The Company's executive compensation philosophy The fundamental objectives of the Company's executive compensation policies are to ensure that executives are provided incentives and compensated in a way that advances both the short- and long-term interests of shareholders while also ensuring that the Company is able to attract and retain executive management talent. The Company approaches this objective through three key components: a base salary; a performance-based annual bonus, which may be paid in cash, shares of stock, stock units or a combination of these; and periodic (generally annual) grants of long-term stock-based compensation, such as stock options, restricted stock units and/or restricted stock, which may be subject to performance-based and/or time based vesting requirements. During fiscal 2004, the Compensation Committee, with advice and assistance from an independent compensation consultant, devoted extensive attention to redesigning its approach to the last two of these components, with particular emphasis on redefining the process for setting individual bonuses for executive officers and bonus pools for all other bonus-eligible individuals, and establishing new standards for long-term incentive grants. The redesign efforts were completed late in the year, and the new processes will be applied beginning in fiscal year 2005. The following report first reviews the processes that the Committee has implemented for fiscal year 2005 and beyond, and then describes the process followed by the Committee in determining key elements of fiscal year 2004 executive compensation, including compensation for the executive officers named in the Summary Compensation Table in this proxy statement. New executive compensation policies beginning in fiscal 2005 In December 2004, the Committee completed a redesign of the processes relating to annual bonus and long-term incentive grants that is intended to achieve two principal objectives: formalize the Company's historical practice of linking compensation with performance, measured at the Company and business segment levels; and improve the clarity of the Company's compensation practices and objectives for both employees and shareholders. Annual bonuses for named executive officers Beginning in fiscal year 2005, the annual bonus process for executive officers named in the Summary Compensation Table in this proxy statement will involve five basic steps: At the outset of the fiscal year: (1) setting overall Company performance goals for the year; (2) setting individual performance measures for the year; and (3) setting a target bonus for each individual; After the end of the fiscal year: (4) measuring actual performance (individual and Company-wide) against the predetermined Company performance goals and individual performance measures to determine the appropriate adjustment to the target bonus; and (5) making adjustments to the resulting preliminary bonus calculation to reflect the Company's performance in earnings per share growth relative to the performance of other S&P 500 companies. These five steps are described below: (1) Setting Company performance goals. Early in each fiscal year, the Compensation Committee, working with senior management and the Committee's compensation consultant, will set performance goals for the Company (which will be in addition to a performance target which will be set in compliance with Section 162(m) in accordance with the Company's past practice as described below under "Compliance with Section 162(m)"). Seventy percent of the final bonus determination for each executive will be based upon performance against these goals. For fiscal 2005, four Company performance goals have been established: operating income; after-tax free cash flow (cash flow from operations less investments in theme parks, resorts and other properties); economic profit (net operating profit after tax, minus a charge for capital employed in the business, based on the cost of capital); and earnings per share. The Committee will weight each of the performance goals as it deems appropriate for each fiscal year. For fiscal year 2005, the Committee has decided that the goals listed above will each be given equal weight. In determining the extent to which the pre-set performance goals are met for a given period, the Committee will exercise its judgment whether to reflect or exclude the impact of changes in accounting principles and extraordinary, unusual or infrequently occurring events reported in the Company's public filings. To the extent appropriate, the Committee will consider the nature and impact of such events in the context of the remaining 30% of the bonus determination. (2) Setting individual performance measures. As it sets Company-wide performance goals, the Committee will also set individual performance measures for each executive. These measures will allow the Committee to play a more proactive role in identifying performance objectives beyond purely financial measures, including, for example, exceptional performance of each individual's functional responsibilities as well as leadership, creativity, collaboration, diversity initiatives, growth initiatives, crisis management and other activities that are critical to driving long-term value for shareholders. (3) Setting a target bonus. Once the Company-wide goals and individual performance measures are set, the Committee will establish a target bonus amount for each executive. This amount is expected to be significantly below the upper bonus limit established for each executive under the Company's 2002 Executive Performance Plan, which was approved by shareholders in 2002. It will also be subject to the conditions of payment set forth in that plan, as required by Section 162(m) of the Internal Revenue Code. The bonus target will take into account all factors that the Committee deems relevant, including (but not limited to) a review