Seeking Explanations for Disney's Profit Problems.

SO you weren't privy to the recent meeting of analysts hosted by Walt Disney Co.?

Disney, the world's No. 2 media company, is the leader in box-office receipts, home video sales and theme park attendance, yet the company's operating income fell 36 percent to $521 million in the year ended Sept. 30. Disney has warned that the current fiscal year looks much the same.

No matter. Lots of regular folk are looking for answers to Disney's sad earnings report, which drove the stock down to its lowest closing price in 13 months.

What to think? Who to blame? Disney has announced a flurry of cost-cutting moves, but it's hard to think tough-minded Chairman Michael Eisner has been running a profligate business.

If anything, Eisner looks and sounds overly cautious. He told analysts in a conference call that he is unlikely to buy a recorded music company or TV stations because prices are too high and he has enough on his plate.

No one disputes the problems Disney has encountered in its consumer products business, where the company says it must pare the clutter from its stores and make better use of Internet retailing.

But even jaded Hollywood executives are surprised by the performance of Disney's studio entertainment segment, which reported an operating loss in the fourth quarter and an 85 percent decline in operating profit for its fiscal year. There's a sense of disbelief: How can Disney, the standard-bearer, have these problems?

Look at the box office, where Disney is the top-ranked studio. (Indeed, Disney has been ranked No. 1 in theatrical revenue for four of the past five years.) The studio has a runaway hit in "The Sixth Sense," which has grossed more than $261 million in U.S. ticket sales since early August, yet it reported an operating loss of $94 million for its studio entertainment segment in the three months ended Sept. 30.

Did Disney spend too much on "The Sixth Sense"? To the contrary. In a little-reported move, Disney agreed to let Spyglass Entertainment, its partner on the film, assume most of the cost of production. That means Spyglass, not Disney, will reap most of the movie's profit. Disney will get a distribution fee but not in the countries where Spyglass uses other distributors.

"Sixth Sense" underscores the ironies of cost cutting, in which Disney is earnestly engaged. The company is reducing its annual investment in live-action film by $500 million. At the meeting of analysts at the Burbank studio, Walt Disney Studios Chairman Joe Roth said he's reducing the output of films by almost a third.

So, how about home video? For almost a decade, Disney's home video division functioned like an ATM machine for corporate earnings. The release of new or classic Disney animated feature films on video was almost certain to boost profit.

In 1995, the year before Disney acquired Capital Cities/ABC, the video unit generated almost half of the company's operating income, according to Alan Gould, an analyst at Gerard Klauer Mattison & Co. in New York, who has written extensively about Disney's video business.

In 1998, Disney still dominated the $6.6 billion business of "sell-through" videos with a 34 percent market share, according to Adams Media Research, a Carmel Valley firm that predicts Disney will retain its No. 1 ranking this year.

Yet this year, home video couldn't rescue Disney's studio entertainment segment: Operating profit tumbled 85 percent, to $116 million.

Disney elected not to reissue an animated film classic like "Beauty and the Beast" on video. The company said it intends to "rest" its most prized animated films for longer intervals -- up to 10 years, instead of seven. Not until August did the company announce plans to release nine of its animated films on DVD.

Disney's video business was virtually on trial in a months-long courtroom battle earlier this year when former Disney studio chief Jeffrey Katzenberg sued to collect a bonus of 2 percent of the future earnings of films and TV shows initiated during his decade at the company.

Katzenberg contended that he was owed $578 million, based on the earning power of films like "The Little Mermaid," "Beauty and the Beast," "Aladdin" and "The Lion King." But Disney lawyers disputed Katzenberg's estimates of future profits from emerging technologies. They had the unenviable task of devaluing the Disney animated films, long regarded as the company's crown jewels.

Theme parks were called "the bright spot" in Disney's 1999 earnings with operating profit of $1.4 billion, up 12 percent from 1988. But even there, Eisner vowed to show added fiscal restraint in new capital expenditures once the current park projects are built. The company intends to devote more effort to packaging tours instead of costly new rides.

Always a prudent manager, Eisner looks excessively cautious to some analysts. Jessica Reif Cohen, at Merrill Lynch & Co., says Disney's decision against buying additional broadcast properties "may result in further opportunities lost."

It's enough to make some people wistful for the pugnacious tone Eisner took at an analysts' meeting in January 1995, when he regained Wall Street's confidence after the death of longtime Disney President Frank Wells, the ouster of Katzenberg and his own heart-bypass surgery.

At that meeting, Eisner rattled his saber at rival studios. "They're coming after us in animation? We're going to go after them in music." The next day, Disney's stock jumped 6 percent.

Kathryn Harris is a columnist for Bloomberg News.