(continued)

    Operating income increased 13% or $151 million to $1.3 billion, resulting primarily from higher guest spending, increased occupied room nights and record attendance at the Walt Disney World Resort, partially offset by start-up and operating costs associated with Disney's Animal Kingdom and Disney Cruise Line. Costs and expenses, which consist principally of labor, costs of merchandise, food, and beverages sold, depreciation, repairs and maintenance, entertainment and marketing and sales expenses, increased 9% or $367 million. Increased costs and expenses were driven by higher theme park attendance, start-up and operating costs at the new theme park and Disney Cruise Line.

1997 vs. 1996 Revenues increased 11% or $512 million to $5.0 billion, reflecting growth at the Walt Disney World Resort, which celebrated its 25th Anniversary. Growth at the resort included $272 million from greater guest spending, $111 million from increased occupied rooms and $97 million due to record theme park attendance. Higher guest spending reflected increased merchandise and food and beverage sales, higher admission prices and increased room rates at hotel properties. Increased merchandise spending reflected sales of the 25th Anniversary products and the performance of the World of Disney, the largest Disney retail outlet, which opened in October 1996. The increase in occupied rooms reflected higher occupancy and a complete year of operations at Disney's BoardWalk Resort, which opened in the fourth quarter of 1996. Occupied rooms also increased due to the opening of Disney's Coronado Springs Resort in August 1997. Record theme park attendance resulted from growth in domestic tourist visitation. Disneyland's revenues for the year were flat due to higher guest spending offset by reduced attendance from the prior-year's record level.

    Operating income increased 15% or $146 million to $1.1 billion, resulting primarily from higher guest spending, increased occupied rooms and record theme park attendance at the Walt Disney World Resort. Costs and expenses increased 10% or $366 million. Increased operating costs were associated with growth in theme park attendance and occupied rooms, higher guest spending and increased marketing and sales expenses primarily associated with Walt Disney World Resort's 25th Anniversary celebration. Additional cost increases resulted from theme park and resort expansions including Disney's Animal Kingdom and Disney Cruise Line, which both began operations in 1998.

The company generates significant cash from operations and has substantial borrowing capacity to meet its operating and discretionary spending requirements. Cash provided by operations was comparable to the prior year, at $5.1 billion.

    In 1998, the company invested $3.3 billion to develop and produce film and television properties and $2.3 billion to design and develop new theme park attractions, resort properties, real estate developments and other properties. 1997 investments totaled $3.1 billion and $1.9 billion, respectively.

    The $246 million increase in investment in film and television properties was primarily driven by higher live-action and animation spending. Live-action production spending was driven by increases at Miramax and higher animation spending reflected an increase in the number of films in production.

    The $392 million increase in investment in theme parks, resorts and other properties resulted primarily from initiatives including Disney's California Adventure and Disney Cruise Line. Capital spending is expected to increase in 1999, driven by increased spending for Disney's California Adventure.

    The company acquires shares of its stock on an ongoing basis and is authorized as of September 30, 1998 to purchase up to an additional 400 million shares. This amount reflects an increase in the repurchase authorization and the three-for-one split of the company's common shares, both effected in June 1998. During 1998, a subsidiary of the company acquired approximately 1.1 million shares of the company's common stock for approximately $30 million. The company also used $412 million to fund dividend payments during the year.

    During 1998, total borrowings increased to $11.7 billion. The company borrowed approximately $1.8 billion in 1998, with effective interest rates, including the impact of interest rate swaps, ranging from 5.2% to 6.8% and maturities in fiscal 1999 through fiscal 2008. Certain of these financing agreements are denominated in foreign currencies, and the company has entered into cross-currency swap agreements effectively converting these obligations into U.S. dollar denominated LIBOR-based variable rate debt instruments. In August 1998, the company filed a new U.S. registration statement, which replaced the existing U.S. shelf registration statement, and provides for issuance of up to $5.0 billion of debt. As of September 30, 1998, the company had the ability to borrow under the U.S. shelf registration statement and a euro medium-term note program, which collectively permitted the issuance of up to approximately $5.8 billion of additional debt. In addition, the company has $5.2 billion available under bank facilities to support its commercial paper activities.

