStuffins, Jake and the Never Land Pirates, and Mickey Mouse Club House, top three cable shows for kids two to five. Disney Junior’s animated movie Sofia The First, Once Upon a Mattress was 2012s highest rated telecast among those young viewers and is now a new and very popular series as well.
Anchoring the Disney Junior channel that we launched last March, these shows drive the growing popularity of Disney Junior as well as extremely high consumer demand at retail. On the sports side, ESPN is the number one sports brand and undisputed market place leader. With a 33 head start on the competition, unprecedented sports coverage, and constant innovation in both programming and distribution, ESPN delivers incomparable value to multichannel operators as well as consumers. And with long-term sports rights now locked in, we expect ESPN to remain the must have brand for sports fans.
ESPN serves sports fans nationwide with almost 30,000 hours of live events, news and original programming across all of its networks and services each year. In every week, more than 113 million of the estimated 230 million sports fans in America interact with ESPN for sports coverage and sports information. By contrast, emerging regional sports networks serve fans of local teams with limited programming. RSNs may compete for local market share but ESPN offers an entirely different value proposition to sports fans and multi-channel operators.
ESPN delivers almost twice the audience of all RSNs combined and among the key sports demo of men 18 to 34, on average, ESPN’s audience is more than four times the size of the audience of all RSNs put together. ESPN leads in the mobile sports space as well, with sports fans spending far more time with ESPN than any other sports site and ESPN’s minute share is more than three times that of the nearest competitor. Additionally, the authenticated mobile service, Watch ESPN is now in 46 million homes and that number jumps to 55 million next month when new affiliate agreements take effect.
Moving on to our parks and resorts, I was at Walt Disney World last week to see the progress of our expansion and I had the chance to try out our optional MyMagic Plus which will empower our guests to get more out of their time with us and enjoy more of what we have to offer. As we roll out this new program over the next several months, Disney World guests who want more seamless vacation experience, will have the ability to plan the details of their visit ahead of time so that you just have fun with the whole family while they’re with us. The product I tested was impressive and is a stunning example of how we’re using technology to make our products and experiences more accessible and more compelling.
Also in Florida, our ongoing expansion of Fantasy Land has been extremely well received which is something we’re quite happy about. We’re well into the process of doubling its size with spectacular new attractions based on the Little Mermaid and Beauty and the Beast and we’ll finish the Fantasy Land expansion in 2014.
Profitability at Disney Interactive has been a goal of ours in 2013 and the solid results this quarter are certainly noteworthy. We know we have more work to do and Disney Infinity remains a big swing factor for the year, but we’ve been extremely pleased by the overwhelmingly positive reaction to our announcement of this ambitious video game initiative. With Infinity, we’ve created a whole new universe where players have the freedom to create stories and adventures with some of Disney and Pixar’s most beloved characters for the first time ever. Our goal is to deliver a riveting platform that can live for years to come, continually introducing new games play sets based on our tremendous portfolio of creative content.
On the studio side, we’re pleased with the success of Disney Animation’s Wreck-It Ralph which has been a hit at the box office and has been recognized with Critic’s Choice award and the award from the Producers Guild of America for excellence in animation. Wreck-It Ralph is one of three Disney movies to earn Golden Globe and Oscar nominations for Best Animated film of the year, along with Frankenweenie and Pixar’s Brave which took home the Golden Globe.
We’ve got a lot of great movies coming up this year. Next month we’ll release Disney’s fantastical Oz the Great and Powerful, followed by Marvel’s highly anticipated Iron Man III in May. This summer we’re looking forward to Disney Pixar’s Monsters University in June as well as the Lone Ranger, an extraordinary action adventure starring Johnny Depp which opens in July. In November, we’ve got Marvel’s Thor, the Dark World as well as Disney Animations’ next adventure, Frozen and we’ll close out the year with Saving Mr. Banks, the story behind one of our most beloved classics, Mary Poppins with Tom Hanks as Walt Disney. It’s a strong diverse slate of movies that we are very excited about.
So overall we feel good about what we’ve achieved in Q1. We’re confident about the year ahead as well as our ability to create continued long term growth.
And now I’m going to ask Jay to review the details of our Q1 performance and then we’ll take your questions. Thank you.
Thanks Bob and good afternoon everyone. We’re very pleased with our first quarter results, which set the stage for continued growth in 2013, following a year of record revenue, net income and earnings per share in 2012.
Our Media Network segment grew as a result of increased operating income at broadcasting, partially offset by a decline at cable. At broadcasting, higher operating income was driven by an increase in advertising revenue and program sales despite higher programming and production costs in the quarter. Network ad revenue increased as a result of higher rates, partially offset by lower ratings and fewer units sold and ad revenue at our stations were up, benefitting from higher political spending. The increase in program revenue was due in part to sales of Revenge and Once Upon a Time.
