Investments As of September 30, 1998 and 1997, the company held $126 million and $137 million, respectively, of securities classified as available for sale. In 1998, 1997 and 1996, realized gains and losses on available-for-sale securities, determined principally on an average cost basis, and unrealized gains and losses on available-for-sale securities were not material.
Interest Rate Risk Management The company is exposed to the impact of interest rate changes. The company's objective is to manage the impact of interest rate changes on earnings and cash flows and on the market value of its investments and borrowings. The company maintains fixed rate debt as a percentage of its net debt between a minimum and maximum percentage, which is set by policy.
The company uses interest rate swaps and other instruments to manage net exposure to interest rate changes related to its borrowings and to lower its overall borrowing costs. Significant interest rate risk management instruments held by the company at September 30, 1998 and 1997 included pay-floating and pay-fixed swaps, interest rate caps and swaption contracts. Pay-floating swaps effectively converted medium-term obligations to LIBOR-based or commercial paper variable rate instruments. These swap agreements expire in one to fourteen years. Pay-fixed swaps and interest rate caps effectively converted floating rate obligations to fixed rate instruments. These instruments expire within one year. Swaption contracts were designated as hedges of floating rate debt and expired in 1998.
The following table reflects incremental changes in the notional or contractual amounts of the company's interest rate contracts during 1998 and 1997. Activity representing renewal of existing positions is excluded.
The impact of interest rate risk management activities on income in 1998, 1997 and 1996, and the amount of deferred gains and losses from interest rate risk management transactions at September 30, 1998 and 1997 were not material.
Foreign Exchange Risk Management The company transacts business in virtually every part of the world and is subject to risks associated with changing foreign exchange rates. The company's objective is to reduce earnings and cash flow volatility associated with foreign exchange rate changes to allow management to focus its attention on its core business issues and challenges. Accordingly, the company enters into various contracts which change in value as foreign exchange rates change to protect the value of its exiting foreign currency assets and liabilities, commitments and anticipated foreign currency revenues. By policy, the company maintains hedge coverage between minimum and maximum percentages of its anticipated foreign exchange exposures for periods not to exceed five years. The gains and losses on these contracts offset changes in the value of the related exposures.
It is the company's policy to enter into foreign currency transactions only to the extent considered necessary to meet its objectives as stated above. The company does not enter into foreign currency transactions for speculative purposes.
The company uses option strategies which provide for the sale of foreign currencies to hedge probable, but not firmly committed, revenues. While these hedging instruments are subject to fluctuations in value, such fluctuations are offset by changes in the value of the underlying exposures being hedged. The principal currencies hedged are the Japanese yen, French franc, German mark, British pound, Canadian dollar and Italian lira. The company also uses forward contracts to hedge foreign currency assets, liabilities and foreign currency payments the company is committed to make in connection with the construction of a cruise ship (see Note 13). Cross-currency swaps are used to hedge foreign currency-denominated borrowings.
At September 30, 1998 and 1997, the notional amounts of the company's foreign exchange risk management contracts, net of notional amounts of contracts with counterparties against which the company has a legal right of offset, the related exposures hedged and the contract maturities are as follows:
Gains and losses on contracts hedging anticipated foreign currency revenues and foreign currency commitments are deferred until such revenues are recognized or such commitments are met, and offset changes in the value of the foreign currency revenues and commitments. At September 30, 1998 and 1997, the company had deferred gains of $245 million and $486 million respectively, and deferred losses of $118 million and $220 million, respectively, related to foreign currency hedge transactions. Deferred amounts to be recognized can change with market conditions and will be substantially offset by changes in the value of the related hedged transactions. The impact of foreign exchange risk management activities on operating income in 1998 and in 1997 was a net gain of $227 million and $166 million, respectively.
Fair Value of Financial Instruments At September 30, 1998 and 1997, the company's financial instruments included cash, cash equivalents, investments, receivables, accounts payable, borrowings and interest rate and foreign exchange risk management contracts.