of peer group compensation both within the entertainment industry and more broadly, and the Committee's assessment of the aggressiveness of the level of growth reflected in the Company's annual operating plan. For each of the performance goals, there will be a formula that establishes a payout range around the target bonus allocation. The formula determines the percentage of the target bonus to be paid, based on a percentage of goal achievement, with a minimum below which no payment will be made and an established upper cap. (4) Measuring performance. After the end of the fiscal year, the Committee will review the Company's actual performance against each of the performance goals established at the outset of the year. To make its preliminary bonus determination, the Committee will then adjust 70% of the target bonus amount up or down to reflect actual performance as compared to the performance goals. The remaining 30% of the preliminary bonus determination will be based upon the Committee's assessment of other individual performance goals set at the outset of the year as well as the executive's role and responsibilities with respect to any one-time, unusual or infrequent items. This assessment will allow the Committee an opportunity to take into account each executive's personal performance and contribution during the year and this portion of the bonus may be adjusted up or down depending on the level of performance against the individual goals. (5) Adjustment to reflect comparative performance. The last step in the bonus process will be a final adjustment of the preliminary bonus amount to take into account the extent to which the change in the Company's earnings per share for the year outperformed or underperformed EPS change over the same period among all other S&P 500 companies. The preliminary bonus amount will be subject to reduction by up to 20% in the event of relative underperformance or increase by up to 20% in the event of over performance. Discretion. Under the redesigned incentive bonus plan, the Compensation Committee will continue to have discretion as to whether annual bonuses for the Company's most senior corporate executive officers will be paid in cash, restricted stock, restricted stock units or a combination thereof. Any restricted stock or restricted stock units that are awarded will be granted under a long-term incentive plan approved by the shareholders of the Company (currently the 1995 Stock Incentive Plan). The Committee also retains discretion, in appropriate circumstances, to grant a lower bonus or no bonus at all. Compliance with Section 162(m). In order to ensure that bonuses paid to executives subject to Section 162(m) will be deductible by the Company, the specified performance target(s) set for each fiscal year under the 2002 Executive Performance Plan must also be met, as described under "Fiscal 2004; Annual Bonuses; Executive Officers" below. For fiscal year 2005 the performance criterion is "adjusted net income," as defined in the Company's 2002 Executive Performance Plan. In the event that the Section 162(m) performance target(s) for fiscal 2005 are not met, no bonuses will be paid to any Section 162(m) executives under the 2002 Executive Performance Plan or the redesigned bonus program, even if the performance goals under the redesigned program have been achieved. However, as noted below under "How is the Company addressing Internal Revenue Code limits on deductibility of compensation?", the Compensation Committee will retain the right to award bonuses outside of these plans in appropriate circumstances, including bonuses that may not be deductible in part or in full. Annual bonuses for other bonus eligible employees Beginning in fiscal year 2005, the size of the pool of funds from which bonuses may be awarded to corporate executives other than those named in the Summary Compensation Table as well as business segment executives and other eligible employees will depend upon performance against financial goals and other measures established at the outset of the fiscal year. At the corporate level, 70% of the bonus pool determination will be based upon performance against the same financial measures used for bonus determinations for executive officers named in the Summary Compensation Table, as described above under "Setting Company performance goals." The remaining 30% will be based on an assessment by senior management and the Committee of other performance factors. For the Company's business segments, 50% of the bonus pool determination will be based upon performance against segment-level financial goals, 30% will be based on other segment-level performance factors and 20% will be based on the Company's overall performance against the Company performance goals described above under "Setting Company performance goals." As in the past, actual bonus awards to individual eligible employees will remain subject to the overall discretion of the Committee. Long-term incentive compensation In December 2004, the Committee also approved a new approach to long-term incentive compensation as a complement to the modifications made to the Company's annual bonus compensation policies. The redesign also took into account evolving practices at other major public corporations, as well as the Company's own critical objective of further enhancing linkages between employee performance and the creation of shareholder value. Key elements of the redesigned policy include: introducing performance requirements for the vesting of some long-term incentive grants granted to senior executives; increasing the proportion of restricted stock units (RSUs) and decreasing the proportion of stock options used in long-term incentive awards; establishing minimum stock ownership requirements for named executive officers; establishing holding requirements for named executive officers for a portion of any shares acquired upon the