Ad revenue at the ABC Network was up low single digits compared to the prior year. Quarter to date, scatter pricing at the ABC Network is running low double digit percentage points above upfront levels. We are extremely pleased with the pace of ad sales for the February 24th Academy Awards. We are virtually sold out of our inventory with the vast majority of spots sold before Christmas. Ad revenue at the stations was up 5% during the first quarter and so far in 12, TV station ad sales are pacing up versus prior year. The decline in operating income in cable was due to lower results at ESPN despite strong performance from domestics Disney channels and ABC Family. ESPN’s results from the quarter were impacted by higher programming costs which more than offset higher affiliate revenue. The increase in programming cost was related to higher rights fees for college football. That’s new deals with the [back] 12 and the Big 12, the NFL and the NBA.
NBA programming costs were higher compared to last year as we returned to a normal schedule versus the prior year which was impacted by the lockout. Growth in affiliate revenues during the quarter was driven by both higher rates and lower revenue deferrals compared to the prior year. We deferred $36 million less in revenue during Q1 as a results of two new affiliate agreements signed during the quarter, under which ESPN is no longer required to defer affiliate revenue. This change will impact ESPNs revenue recognition for the remainder of the year and we now expect ESPN to defer approximately $70 million in less revenue during the second quarter than in the prior year.
I will remind you these changes in ESPN’s revenue recognition related to the implementation of annual programming commitments have no impact on its full year results. ESPNs cash ad sales were up 2% in Q1 driven by higher rates and volume. But this increase was offset by lower ratings. So far this quarter, ESPNs ad sales are pacing up 7%. While ESPNs results in this quarter were impacted by higher costs, we expect ESPN starting the second quarter to benefit from several new affiliate deals and therefore deliver attractive growth for the full year.
Our confidence in ESPNs full year performance is based on our visibility into the value and timing of new affiliate agreements and ESPNs positive advertising trends. At the same time, Q1 programming cost growth will be the high watermark of the year. Domestic Disney channels grew in the quarter due to higher affiliate revenue from contractual rate increases. ABC Family’s strong performance resulted from higher advertising revenue and lower marketing costs. ABC Family’s ad revenue was up 15% in the quarter and that’s on top of a 10% increase in Q1 last year.
At Parks and Resorts, the investments we have made over the past couple of years to enhance the overall guest experience are resulting in increased visitation and higher spending. We expect the final impact of these investments, some of which is evident in our first quarter results, to continue to ramp up over the coming quarters. In the quarter higher operating income at our domestic operations was partially offset by lower results at our international operations. The increase in operating income at our domestic operations was driven by higher guest spending at Walt Disney World and the Disneyland Resort and attending growth at Disneyland Resort.
For the quarter, attendance at our domestic parks was up 4% and per capita spending was up 6% on higher ticket prices, food and beverage, and merchandise spending. Average per room spending at our domestic hotels was up 4% and occupancy was down 4 percentage points to 81%, primarily due to an increase in available room nights at Walt Disney World, given the opening of Disney’s Art of Animation Resort during the second half of fiscal 2012.
So far this quarter, domestic reservations are pacing up 4% compared to prior year levels, while book rates are up high single digits. Lower operating income at our international operations reflects higher cost at Disneyland, Paris, and expenses associated with our Shanghai Disney Resort, despite higher guest spending at Hong Kong Disneyland Resort. Segment margins for the first quarter were adversely impacted by 60 basis points due to the growth initiatives and as a result, segment margins were down 50 basis points compared to last year. We feel very good about the underlying margin trends we are seeing in our domestic parks and resorts.
While growth initiatives reduced margins by 80 basis points at Walt Disney World and Disneyland, there combined margin was still up about 100 basis points for the quarter. Studio Entertainment operating income was down in the quarter due to declines in our home entertainment and theatrical businesses, despite an increase in television and subscription video on-demand distribution revenue.
Home entertainment results faced a difficult comparison given the releases of Cars 2 and the Lion King last year compared to Brave and Cinderella this year. While theatrical revenue was higher in the quarter due to the release of Wreck-It Ralph, Lincoln and Frankenweenie, operating income declined as a result of higher distribution and film amortization costs compared to prior year.
At consumer products, the increase in operating income resulted from higher performance in merchandize licensing and retail. The increase in licensing reflect lower revenue share with the studio compared to the prior year. On a comparable basis, earned licensing revenue was up 1% versus last year as higher sales of Spiderman, Avengers and standard character merchandize more than made up for declining sales of Cars merchandise.