    The company's financial condition remains strong. The company believes that its cash, other liquid assets, operating cash flows and access to capital markets, taken together, provide adequate resources to fund ongoing operating requirements and future capital expenditures related to the expansion of existing businesses and development of new projects.

YEAR 2000
The Y2K Problem. The company is devoting significant resources throughout its business operations to minimize the risk of potential disruption from the "year 2000 ("Y2K") problem." This problem is a result of computer programs having been written using two digits (rather than four) to define the applicable year. Any information technology ("IT") systems that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in miscalculations and system failures. The problem also extends to many "non-IT" systems; that is, operating and control systems that rely on embedded chip systems. In addition, like every other business enterprise, the company is at risk from Y2K failures on the part of its major business counterparts, including suppliers, distributors, licensees and manufacturers, as well as potential failures in public and private infrastructure services, including electricity, water, gas, transportation and communications.

    System failures resulting from the Y2K problem could adversely affect operations and financial results in all of the company's business segments. Failures may affect security, payroll operations or employee and guest health and safety, as well as such routine but important operations as billing and collection. In addition, the company's business segments face more specific risks. For example:

    The company's Theme Parks and Resorts operations could be significantly impeded by failures in hotel and cruise line reservation and operating systems; in theme park operating systems, including those controlling individual rides, attractions, parades and shows; and in security, health and safety systems.

    In the Creative Content segment, Y2K failures could interfere with critical systems in such areas as the production, duplication and distribution of motion picture and home video product and the ordering, distribution and sale of merchandise at the company's retail stores and catalog operations.

    In the Broadcasting segment, at-risk operations include satellite transmission and communication systems. Y2K failures in such systems could adversely affect the company's television and radio networks, including cable services, as well as its owned and operated stations.

Addressing the Problem. The company has developed a six-phase approach to resolving the Y2K issues that are reasonably within its control. All of these efforts are being coordinated through a senior-level task force chaired by the company's Chief Information Officer ("CIO"), as well as individual task forces in each major business unit. As of September 30, 1998, approximately 400 employees were devoting more than half of their time to Y2K efforts, in addition to approximately 400 expert consultants retained on a full-time basis to assist with specific potential problems. The CIO reports periodically to the Audit Review Committee of the Board of Directors with respect to the company's Y2K efforts.

    The company's approach to and the anticipated timing of each phase are described below.

    Phase 1 - Inventory. The first phase entails a worldwide inventory of all hardware and software (including business and operational applications, operating systems and third-party products) that may be at risk, and identification of key third-party businesses whose Y2K failures might most significantly impact the company. The IT system inventory process has been completed, and the inventories of key third-party businesses and of internal non-IT systems are expected to be completed by December 31, 1998.

    Phase 2 - Assessment. Once each at-risk system has been identified, the Y2K task forces assess how critical the system is to business operations and the potential impact of failure, in order to establish priorities for repair or replacement. Systems are classified as "critical," "important" or "non-critical." A "critical" system is one that, if not operational, would cause the shutdown of all or a portion of a business unit within two weeks, while an "important" system is one that would cause such a shutdown within two months. This process has been completed for all IT systems, resulting in the identification of nearly 600 business systems that are "critical" to continued functioning and more than 1,000 that are either "important" or are otherwise being monitored. The assessment process for internal non-IT systems and for key third-party businesses is expected to be completed by mid-1999. Systems that are known to be critical or important are receiving top priority in assessment and remediation.

    Phase 3 - Strategy. This phase involves the development of appropriate remedial strategies for both IT and non-IT systems. These strategies may include repairing, testing and certifying, replacing or abandoning particular systems (as discussed under Phases 4 and 5 below). Selection of appropriate strategies is based upon such factors as the assessments made in Phase 2, the type of system, the availability of a Y2K-compliant replacement and cost. The strategy phase has been completed for all IT systems. For some non-IT embedded systems, strategy development is continuing. At the company's theme parks, the majority of ride and show control systems have been tested and certified. A strategy for addressing embedded systems in office buildings is being developed in concert with building managers and systems vendors and should be completed by spring 1999. The process of analysis, certification or replacement or "workaround" for embedded systems in office buildings is expected to consume the first half of 1999. Strategies for other embedded systems, such as satellite communications systems, are being developed and are also expected to be complete by mid-1999.

