NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited; tabular dollars in millions, except for per share data)

 

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 six months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending September 29, 2018 . 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 2017 Annual Report on Form 10-K.

The Company enters into relationships or investments with other entities that may be variable interest entities (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 (as defined by ASC 810-10-25-38) to the VIE. Hong Kong Disneyland Resort and Shanghai Disney Resort (collectively the Asia Theme Parks) are VIEs in which the Company has less than 50% equity ownership. Company subsidiaries (the Management Companies) have management agreements with the Asia 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 Asia Theme Parks. In addition, the Management Companies receive management fees under these arrangements that we believe could be significant to the Asia Theme Parks. Therefore, the Company has consolidated the Asia 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.

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the Condensed Consolidated Balance Sheet to the total of the amounts reported in the Condensed Consolidated Statement of Cash Flows.

The operating segments reported below are the segments of the Company for which separate financial information is available and for which 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, other income, 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.

Segment revenues and segment operating income are as follows:

A reconciliation of segment operating income to income before income taxes is as follows:

In March, the Company announced a strategic reorganization of its businesses into four operating segments: the newly-formed Direct-to-Consumer and International; the combined Parks, Experiences and Consumer Products; Media Networks; and Studio Entertainment. The Company is in the process of modifying internal and external reporting processes and systems to accommodate the new structure and expects to transition to the new segment reporting structure by the beginning of fiscal 2019. We continue to report operating results to our chief operating decision maker using our current operating segments.

BAMTech

On September 25, 2017, the Company acquired an additional 42% interest in BAMTech, a streaming technology and content delivery business, from an affiliate of Major League Baseball (MLB) for $1.6 billion (paid in January 2018). The acquisition increased our interest from 33% to 75% , and as a result, we began consolidating BAMTech during the fourth quarter of fiscal 2017. The estimated acquisition date fair value of BAMTech is $3.9 billion .

BAMTech’s noncontrolling interest holders, MLB and the National Hockey League (NHL), have the right to sell their shares to the Company in the future. MLB can generally sell their shares to the Company starting five years from and ending ten years after the September 25, 2017 acquisition date at the greater of fair value or a guaranteed floor value ( $563 million accreting at 8% annually for eight years). The NHL can sell their shares to the Company in fiscal 2020 for $300 million or in fiscal 2021 for $350 million . Accordingly, these interests are recorded as “Redeemable noncontrolling interests” in the Company’s Condensed Consolidated Balance Sheet.

The Company has the right to purchase MLB’s interest in BAMTech starting five years from and ending ten years after the acquisition date at the greater of fair value or the guaranteed floor value. The Company has the right to acquire the NHL interest in fiscal years 2020 or 2021 for $500 million .

The acquisition date fair value of the noncontrolling interests was estimated at $ 1.1 billion , which was calculated using an option pricing model and generally reflects the net present value of the expected future redemption amount.

As a result of the MLB and NHL sale rights, the noncontrolling interests will generally not be allocated BAMTech losses. Prospectively, the Company will record the noncontrolling interests at the greater of (i) their acquisition date fair value adjusted for their share (if any) of earnings, losses, or dividends or (ii) an accreted value from the date of the acquisition to the earliest redemption date. The accretion of the MLB interest to the earliest redemption value in five years after the acquisition date will be recorded using an interest method. As of March 31, 2018 , the redeemable noncontrolling interest subject to accretion would have had a redemption amount of $586 million if it were redeemed at that time. Adjustments to the carrying amount of redeemable noncontrolling interests increase or decrease income available to Company shareholders through an adjustment to “Net income attributable to noncontrolling interests” on the Condensed Consolidated Statement of Income.

The Company is negotiating to provide the noncontrolling interest holder in ESPN a portion of the Company’s share of the BAMTech direct-to-consumer sports business at a price that is consistent with the amount the Company invested. If such transaction is finalized, the ESPN noncontrolling interest holder’s investment would be recorded as a noncontrolling interest transaction when consummated.

We have allocated $3.5 billion of the purchase price to goodwill (approximately half of which is deductible for tax purposes) with the remainder primarily allocated to identifiable intangible assets. We are in the process of finalizing the valuation of the acquired assets, assumed liabilities and noncontrolling interests.