Results in our retail business were driven by higher comp store sales in Japan and growth in North America, which benefited from higher online sales, comp store sales growth and store format changes.
At Interactive, we generated a profit of $9 million in the quarter compared to a loss of $28 million last year due to improved results in games as well as continued strength in our Japan mobile business. Higher operating income in games was due to a lower impact of purchase accounting compared to the prior year.
While we continue to target profitability for 2013, we expect operating losses in the second quarter to be comparable to prior year given the lack of key title releases. As we look into the second quarter, I’d like to highlight a few comparability factors that will affect our Q2 results. At broadcasting, we expect programming expenses to be $40 million higher than the prior year. At parks and resorts, I want to point out that the timing of the Easter holiday will benefit our Q2 results as one week of the two-week holiday will fall in Q2 whereas the entire holiday period fell in Q3 last year. We estimate the impact of this one week shift to be roughly $25 million to $30 million and operating income shifting to Q2 from Q3.
We continued to repurchase our stock during the first quarter by buying back 21 million shares for about $1 billion. Fiscal year to date, we have repurchased 27.1 million shares for $1.4 billion. Overall, we feel great about the start of the fiscal year. We continue to manage our businesses with an eye towards creating long term, sustainable value for our shareholders. We are making good progress on a number of key strategic initiatives. So as we look to the rest of 2013 and beyond, there’s a lot to be excited about.
With that, I’ll turn the call over to Lowell Singer for questions.
Thanks Jay. Ellen, we are ready for the first question.
(Operator Instructions). Our first question is from Ben Swinburne from Morgan Stanley. Please go ahead.
Benjamin Swinburne – Morgan Stanley
Good afternoon. Jay, I wanted to ask you a little bit about the ESPN affiliate growth or cable affiliate growth, whatever you’re more comfortable speaking to. You called out the renewals that you’ve got behind you and the visibility into affiliate revenue growth. So can you talk about what it was in the quarter and then maybe any kind of guidance or expectations for the acceleration level into fiscal Q2 now that you’re a month in. and then Bob, I wanted to ask you, you brought up the Disney Channel and some of the creative successes there. That’s a pretty big business. It sort of gets lost a bit in the cable segment. I just wonder if you could talk about how you think about financially exploring more the products that you’ve got, the shows you’ve got that have done so well in the past year or two into driving earnings because it’s not obvious since it’s not a huge advertising piece of that business to the rest of us.
Let me start, Ben. In terms of cable affiliate growth in the quarter, Q1, consistent with the trend that we’ve been seeing over the past couple of quarters, Q1 adjusted cable affiliate revenue grew high single digits for the quarter and when I say adjusted this adjusts for both the deferrals that I spoke of and for some FX that affect the quarter. I really don’t want to get into looking down the road on affiliate revenues though.
Regarding the Disney channels, as you know Ben, we started off with a Disney channel that initially begun as a premium service. We grew it and we grew revenue by ultimately turning into a basic service and improving not only the bottom line but the visibility and the exposure to our brand and to the various intellectual property that we created on that channel. We re-launched this set of channels to XD and only recently launched junior. So as we look across the globe, we now are sitting on well over 100 of these channels, some of which are advertisement-supported. All of which support the brand and the intellectual property and ultimately support our other businesses, particularly consumer products but also online interactive parks and resorts, parts of consumer products like publishing, mobile apps, those sorts of things.
So in effect we have created a pretty broad ecosystem of product emanating from these channels. And I would say overtime, and it will take some time, you will see continued increase in revenue from higher subs, higher sub fees, higher advertising, then of course all the other businesses that get ultimately the benefit of this great product. So when we have suddenly four very popular shows with kids two to five, we are already starting to see that in consumer products. But I think the long term impact is really significant because, for instance, in the last go around with our distributors, we obviously were looking to get Disney Junior penetrated. That resulted in relatively modest sub-fee structure.
Over time that sub-fee structure will change dramatically and that will start to generate a lot of revenue. So I think it’s an extremely valuable business for us. You are right, it doesn’t get that much visibility and yet it is visible to us in almost everything that we do.
We have Michael Nathanson with Nomura. Please go ahead.
Michael Nathanson - Nomura Securities
Thanks. I have one housekeeping for Jay and then a follow-up to Ben’s question. So Jay the question is, the Hulu charge of $55 million, that’s not shown in the OI line and broadcasting so we don’t have to add back $55 million to OI there?
Let me try to clarify that. The $55 million which was a charge that was an executive compensation charge for the Hulu team that was triggered when we bought Providence out of Hulu, is reflected in the equity income line in the income statement but is excluded from the segment OI.
