Walt Disney Co. — Q3 FY2019 Form 10-Q
Reporting period: Quarter and nine months ended June 29, 2019; comparative periods ended June 30, 2018. Amounts are in U.S. dollars. Disney completed its acquisition of Twenty-First Century Fox (21CF) on March 20, 2019, so current-period results include 21CF and consolidated Hulu only from the acquisition date and are not fully comparable with prior periods.
Financial performance and liquidity
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $20.245B | $15.229B | $50.470B | $45.128B |
| Segment operating income | $3.961B | $4.189B | $11.432B | $12.412B |
| Net income attributable to Disney | $1.760B | $2.916B | $10.000B | $10.276B |
| Diluted EPS, continuing operations | $0.79 | $1.95 | $5.98 | $6.81 |
- Q3 revenue rose 33%; nine-month revenue rose 12%. Segment operating income fell 5% and 8%, respectively. Q3 segment operating margin was about 19.6%, versus 27.5% a year earlier; this comparison is affected by the acquisition and changed segment mix.
- Q3 continuing-operations income was $1.623B, down 47%. Total Q3 diluted EPS was $0.97, including $0.18 from discontinued operations. Nine-month total diluted EPS was $6.19, including $0.21 from discontinued operations.
- Segments, Q3: Media Networks revenue $6.713B and operating income $2.136B; Parks, Experiences and Products $6.575B and $1.719B; Studio Entertainment $3.836B and $792M; Direct-to-Consumer & International (DTCI) $3.858B and an operating loss of $553M.
- Cash flow, nine months: continuing operating cash flow was $4.266B, down from $10.442B. Capital spending was $3.567B; investing activities used $13.785B. Cash, cash equivalents and restricted cash ended at $7.357B. Management attributed the operating cash-flow decline partly to tax payments related to the Fox spin-off, lower DTCI cash flows and higher interest payments.
- Debt and liquidity: balance-sheet borrowings were $58.234B, comprising $21.923B current and $36.311B long term; a further $1.101B of borrowings was classified with assets held for sale. Cash and cash equivalents were $6.728B. Disney reported $12.25B of unused committed bank-facility capacity and said it met its interest-coverage covenant by a significant margin.
Material changes and unusual items
- The 21CF acquisition purchase price was $69.5B, paid with $35.7B cash and $33.8B in Disney shares. Disney consolidated Hulu and recorded a $4.794B non-cash gain on remeasurement of its previously held Hulu interest; an adjustment reduced that gain by $123M in Q3.
- The nine-month results include the Hulu gain, while Q3 results include a $123M adverse adjustment. Other notable Q3 items included $779M of 21CF/Hulu purchase-accounting amortization and film-cost step-up, $207M of restructuring and impairment charges, and $185M of equity-investment impairments. Disney estimated these items reduced Q3 EPS by a combined $0.56.
- Nine-month restructuring and impairment charges were $869M, including charges associated with severance and accelerated equity awards. Disney anticipated approximately $1.5B of total severance and related costs under the integration plan; $608M of severance and related costs had been recorded to date, in addition to $261M of equity-compensation charges.
- Disney adopted new revenue-recognition guidance in FY2019. It reduced Q3 net income by $41M and increased nine-month net income by $28M versus historical accounting. Management did not expect the full-year impact to be material.
- DTCI losses widened as Disney consolidated Hulu and increased spending on streaming, including ESPN+ and preparation for the planned late-2019 launch of Disney+. Studio operating income fell 33% for the nine months, while Parks, Experiences and Products operating income rose 9%.
Outlook, risks and contingencies
- Disney expected FY2019 capital expenditures to be about $0.5B above FY2018’s $4.5B, reflecting increased investment in domestic and international parks and resorts. The filing cautions that nine-month results are not necessarily indicative of full-year results; businesses are seasonal.
- Disney agreed to sell 21 of the 21CF regional sports networks to Sinclair for approximately $10B, subject to customary closing conditions and Department of Justice approval. The YES Network and sports operations in Brazil and Mexico were also slated for divestiture, with required regulatory approvals and deadlines. Proceeds were expected to help repay acquisition debt; timing and final proceeds remained uncertain.
- The remaining $15B 364-day acquisition bridge loan carried a 3.26% rate at June 29, 2019. Disney cited substantially increased indebtedness as a risk to financial flexibility, investment capacity and shareholder distributions.
- Disney disclosed $16B of revenue expected from unsatisfied performance obligations, primarily fixed commitments and minimum guarantees; its estimates were approximately $2B for the rest of FY2019, $6B in FY2020, $4B in FY2021 and $5B thereafter.
- Other stated risks include competition and execution in streaming, consumer demand and economic conditions, international operating and regulatory exposure, content performance, foreign exchange, and seasonality. Disney said it did not believe the disclosed legal actions involved a probable material loss. The company had $2.7B of gross unrecognized tax benefits and $0.7B of related interest and penalty reserves, largely associated with 21CF.
Investor verification priorities
- Track completion, approvals, net proceeds and debt repayment from the regional sports network and other required divestitures.
- Assess debt reduction, interest expense and cash generation after the acquisition-related borrowing and unusually high tax payments.
- Separate recurring operating performance from the Hulu remeasurement gain, purchase-accounting amortization, restructuring charges and investment impairments.
- Monitor DTCI subscriber growth, spending and losses, including the economics of Hulu, ESPN+ and the planned Disney+ launch.
- Verify the pace and final cost of 21CF integration, restructuring and expected synergies, and watch for changes to acquisition valuations and held-for-sale balances.