The revenue and costs of BAMTech included in the Company’s Condensed Consolidated Statement of Income for the six months ended March 31, 2018 were approximately $0.2 billion and $0.3 billion , respectively.

Twenty-First Century Fox

On December 14, 2017, the Company and Twenty-First Century Fox, Inc. (“21CF”) announced a definitive agreement (the “Merger Agreement”) for the Company to acquire 21CF. Prior to the acquisition, 21CF will transfer a portfolio of its news, sports and broadcast businesses, including the Fox News Channel, Fox Business Network, Fox Broadcasting Company, Fox Sports, Fox Television Stations Group, FS1, FS2, Fox Deportes and Big Ten Network and certain other assets and liabilities into a newly formed subsidiary (“New Fox”) (the “New Fox Separation”) and distribute all of the issued and outstanding common stock of New Fox to shareholders of 21CF (other than holders that are subsidiaries of 21CF (shares held by such holders, the “Hook Stock”)) on a pro rata basis (the “New Fox Distribution”). Prior to the New Fox Distribution, New Fox will pay 21CF a dividend in the amount of $8.5 billion . As the New Fox Separation and the New Fox Distribution will be taxable to 21CF at the corporate level, the dividend is intended to fund the taxes resulting from the New Fox Separation and New Fox Distribution and certain other transactions contemplated by the Merger Agreement (the “Transaction Tax”). 21CF will retain all assets and liabilities not transferred to New Fox, which will include the 21CF film and television studios, certain cable networks (including FX and National Geographic) and 21CF’s international television businesses. Following the New Fox Separation and the New Fox Distribution, TWC Merger Enterprises 2 Corp., a wholly owned subsidiary of the Company (“Merger Sub”) will merge with and into 21CF (the “Initial Merger”), with 21CF surviving (the “Surviving Corporation”). Immediately after the effective time of the Initial Merger, the Surviving Corporation will merge with and into TWC Merger Enterprises 1, LLC, a wholly owned subsidiary of the Company (“Merger LLC”), with Merger LLC to be the surviving entity (the “Subsequent

Merger,” and together with the Initial Merger, the “Mergers”). As a result of the Mergers, 21CF will become a wholly owned subsidiary of the Company.

The Boards of Directors of the Company and 21CF have approved the transaction. In order to seek approval from 21CF and the Company’s shareholders, the Company filed a preliminary Form S-4 Registration Statement (“S-4”) with the U.S. Securities and Exchange Commission (“SEC”) on April 18, 2018, which S-4, once effective, will constitute a prospectus for the registration of Company common stock to be delivered to 21CF shareholders pursuant to the Merger Agreement as well as a joint proxy statement of the Company and 21CF. The consummation of the transaction is subject to various conditions, including, among others, (i) customary conditions relating to the adoption of the Merger Agreement by the requisite vote of shareholders of 21CF and the approval of the stock issuance by the requisite vote of the Company’s shareholders, (ii) the consummation of the New Fox Separation, (iii) the receipt of a tax ruling from the Australian Taxation Office and certain tax opinions with respect to the treatment of the transaction under U.S. and Australian tax laws, and (iv) the receipt of certain regulatory approvals and governmental consents.

Upon consummation of the transaction, each issued and outstanding share of 21CF common stock (other than Hook Stock) will be exchanged automatically for 0.2745 shares of Company common stock. The exchange ratio may be subject to an adjustment based on the final estimate of the Transaction Tax and other transactions contemplated by the Merger Agreement. The initial exchange ratio in the Merger Agreement of 0.2745 shares of Company common stock for each share of 21CF common stock (other than Hook Stock) was set based on an estimate of $8.5 billion for the Transaction Tax and will be adjusted immediately prior to consummation of the transaction if the final estimate of the Transaction Tax at closing is more than $8.5 billion or less than $6.5 billion . Such adjustment could increase or decrease the exchange ratio, depending on whether the final estimate is lower or higher, respectively, than $6.5 billion or $8.5 billion . Additionally, if the final estimate of the Transaction Tax is lower than $8.5 billion , the Company will make a cash payment to New Fox reflecting the difference between such amount and $8.5 billion , up to a maximum cash payment of $2.0 billion . As included in the S-4 filing, based on the number of shares of 21CF common stock outstanding as of April 11, 2018 and the closing price for the Company’s common stock on April 11, 2018 of $100.80 , the Company would be required to issue approximately 512 million new shares of Company common stock, a value of approximately $51.6 billion . The value at which the Company will record the equity consideration will be based upon the Company’s stock price on the date the transaction closes. In addition, the Company will assume 21CF’s net debt, which was approximately $14.6 billion as of December 30, 2017 (approximately $19.8 billion of debt less approximately $5.2 billion in cash).