Michael Nathanson - Nomura Securities
Okay. Got that. And then let me just follow up to Ben’s. The Q came out and it looks in the 10-Q it’s saying that the rate increases you had at the cable was at 7% in the quarter. So is it safe to assume that now that the new deals will kick in in the March quarter, the 7% growth rate you saw for just pricing should ultimately go up from there. Isn’t that a logical assumption?
You know we are beginning to recognize in the second fiscal quarter the new rate that are associated with those new deals that was negotiated. You are right about that at ESPN. And the rates of course are differential across all of the ESPN channels that are out there. So, yes, I think we can expect to see an increase. I don’t want to talk about how much.
We have Alexia Quadrani with JP Morgan. Please go ahead.
Alexia Quadrani - JPMorgan
Any sense on how much the new attractions or the investments at the parks are driving these strong results? And I guess any sense at how much do you think pricing can continue to climb here?
While we are definitely seeing strong results in California from the rather significantly changed California adventure, clearly Cars Land and the whole experience that’s been created has helped because we have had dramatic increases in attendance, occupancy and strong pricing increases since we opened in June. In Orlando, Fantasy Land has already been a success, although it is far from complete. We are doubling the size of Fantasy Land and in fact the current improvements and the current expansion will not be completed until sometime in 2014. But it’s already starting to work.
So we think that we have got certainly some pricing leverage from it. We found that obviously over time when we build the right thing, not only will people come but it obviously gives us some leverage as well.
Alexia Quadrani – JPMorgan
And how was attendance at Disney World in the quarter?
Attendance at Disney World was down a hair, I would say, and that the – oh I’m sorry, t was up a hair, but it wasn’t the driver for the quarter. As Bob just said, everything that’s going on at the Disneyland resort is really what’s driving the attendance strengths for domestic parks.
You also add some effect of we how the holiday broke this year. First of all the quarter ended on December 29, but as opposed to December 31 of a year ago, but you also had a Christmas season and a holiday season that extended more into the second quarter or into January than it had the year before. So there was some shift in visitation.
Alexia Quadrani – JPMorgan
So that would suggest that attendance obviously at Disney World is trending much better obviously in the first quarter?
(Inaudible) commented about the current trends yes, and the answer is yes.
We have Jessica Reif-Cohen with Bank of America. Please go ahead.
Jessica Reif-Cohen – Bank of America Merrill Lynch
A question on the parks and one on cable networks. On the parks I guess mostly cost related. Can you just clarify on the technology spend or MyMagic Plus, however you want to refer to it., how much more to go is – in the press reported something like $800 million to $1 billion of spend on that effort. How much more is there to go? It sounds like the early results are positive. When does it fully rollout? And the press release called out the Shanghai operating expenses are starting to ramp. Can you give us any color on what that would look like over the course of the year?
Majority of the capital expense to create this initiative has already been spent. There'll be some increased operating expenses, which we're already starting to see this year, but obviously they will probably ramp up more as we rollout the feature. The product itself is in a test phase. Some of it in a very limited form is available to our guests. I actually tried it out last week and was extremely impressed because it will give people an opportunity to really plan their vacation in advance of coming, notably the ability to make reservations on some of our most popular attractions or more importantly some of their favorite attractions and that will obviously have an impact on guest experience by not only improving the number of attractions they can experience while they are there, but guaranteeing that they’ll be able to see the ones or experience the ones that they want.
And additionally, the band serves as your room key. That already was – it's already somewhat operational, although in test phase. It serves as your wallet, it serves as your ticket and it gives us the ability, with the voluntary information that you provide to us, to enable personalization and customization, which we have not been able to do before and that's really impressive. So I'd say you are going to see the product rollout at some point later this year. We're purposely not announcing when it will be rolled out. And in fact, a lot of the features of this product will actually be rolled out over a long period of time. We want to make sure that we get this right before we go too fast with it. But so far we're very, very excited about it.
One thing I just wanted to add for all of you, Jessica, as well is that part of the expense that Bob talked about of course will be depreciation of the capital investment and compared to what we usually invest in, the life of these assets particularly on the system side is very short, and that will impact us going forward. Did you ask about Shanghai, Jessica?
Jessica Reif-Cohen – Bank of America Merrill Lynch
Yeah, because you put in the press release, the ramp.
Yeah. So along with of course the capital expenditures we're doing over there, there’s an increase in expenses that are accompanying that and it's about $50 million for the fiscal year. Not a huge number but something you cannot put in your models.