    Phase 4 - Remediation. The remediation phase involves creating detailed project plans, marshalling necessary resources and executing the strategies chosen. For IT systems, this phase is approximately 75% complete for critical and important systems, and is expected to be completed (including certification) by July 31, 1999. For non-critical systems, most corrections are expected to be completed by December 31, 1999. For those systems that are not expected to be reliably functional after January 1, 2000, detailed manual workaround plans will be developed prior to the end of 1999.

    Phase 5 - Testing and Certification. This phase includes establishing a test environment, performing systems testing (with third parties if necessary), and certifying the results. The certification process entails having functional experts review test results, computer screens and printouts against pre-established criteria to ensure system compliance. The company expects all critical and important IT systems to be certified by July 31, 1999. Testing for non-IT systems has been initiated; however, due to the company's reliance on many third-party vendors for these systems, the company cannot estimate precisely when this phase will be completed. The majority of embedded systems at the company's theme parks are expected to be certified by December 31, 1998. The company's target for all critical and important non-IT systems is July 1999.

    The company has initiated written and telephonic communications with key third-party businesses, as well as public and private providers of infrastructure services, to ascertain and evaluate their efforts in addressing Y2K compliance. It is anticipated that the majority of testing and certification with these entities will occur in 1999.

    Phase 6 - Contingency Planning. This phase involves addressing any remaining open issues expected in 1999 and early 2000. As a precautionary measure, the company is currently developing contingency plans for all systems that are not expected to be Y2K compliant by March 1999. A variety of automated as well as manual fallback plans are under consideration, including the use of electronic spreadsheets, resetting system dates to 1972, a year in which the calendar coincides with that of 2000, and manual workarounds. The company estimates that all of these plans will be completed by December 1999.

Costs. As of September 30, 1998, the company had incurred costs of approximately $136 million related to its Y2K project, of which $82 million has been capitalized. The estimated additional costs to complete the project are currently expected to be approximately $125 million, of which $60 million is expected to be capitalized. A significant portion of these costs have not been incremental, but rather reflect redeployment of internal resources from other activities. The company does not expect these redeployments to have a material adverse effect on other ongoing business operations of the company and its subsidiaries, although it is possible that certain maintenance and upgrading processes will be delayed as the result of the priority being given to Y2K remediation. All of the costs of the Y2K project are being borne out of the company's operating cash flow.

    Based upon its efforts to date, the company believes that the vast majority of both its IT and its non-IT systems, including all critical and important systems, will remain up and running after January 1, 2000. Accordingly, the company does not currently anticipate that internal systems failures will result in any material adverse effect to its operations or financial condition. During 1999, the company will also continue and expand its efforts to ensure that major third-party businesses and public and private providers of infrastructure services, such as utilities, communications services and transportation, will also be prepared for the year 2000, and to develop contingency plans to address any failures on their part to become Y2K compliant. At this time, the company believes that the most likely "worst-case" scenario involves potential disruptions in areas in which the company's operations must rely on such third parties whose systems may not work properly after January 1, 2000. In addition, the company's international operations may be adversely affected by failures of businesses in other parts of the world to take adequate steps to address the Y2K problem. While such failures could affect important operations of the company and its subsidiaries, either directly or indirectly, in a significant manner, the company cannot at present estimate either the likelihood or the potential cost of such failures.

    The nature and focus of the company's efforts to address the Year 2000 problem may be revised periodically as interim goals are achieved or new issues are identified. In addition, it is important to note that the description of the company's efforts necessarily involves estimates and projections with respect to activities required in the future. These estimates and projections are subject to change as work continues, and such changes may be substantial.