At September 30, 1998 and 1997, the fair values of cash and cash equivalents, receivables, accounts payable and commercial paper approximated carrying values because of the short-term nature of these instruments. The estimated fair values of other financial instruments subject to fair value disclosures, determined based on broker quotes or quoted market prices or rates for the same or similar instruments, and the related carrying amounts are as follows:
Credit Concentrations The company continually monitors its positions with, and the credit quality of, the financial institutions which are counterparties to its financial instruments and does not anticipate nonperformance by the counter-parties. The company would not realize a material loss as of September 30, 1998 in the event of nonperformance by any one counterparty. The company enters into transactions only with financial institution counterparties which have a credit rating of A- or better. The company's current policy regarding agreements with financial institution counterparties is generally to require collateral in the event credit ratings fall below A- or in the event aggregate exposures exceed limits as defined by contract. In addition, the company limits the amount of credit exposure with any one institution. At September 30, 1998, financial institution counterparties posted collateral of $83 million to the company, and the company was not required to collateralize its financial instrument obligations.
The company's trade receivables and investments do not represent significant concentration of credit risk at September 30, 1998, due to the wide variety of customers and markets into which the company's products are sold, their dispersion across many geographic areas, and the diversification of the company's portfolio among instruments and issuers.
New Accounting Guidance In June 1998, the Financial Accounting Standards Board ("the FASB") issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), which the company is required to adopt effective October 1, 1999. SFAS 133 will require the company to record all derivatives on the balance sheet at fair value. Changes in derivative fair values will either be recognized in earnings as offsets to the changes in fair value of related hedged assets, liabilities and firm commitments or, for forecasted transactions, deferred and recorded as a component of other stockholders' equity until the hedged transactions occur and are recognized in earnings. The ineffective portion of a hedging derivative's change in fair value will be immediately recognized in earnings. The impact of SFAS 133 on the company's financial statements will depend on a variety of factors, including future interpretative guidance from the FASB, the future level of forecasted and actual foreign currency transactions, the extent of the company's hedging activities, the types of hedging instruments used and the effectiveness of such instruments. However, the company does not believe the effect of adopting SFAS 133 will be material to its financial position.
Pursuant to an agreement with a shipyard for the construction of a cruise ship for its Disney Cruise Line, the company is committed to make payments totaling approximately $290 million in 1999.
The company is committed to the purchase of broadcast rights for various feature films, sports and other programming aggregating approximately $14.7 billion as of September 30, 1998. This amount is substantially payable over the next six years.
The company has various real estate operating leases including retail outlets for the distribution of consumer products and office space for general and administrative purposes. Future minimum lease payments under these non-cancelable operating leases totaled $2 billion at September 30, 1998, payable as follows:
Rental expense for the above operating leases during 1998, 1997 and 1996, including overages, common-area maintenance and other contingent rentals, was $321 million, $327 million and $233 million, respectively.
The company, together with, in some instances, certain of its directors and officers, is a defendant or co-defendant in various legal actions involving copyright, breach of contract and various other claims incident to the conduct of its businesses. Management does not expect the company to suffer any material liability by reason of such actions, nor does it expect that such actions will have a material effect on the company's liquidity or operating results.
In April 1997, the company purchased a significant equity stake in Starwave Corporation ("Starwave"), an internet technology company. In connection with the acquisition, the company was granted an option to purchase substantially all the remaining shares of Starwave, which the company exercised during the third quarter of 1998. Accordingly, the accounts of Starwave have been included in the company's September 30, 1998 consolidated financial statements. On June 18, 1998, the company reached an agreement for the acquisition of Starwave by Infoseek Corporation ("Infoseek"), a publicly-held internet search company, pursuant to a merger. On November 18, 1998, the shareholders of both Infoseek and Starwave approved the merger. As a result of the merger and the company's purchase of additional shares of Infoseek common stock pursuant to the merger agreement, the company owns approximately 43% of Infoseek's outstanding common stock. In addition, pursuant to the merger agreement, the company purchased warrants enabling it, under certain circumstances, to achieve a majority stake in Infoseek. These warrants vest over a three-year period and expire in five years. Effective as of the November 18, 1998 closing date of the transaction, the company will record a significant non-cash gain, a write-off for purchased in-process research and development costs and an increase in investments, reflecting the company's share of the fair value of Infoseek's intangible assets. The company is currently performing the necessary valuations to determine the gain, the research and development write-off and the amount of and amortization period for the intangible assets. Thereafter, the company will account for its investment in Infoseek under the equity method. The merger is not expected to have a material effect on the company's financial position.