Jessica Reif-Cohen – Bank of America Merrill Lynch
And then just on the Cable Networks deals that you signed, what's the average length of the new deals? We know the Comcast deal was 10 years, but what about the others?
We haven't really been out there about those deals for the confidentiality of our partners and ourselves and they are of term, but we're not going to get into the details of each one.
We have Douglas Mitchelson with Deutsche Bank. Please go ahead.
Douglas Mitchelson – Deutsche Bank
Thanks so much. So, one for Bob and then one for Jay. Bob, who’s been losing money and that's despite free access to ABC and Fox and NBC content. I would think having ABC content available for free online could encourage [core] cutting over time. So the release noted that ABC grew ad revenue in part due to online growth where I think they are actually competing with Hulu for ad dollars. So anyway thus syndication seems to be the superior model around. Can you help me understand the strategy for Hulu going forward and how much more capital you might have to put in that business? And then for Jay, there’s been some discussion at ESPN’s strategy in the UK, you know it’s changing with the loss of preliminary league games. And since that was a startup initiative only a few years ago, I would think that’s losing money. So is there any sense of the losses or the margin on that UK operation that you can give us. And when might the improvement of those losses hit the P&L, is that fiscal ’13, fiscal ’14, how might that flow through?
Doug, I am not going to address your specific questions about Hulu because they are partners and there is a board. And the strategy for Hulu is determined by that group and not only I am not a member of the board but I am not a spokesperson for Hulu either. I will say that as ABC analyzes how best to not only monetize its content but to maintain the health of its broadcast business, it’s network. They are obviously looking at continuing to make product available and I will call it alternative forms, mobile being one. But mindful of the fact that how they move product into that market place, needs obviously to consider a few factors.
One, the impact on advertising, and not necessarily in this order, and two, the impact on the multi-channel business and retransmission consent. So they are working very hard at creating a watch out that will be available to people who are subscribers to multichannel services. We are not saying one that will come out. And there windowing strategy, which is morphing, reflects a feeling that the best way to monetize content is to make it available to people who already are subscribers and to limit the availability of the content basically that is in-season. And to do what it possibly can do to improve the effectiveness of advertising.
I will note that in looking at the recent C3 figures for ABC, it was interesting to see that homes with ABC’s rating is actually higher in homes with C3 rating -- is higher at homes with DVRs, which I found quite interesting. That includes by the way some VOD consumption as well and in some cases that VOD consumption has a mechanism that disables fast-forward. Which is also interesting because consumer is clearly looking for access to shows and willing to tolerate some inability to skip through commercials in order to see the shows that they want to watch.
Doug, on the UK ESPN channel, you are correct in that we were experiencing losses due to the ramp up and newness of that business for us. We talked about that on many calls. And at this point we are exploring and exit from that but I don’t really want to talk -- I don’t think that given the magnitude of those losses I don’t think there is any point in doing it now. I will tell you that relative to your question about Hulu and the online revenue for broadcasting. The drivers of that were ad sales on the ABC episode player as you mentioned, also Hulu ad sales as well ad sales from our ABC News Yahoo partnership. That was what made up the components of it.
We have Todd Juenger with Sanford Bernstein. Please go ahead.
Todd Juenger - Sanford C. Bernstein
Back to the affiliate deals once more, sorry. You mentioned having completed deals with seven of the ten top distributors and think a big component of all those deals was TV everywhere and DOD type of rights. So turning to the three of the ten who are still pending, I presume those guys would like to offer those services to their subscribers too. I think two of the three big distributors without those types of rights are the satellite distributors, you can correct me if I am wrong about that. But I wonder, is there anything about the technology of satellite distribution that sort of stands in the way of those services work. And if there is any comment you can make on the status of discussion with any of those providers who are still waiting for those services and when you think you might be able to come together on those?
Well, I will confirm that there is significant amount of demand of the watch apps that we have created, which have done quite well. And it doesn’t seem to be anything from a technological perspective that would be a factor with the satellite providers and among the deals that we have cut in terms of long-term deals that would include access to these WATCH Apps are the two satellite providers, but nothing to say in terms of specifics regarding the status of those negotiations.
Todd Juenger – Sanford Bernstein
Fair enough. And then one small follow-up if you don't mind, just probably for Jay. In terms of thinking about the accounting for those elements of the deals, would it be fair, especially first of the WATCH Apps that are library in nature and sort of on-demand in nature, does that work in a TV Everywhere content in the same ways it does say for SVOD? In other words, are we looking at situations where a lot of content might be made available right away and the revenue falls accordingly or is it spread differently somehow? Thanks.