exercise of options granted after December 2004 under the long-term incentive plan; and shortening the life of stock option grants from ten to seven years. Mix of restricted stock units and stock options. Beginning in fiscal year 2005, the long-term incentive policy contemplates that long-term compensation will generally take the form of a mix of restricted stock unit grants and option awards. It is anticipated that, for grants made to senior executives, approximately 60% of the total value of a long-term compensation award will typically take the form of restricted stock unit grants, with stock options accounting for the remaining value. The Committee may in the future make adjustments to this mix of award types or approve different award types, such as restricted stock, as part of the overall long-term incentive award. Vesting of restricted stock units. Under the new policy, restricted stock unit awards granted as long-term incentive compensation to senior executives will generally continue to have scheduled vesting dates on each of the second and fourth anniversary dates of the grant date, and on each of those dates 50% of the total award will be scheduled to vest, contingent upon the executive's continued employment with the Company. However, the scheduled vesting with respect to half of the stock units eligible for vesting on each such anniversary date will also be subject to a performance-based vesting requirement; namely, that the Company's "total shareholder return" (as described below) as of each of such vesting dates must exceed the weighted average "total shareholder return" of corporations in the Standard & Poor's 500 Index over either the prior year or the prior three years. If the performance test is not met on the first scheduled vesting date, the stock units subject at that time to the performance requirement may still vest on the second vesting date (i.e., on the fourth anniversary date), provided that the performance test for the second vesting date is met, and the executive remains employed. For purposes of these determinations, "total shareholder return" reflects (i) the aggregate change, for the performance time period specified, in the market value of the Company's or the S&P 500 Index, as the case may be, and (ii) the value returned to shareholders in the form of dividends or similar distributions, assumed to be reinvested on a pre-tax basis, during the performance period. The 50% of the restricted stock unit grants not subject to performance vesting will be scheduled to vest in equal tranches on the second and fourth anniversaries of grant, contingent upon the executive's continued employment with the Company. However, for executives subject to Section 162(m), vesting of all restricted stock units covered by the grant will be subject to performance-based vesting requirements that will be established to satisfy the requirements for qualified performance-based compensation under Section 162(m) of the Code. The foregoing performance-based requirements do not relate to restricted stock unit awards granted in lieu of cash under the Company's annual bonus program, because the bonus awards under that program are granted based on performance under the annual bonus incentive program and, in the case of awards to the named executive officers, are themselves subject to the requirements of Section 162(m). The amounts of these awards will be determined based on the annual bonus earned by the executive and the portion thereof, if any, determined by the Committee to be payable as a restricted stock unit award. Half of these awards will generally become vested at the end of two years and the remainder at the end of four years, contingent upon the continued employment of the executive, unless vesting is accelerated as provided in employment agreements, awards or plan documents. See note 1 to the Summary Compensation Table. However, the Committee has on occasion made adjustments to the vesting schedule for bonus-related restricted stock units and reserves the right to do so in the future. Stock options. The Committee anticipates that stock options will continue to be granted with exercise prices equal to the market price of the Company's stock on the date of grant and will vest over four years, based on continued employment. The Committee anticipates that new option grants will have a term of seven years, rather than the ten-year term that has been used in the past. The Committee will not grant stock options with exercise prices below the market price of the Company's stock on the date of grant, and will not reduce the exercise price of stock options without shareholder approval. Stock ownership and holding policy. As part of the redesigned incentive compensation program, the Committee has established new stock ownership and holding requirements for the executive officers named in the Summary Compensation Table. These officers will now be expected, over time, to acquire and hold Company stock equal in value to at least three to five times their base salary amounts, depending on their positions. In addition, for all stock option grants made beginning in 2005, the executives will be required, as long as they remain employed by the Company, to retain ownership of shares representing at least 75% of the after-tax gain realized (100% in the case of the Chief Executive Officer) upon exercise of such options for a minimum of months. The Committee believes that this ownership and holding policy further enhances the alignment of executive and shareholder interests and thereby promotes the objective of increasing shareholder value. Periodic review. The Committee intends to review the operation of the redesigned long-term incentive program at least annually to be assured that its key elements continue to meet the Company's fundamental objective of enhancing the alignment of senior management's interests with those of its shareholders.