Under the terms of the Merger Agreement, Disney will pay 21CF $2.5 billion if the merger is not consummated under certain circumstances relating to the failure to obtain approvals, or if there is a final, non-appealable order preventing the transaction, in each case, relating to antitrust laws, communications laws or foreign regulatory laws. If the Merger Agreement is terminated under certain other circumstances relating to changes in board recommendations and/or alternative transactions, the Company or 21CF may be required to pay the other party approximately $1.5 billion .

21CF currently has an approximately 39% interest in Sky. In December 2016, 21CF issued an announcement disclosing the terms of a firm offer to acquire the fully diluted share capital of Sky which 21CF and its affiliates do not already own at a price of £10.75 per share, payable in cash, subject to certain payments of dividends (the “Sky Acquisition”). The Sky Acquisition remains subject to certain customary closing conditions, including approval by the UK Secretary of State for Digital, Culture, Media and Sport and the requisite approval by Sky shareholders unaffiliated with 21CF. On April 12, 2018, the U.K. Takeover Panel ruled that, if the closing occurs under the Merger Agreement, and if 21CF has not previously completed its acquisition of the remaining interests in Sky and if no third party has acquired more than 50% of the ordinary shares in Sky prior to such time, then Disney will be obliged to make a mandatory offer for all the ordinary shares in Sky not already owned by 21CF in accordance with Note 8 of Rule 9.1 of the U.K. Takeover Code within 28 days of the closing under the Merger Agreement. The U.K. Takeover Panel further ruled that any such offer would be required to be made in cash and at a price of £10.75 for each ordinary share in Sky.

In connection with 21CF’s efforts to obtain U.K. regulatory approval for the Sky Acquisition, 21CF offered to sell, and Disney has advised 21CF that it is prepared to acquire, the Sky News business for a nominal amount if the Sky Acquisition is completed. Under the terms of the proposal, the Company would be committed to operate the Sky News business at its current cost structure for 10 years and 21CF has agreed to fund the anticipated costs of the Sky News business, based on the current cost structure (plus inflation), for 10 years.

During the six months ended March 31, 2018 , the Company’s borrowing activity was as follows:  

The Company has bank facilities with a syndicate of lenders to support commercial paper borrowings as follows:

The Company had bank facilities totaling $2.5 billion and $2.25 billion expiring in March 2018 and March 2019, respectively. These facilities were refinanced increasing the borrowing capacity to $6.0 billion and $4.0 billion and extending the maturity dates to March 2019 and March 2023, respectively. 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 0.18% to 1.63%. The Company also has the ability to issue up to $500 million of letters of credit under the facility expiring in March 2023, which if utilized, reduces available borrowings under this facility. As of March 31, 2018 , the Company has $196 million of outstanding letters of credit, of which none were issued under this facility. The facilities specifically exclude certain entities, including the Asia 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 March 31, 2018 by a significant margin.

Cruise Ship Credit Facilities

In October 2016 and December 2017, the Company entered into credit facilities to finance three new cruise ships, which are expected to be delivered in 2021, 2022 and 2023. The financings may be used for up to 80% of the contract price of the cruise ships. Under the agreements, $1.0 billion in financing is available beginning in April 2021, $1.1 billion is available beginning in May 2022 and $1.1 billion is available beginning in April 2023. If utilized, the interest rates will be fixed at 3.48% , 3.72% and 3.74% , respectively, and the loan and interest will be payable semi-annually over a 12-year period from the borrowing date. Early repayment is permitted subject to cancellation fees.

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):