Todd, the answer won't be crystal clear and probably won't be very satisfying for you. But I think that those – the revenue from those deals, because they are wrapped up in an entire suite of services, I mentioned many times to all of you that the Comcast deal had 70 separate services of which the apps were few, I would say there are more akin to being recognized as our normal affiliate fees are being recognized, but I reserve the right to say there might be now and again a couple of exceptions to that. But by and large, I think all of you should think about that as being consistent with the flows for the affiliate fees.
We have Anthony DiClemente with Barclays. Please go ahead.
Anthony DiClemente – Barclays
Just one for Bob, just wondering if you could talk a little bit about the Pay TV output deal that Disney signed with Netflix on an exclusive basis, Bob, just at a high level. What got you comfortable with doing that deal from a branding perspective for Disney in light of the potential substitution effect for kids TV viewing and of course in light of the relationships you have with your traditional multichannel distributors? Thanks.
Well, first of all we are impressed with the platform and the user interface. So we thought from an environment perspective it was a perfect place for our product to be distributed. They stepped up and paid the right price, which was also extremely important. We carefully considered the impact of selling to Netflix versus a more traditional pay cable channel. We've been with Stars as you know. We continue with Stars for a few more years and felt that given the volume of product that would flow through the Netflix deal, and given the strength of our channel programming, notably Disney Channel, some of the things we've talked about, that this was not a step in the direction of encouraging people to not subscribe to multichannel services.
We thought long and hard about it, talked about it at length, and believed in the end that this is a movie play. There are limitations in terms of when the movies are available and how many they are in terms of how many we make and the size of our library and felt that it's completely different product than Disney Channel product, and given the popularity of the shows that we have, the demand to see those shows relatively quickly remains pretty high and we believe we may be able to maintain that. So you have to subscribe through multichannel service to see them.
We have Tuna Amobi with S&P Capital IQ. Please go ahead.
Tuna Amobi – S&P Capital IQ
Thank you very much. One for Bob and one for Jay. So, Bob, I think you alluded to on an earlier interview today regarding Star Wars potential spinoff characters in addition to episode 7, 8 and 9. That wasn't something that I've heard you talk about before especially on the call following that announcement. So if you can elaborate on those plans that would be helpful. Any comment on how that might also have affected your valuation of that transaction would be helpful. And then for Jay, regarding pension, in a context of the current interest rate environment, I'm wondering if you see any potential issues with pension, whether it be related to funding and free cash or even on the expense side as to potential impact on the Parks margins would be helpful. Thank you.
Okay. When we were exploring very seriously with George the acquisition of Lucasfilm, the idea of producing a few so-called standalone films that were not part of the overall saga came up. And we discussed not in great detail, a few of the possibilities. What I confirm today is that those possibilities are becoming more real and they are now creative entities that are working on developing scripts for what would be those standalone films. We are not saying how many. Although I did mention two creators, Simon Kinberg and Larry Kasdan, who are working on two different films. Those two gentlemen are also working as consultants on Star Wars Episode 7 with J.J. Abrams and Michael Arndt.
When we did the analysis of Lucasfilm, we did not place value on this activity. What we had seen was just nascent and the concept of creating these was a little premature and so the valuation that we performed was all about the three so called saga films, 7, 8 and 9, and of course all the other best businesses that flow from those. So this activity would be incremental to the activity that was anticipated when we announced the acquisition. And I don’t have details about or specifics about the films themselves.
Tuna Amobi – S&P Capital IQ
Okay, that answers my question. So, Jay?
Let me give you some background and facts to help you think about our pension. First, maybe the most important in the short-term is that we're probably looking at about $70 million increase in pension and postretirement medical this year based on the decrease of the discount rate to 3.85, it was before at 4.75. We pick up about half of that in our Parks and Resorts segment obviously because of the size of the employee base there. You will remember that a couple of years ago we announced that we were implementing changes to our pension plan that that would create total savings between $350 million and $400 million over the next five years. We are experiencing those and this plus 70 is sort of despite that, I might say. In the past couple of years we've made pretty big contributions to our pension plan in light of this sort of declining discount rate as I think many companies that you read about regularly do. This year our contribution is targeted in the $450 million range. Haven't decided yet whether we're going to augment that. But anyway I think that should at least help you think about what's going on with our pension.
We have David Miller with B. Riley Caris. Please go ahead.
David Miller - B. Riley Caris
Just one question for Bob. Bob, it's been a little over 90 days since you acquired Lucasfilm. How is the integration going there? Is there a lot of duplicative functions or just sort of low hanging fruit that you kind of have to eliminate, I know you are sort of hamstrung from talking about that cast up on the call, but just any color on how the integration is going? Do you feel like it's fully integrated at this point or is there just some ways to go? And then as a related question when would be the first quarter in which we would see the brand new wave of Star Wars SKUs, obviously as a promotional mechanism for the first Star Wars film in 2015.
