Disney’s 4Q10: a strong quarter Wall Street initially panned

DIS reported fourth quarter fiscal 2010 (ended October 2nd) results yesterday.  The earnings release was supposed to be available only after the close.  DIS worried that the information was somehow leaking out into the market, however, and published the figures at 3:45pm, fifteen minutes early.  The stock dropped about 4% on the news, but recovered a bit before the close–and some more after.

the results

DIS earned $.45 per share, adjusted for writeoffs, on revenue of $9.74 billion for 4Q10.  This compares with eps of $.46 on revenue of $9.7 billion in the comparable period of fiscal 2009.  DIS doesn’t give detailed earnings guidance.  The reported results fell a penny shy of the Wall Street consensus, however, which covered an unusually large amount of territory for the quarter, ranging from $.39 to $.53.

the adjustments

Hang onto your hat.

1.  DIS’s financial reporting is based on weeks.  This has not-so-obvious accounting consequences.

Q:  How many weeks in a year?  A: 52.    But 52 x 7 = 364.    This means 52 weeks falls one day short of a full year, except in leap year, when it falls two days short.  Therefore, to keep its accounting year more or less anchored to the actual calendar, every six or seven years, DIS has to make a leap-year-like adjustment by having a 53 week year.

That happened in fiscal 2009.

Because of this, the fourth quarter of fiscal 2010 contains 13 weeks, but the fourth quarter of fiscal 2009 contained 14–meaning it had 7.7% more days in it.

There’s no easy way to make an accurate adjustment that will make the year on year comparison an apples-to-apples one.  The the thing any portfolio manager worth his/her salt will do is to make an easy adjustment that may not be accurate but will give a flavor of what the right number should be.  In this case, let’s assume the extra week has no operating leverage effects.  In other words, let’s just multiply the 4Q2010 eps by 1.077.  That yields eps of $.485, a $.035 gain.

2.  DIS’s cable deals are like oil and gas deals, insanely complex and no two alike.  One common feature, though, is minimum performance guarantees (of one sort or another).  In general, these contract clauses call for higher payments to DIS throughout the year if the product it sells exceeds the contractual guarantees (whatever they may be in a given contract).

How does DIS account for these contracts?  It starts out with the assumption that it will not meet the guarantee minimums (even though it may think it can do so in its sleep) and reports the only the amount it would earn if it didn’t.  Once it achieves the minimum, however, DIS does two things.   It begins to report the higher amount from that point onward; and, in the quarter it hits the minimum, it reports–in one big lump–all the extra money it has earned year-to-date at the higher meeting-the-minimum rate.

Normally, this is a bonanza for the fourth quarter.  Fiscal 2010 was so good, however, that the big payday came in the third.  Here are the figures:

deferred revenue recognized:

3Q2010     $344 million     vs.     3Q2009     -$37 million

3Q2010     $170 million     vs.     4Q2009     $524 million.

Net extra payments in the second half of 2010 were $27 million higher than in the second half of fiscal 2009.  But hitting the minimum performance levels earlier this year than last shifted $.09 in eps that would normally be shown in the fourth quarter into the third.

3.  Oh, yes.  DIS is exiting its image capture business, IMD, and wrote off $100 million ($.07 a share) that reduced operating income from the Media Networks segment.

Let’s add all this up.  $.45 reported + $.035 to correct for the extra week last year + $.09 for the cable contract timing shift  +  $.07 for IMD   =  $.595.  In other words, 4Q2010 was a really good quarter.

things I noticed in the report

From an investment point of view, the key positive is that the advertising market is growing very strongly, both for ESPN and for ABC.  But there are other positives that caught my eye as well, namely:

Writeoffs of older, unsuccessful movies appear to have stopped.  For the full fiscal year, DIS reported impairment charges of $132 million, the largest part of which was for writeoffs of abandoned/unsuccessful movie projects.  The fourth quarter number was only $3 million.  If I’m correct, this is a real positive.

The theme parks are perking up.  Adjusting for the extra week last year, park attendance was up 1% and spending per person up 6% for the quarter.  Hotel occupancy was flat, with spending up about 5%.

Hotel reservations are up 5% year on year so far in 1Q11, with room rates also up by about 5%.  Unlike the case during the past couple of years, both metrics are moving in a positive direction.

what about the stock?

I like it.  It probably won’t be a rocket ship ride, but up 15% in eps is easily achievable in the current fiscal year, I think.  The company has also been buying back its own stock at around the $35.50 level recently–always a good sign.  I probably should mention, though, that I trimmed my DIS position a bit a couple of weeks ago, because I thought it had gotten too big.




2 responses

  1. Excellent analysis. Didn’t know about the accounting in “weeks” by DIS. Seems someone over there should really reconsider using this wacky method and join the 21st century.

    • Thanks for your comment. A lot of hotels and restaurants base their accounting on “weeks.” I’m not sure why. It may be for some operational reason that influences the way they organize their management control books, like that their customers’ use of their services follows a weekly pattern, or that’s the way they pay their employees or their suppliers. Or it could be that this is simply the way leisure companies have always done things.
      I agree with you that with DIS it doesn’t make much sense. It’s a case of the tail wagging the dog. In fiscal 2010, Parks and Resorts only accounted for 17% of the company’s operating income.

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