Well the integration is not all that complicated and we're well underway in terms of not only implementing but addressing all the integration that we expect to get from this acquisition. I can't be specific with you though. Like Marvel, Lucas used a number of third-party agents internationally to help their licensing business or the license, and we obviously because of our global footprint and our presence in so many markets, are seeking to ultimately eliminate all of those third-parties which was a target obviously for Marvel and for this acquisition for so many obvious reasons.
We had a very good meeting of that with Lucas a couple of weeks ago with the whole group of their executives and ours from all walks of Disney Live to explore a variety of possibilities in terms of initiatives. I think it's safe to say that the priority of the company, meaning both entities, is to create a great film for 2015 and to do everything we can across all of our businesses to see to it that any activity that enters the marketplace between now and then is designed to help the success of that film. So while there will probably be an array of different products that enter the marketplace as we get close to a release date, we don't have a target right now of when you would start to see those. But there's activity across our businesses, including online and mobile apps and television and consumer products and publishing as you’d expect and Parks and Resorts that we've been working on now for quite some time and time will start exposing all that to the outside world.
We have Jason Bazinet with Citigroup. Please go ahead.
Jason Bazinet – Citigroup
I just have a big picture question maybe for Mr. Rasulo. Your earnings are at record levels, your stock is at record levels and it seems to me that in order for investors to get excited about your stock, they’re going to have to start putting a higher multiple on it. And so I was wondering if you could just summarize for us in broad terms over the next three years the major swing variables, either loss making things that will turn to profits or new initiatives that will come on stream just to make sure we're thinking about the next three years appropriately. If you can just summarize – I think you probably have it all in your head and it's I think an easy question, but if you could just summarize it that would be great.
Well, let me – I think there are number of things that are pretty straight forward and pretty large in magnitude. First, one that we've been talking about for a long time is the ramp up in accretive accretion from all the Parks and Resorts investments that we have put in place over the last three to four years, and by way, a couple of them will come online over the next couple of years as well. And that – we've been talking for two years about launch cost and ramp up, holding back if you will, the contribution to OI that these projects will have, but every single one of them – by the way some of them are already accretive, but every single one of them was approved on a pro-forma that would be quickly become accretive to OI and I think over the next three to five years, you'll see that number significantly impacting our Parks and Resorts segment. And so that would be the first big category.
We've been talking a little bit about the Lucasfilm acquisition. We’re in 2013 now. 2015 should be the year that becomes accretive. It will not be surprising to me that that will start to play shortly starting that year and shortly thereafter a very big role in our studio OI. That’s why we made this acquisition. It's got lots and lots of stuff for it. Remember last year we talked about the launch of Avengers really being our coming out party for the Marvel acquisition and we continue to build on the films around that, whether it's Thor, Captain America, Iron Man and the next Avengers film and that can only be frankly accretive given the strength that that franchise already has in the merchandise circles around there with kids. With the success of that film, we have big expectations.
And then if we're talking about three to five years, you can't leave Shanghai Disneyland out of the picture, which will have its gigantic splash in 2015 and start to be significantly accretive from that point forward. In the rest of our businesses, we've talked at length about the knowledge that we had in doing our new affiliate deals for ESPN, of the cost base that we’re going to be experiencing over a long period of time, certainly covering the three to five year horizon and we continue to look for growth in that business given our position and how strong a hold we have on fans in this space. So I think there are a lot of things that we continue to look at moving forward that will be significant additions to the growth of our company.
Jason Bazinet – Citigroup
That’s exactly what I was looking for. Thank you.
We have David Bank with RBC Capital Markets. Please go ahead.
David Bank – RBC Capital Markets
Two questions with respect to ESPN, I guess the first first one on competitive positioning. You know through most of the NFL season, Monday Night football ratings were somewhat weaker than we might have expected. And I think there is some discussion around how much of that had do with just your weak match ups versus maybe a fatigue for football on national television platforms. Right. There is a lot more college than there had been historically. So, how do you think at the end now, in terms of reflecting on your competitive position, how much you think of the ratings were about just more sports on other national platforms versus the matchups?
And the second question is on distribution. Historically, I think you've given the distributors a carve-out to allow for some number of discount packages that could be sold that don't require carriage of certain basic channels like ESPN. So, can you talk about what percentage of the overall base you usually allow for a carve out for and is that percentage changing at all as you are doing some of these new deals?
I can't comment about the nature of the deals except to say that our subs are basically flat for the last two years, correct. So we've not suffered an overall loss of subs because of what is perceived to be a growth of so-called cable light packages. And the conversations that we've had with a couple of large cable operators very recently, they've actually suggested to us that they view these subs as saves, subs that they would lose completely, but they feel that they've been better off keeping them at a lower price. So ultimately they have a better opportunity to up sell them back into a broader package. We also believe by and large as witnessed by the marketplace today but we think it will last a while. People are going to gravitate to the bigger packages because there is a lot of value there and there's a lot of sort of can't miss product.
The other thing obviously we have to look at when we look at subs is not just cable, we look across the business. So you have to include satellite and the various telco providers that have been in as well, and that's all helped us essentially maintain essentially a steady state in terms of number of subs. Disney Channel actually has grown in subs fairly recently. Regarding, ESPN's NFL package, we happen to believe that the NFL is unique enough that it stands up to all the competition that is out there and there isn't that much of a fatigue factor for sports or competitive factor that results in lower NFL ratings because there are so many other sports on the air.
I do believe though that the ratings can be very match centric in the sense that when you have games that either are not as competitive during the game or not as interesting going in, there tends just to be less interest in it. By the way it's not just about -- people have so many different things they can do with their time today, so it's not competition from sports that I'd really consider a factor, it's just competition for people time. They don't have to watch TV because they can be entertained and informed, whatever, in so many other ways.
We talk to the NFL a lot about the quality of the schedule. You know they've worked hard on our behalf to maintain a quality schedule. We look at the schedule when we get it every spring and figure around what are going to be the great games and which games we're little bit worried about and so on and try to assess the schedule. And then you know so many things can happen in the season. A team can suddenly go 0 and 3 unexpected. They can lose their star player, they can lose their quarter back. All kinds of things can happen that end up out of our control. And I'd say this year, while ESPN had some real strength in the latter part of the schedule, the beginning of the schedule turned out to be I think a little bit weaker than we anticipated that it would be. It's still a great product for us though and I think it's great product for all of the television partners.
We have Marci Ryvicker with Wells Fargo. Please go ahead.
Marci Ryvicker - Wells Fargo
Thanks. I have two questions. The first, you mentioned that these stations were pacing up in the current quarter, so just wondering what's driving the strength of the certain ad categories. And then the second question is on Interactive. You were slightly profitable this quarter but that's before Infinity, so is Infinity going to drive profitability further or could we see some startup costs that would offset revenue at some point this year?
Well, our goal is to be profitable this year. We've taken some big steps to do that. A lot of it has to do with cost and the mix of our product. We obviously were off to a good start. It was nice to see profitability for the first time that we've been announcing these results separately. The biggest swing factor for the year, as I said in my remarks, is Infinity. If Infinity does well, it bodes very well for the bottom line for this unit. If it doesn't do well, the opposite will be the case. Infinity's numbers really in terms of positive impact though, really won't be felt until the third quarter. As Jay mentioned, the second quarter because of the lack of other product and some startup costs for Infinity, we're probably going to swing to a red ink in the quarter before we have a chance to turn positive again if Infinity works later in the year.
Reaction, as I said in my remarks, to Infinity has been fantastic. We've seen the product. By the way, when I talk about reaction, I'm talking about reaction from gamers, the people that cover the industry and from retailers. Buying at retail has been very, very strong and the commitment that we have from retail for this product is beyond what we believed it would be and that bodes very well. Now, the consumers got to see the product and enjoy it for it to truly do well. But the biggest swing factor for the year is that game, and if it does well, then we're going to be extremely pleased with the result from that sector this year. Jay you want to talk about the stations.
Yeah, in terms of advertising, you are right, Marci, they are pacing up and the support has been pretty broad-based to be honest with you. I won't single out a specific industry but it's those categories that our typical advertisers have all stepped up, kind of equally. There is no standouts and no real laggards.
Thanks, Marci, and thank you everyone for joining us today. Note that a reconciliation of non-GAAP measures that were referred to on the call to equivalent GAAP measures can be found on our website. Let me also remind you that certain statements on this call may constitute forward-looking statements under the securities laws. We make these statements on the basis of our views and assumptions regarding future events and business performance at the time we make them and we do not undertake any obligation to update these statements. Forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from the results expressed or implied in light of a variety of factors, including factors contained in our Annual Report on Form 10-K and in our other filings with the Securities and Exchange Commission.
This concludes today's call. Thanks everyone and have a great day.
Thank you, ladies and gentlemen. This concludes The Walt Disney Company's first quarter 2013 earnings conference call. Thank you for participating. You may now disconnect.
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