Edgar Filing: Discovery Communications, Inc.

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-34177

DISCOVERY COMMUNICATIONS, INC.

(Exact name of Registrant as specified in its charter)

Delaware

35-2333914

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

One Discovery Place

Silver Spring, Maryland

20910

(Address of principal executive offices)

(Zip Code)

(240) 662-2000

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Total number of shares outstanding of each class of the Registrant’s common stock as of October 26, 2010:


Series A Common Stock, $0.01 par value			137,087,129
Series B Common Stock, $0.01 par value			6,589,084
Series C Common Stock, $0.01 par value			140,640,756

DISCOVERY COMMUNICATIONS, INC.

FORM 10-Q

TABLE OF CONTENTS


	Page

PART I. FINANCIAL INFORMATION		3

ITEM 1. Financial Statements.		3

Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009		3

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009		4

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2009		5

Condensed Consolidated Statements of Equity for the Three and Nine Months Ended September 30, 2010 and 2009		6

Notes to Condensed Consolidated Financial Statements		7

ITEM 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition.		35

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.		52

ITEM 4. Controls and Procedures.		53

PART II. OTHER INFORMATION		54

ITEM 1. Legal Proceedings.		54

ITEM 1A. Risk Factors.		54

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.		54

ITEM 6. Exhibits.		55

SIGNATURES		56

PART I. FINANCIAL INFORMATION

ITEM 1.

Financial Statements.

DISCOVERY COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited; in millions, except par value)


	As of September 30, 2010			As of December 31, 2009
				(recast)
ASSETS
Current assets:
Cash and cash equivalents (including $10 and $40 held by VIEs at 2010 and 2009, respectively)	$	1,016		$	623
Receivables, net		843			812
Content rights, net		81			75
Prepaid expenses and other current assets		197			161

Total current assets		2,137			1,671

Noncurrent content rights, net		1,229			1,207
Property and equipment, net		389			409
Goodwill		6,435			6,433
Intangible assets, net		615			643
Other noncurrent assets		593			589

Total assets	$	11,398		$	10,952

LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	464		$	446
Current portion of long-term debt		18			38
Other current liabilities		310			299

Total current liabilities		792			783

Long-term debt		3,595			3,457
Other noncurrent liabilities		267			443
Commitments and contingencies (Note 16)

Redeemable noncontrolling interests		49			49

Equity:
Discovery Communications, Inc. stockholders’ equity:
Series A convertible preferred stock: $0.01 par value; 75 shares authorized; 71 shares issued at 2010 and 2009		1			1
Series C convertible preferred stock: $0.01 par value; 75 shares authorized; 71 shares issued at 2010 and 2009		1			1
Series A common stock: $0.01 par value; 1,700 shares authorized; 137 and 135 shares issued at 2010 and 2009, respectively		1			1
Series B convertible common stock: $0.01 par value; 100 shares authorized; 7 shares issued at 2010 and 2009		—			—
Series C common stock: $0.01 par value; 2,000 shares authorized; 142 shares issued at 2010 and 2009		2			2
Additional paid-in capital		6,664			6,600
Treasury stock, at cost: Series C common stock: 1.12 shares at 2010		(38	)		—
Retained earnings (accumulated deficit)		75			(387	)
Accumulated other comprehensive loss		(23	)		(21	)

Total Discovery Communications, Inc. stockholders’ equity		6,683			6,197
Noncontrolling interests		12			23

Total equity		6,695			6,220

Total liabilities and equity	$	11,398		$	10,952

The accompanying notes are an integral part of these condensed consolidated financial statements.

DISCOVERY COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; in millions, except per share amounts)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
				(recast)						(recast)
Revenues:
Distribution	$	452		$	422		$	1,346		$	1,266
Advertising		402			341			1,185			1,009
Other		72			74			227			233

Total revenues		926			837			2,758			2,508


Costs of revenues, excluding depreciation and amortization listed below		261			251			782			751
Selling, general and administrative		306			324			894			885
Depreciation and amortization		32			39			98			115
Restructuring and impairment charges		15			2			18			40
Gains on dispositions		—			—			—			(252	)

		614			616			1,792			1,539


Operating income		312			221			966			969

Interest expense, net		(49	)		(65	)		(155	)		(182	)
Loss on extinguishment of debt		—			—			(136	)		—
Other (expense) income, net		(16	)		(1	)		(57	)		10


Income from continuing operations before income taxes		247			155			618			797
Provision for income taxes		(83	)		(52	)		(171	)		(387	)


Income from continuing operations, net of taxes		164			103			447			410
Income (loss) from discontinued operations, net of taxes		25			1			25			(2	)


Net income		189			104			472			408
Less net income attributable to noncontrolling interests		(3	)		(4	)		(10	)		(10	)

Net income attributable to Discovery Communications, Inc.		186			100			462			398
Stock dividends to preferred interests		—			(6	)		(1	)		(8	)


Net income available to Discovery Communications, Inc. stockholders	$	186		$	94		$	461		$	390


Income per share from continuing operations available to Discovery Communications, Inc. stockholders:
Basic	$	0.38		$	0.22		$	1.03		$	0.93

Diluted	$	0.37		$	0.22		$	1.01		$	0.92


Income (loss) per share from discontinued operations available to Discovery Communications, Inc. stockholders:
Basic	$	0.06		$	—		$	0.06		$	—

Diluted	$	0.06		$	—		$	0.06		$	—


Net income per share available to Discovery Communications, Inc. stockholders:
Basic	$	0.44		$	0.22		$	1.08		$	0.92

Diluted	$	0.43		$	0.22		$	1.07		$	0.92


Weighted average shares outstanding:
Basic		426			424			425			423

Diluted		431			427			431			424

Income per share amounts may not foot since each is calculated independently.

The accompanying notes are an integral part of these condensed consolidated financial statements.

DISCOVERY COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in millions)


	Nine Months Ended September 30,
	2010			2009
				(recast)
Operating Activities
Net income	$	472		$	408
Adjustments to reconcile net income to cash provided by operating activities:
Stock-based compensation expense		153			196
Depreciation and amortization		100			118
Content amortization and write-offs		526			515
Impairment charges		11			26
Gains on dispositions		(12	)		(252	)
Gains on sales of investments		—			(13	)
Deferred income taxes		(89	)		(38	)
Noncash portion of loss on extinguishment of debt		12			—
Other noncash expenses, net		46			51
Changes in operating assets and liabilities:
Receivables, net		(41	)		1
Content rights		(558	)		(562	)
Accounts payable and accrued liabilities		(8	)		(32	)
Stock-based compensation liabilities		(128	)		(24	)
Other, net		(39	)		(10	)

Cash provided by operating activities		445			384

Investing Activities
Purchases of property and equipment		(29	)		(41	)
Business acquisitions, net of cash acquired		(38	)		—
Proceeds from dispositions, net		24			300
Proceeds from sales of investments		—			22
Investments in and advances to equity investees		(71	)		(22	)

Cash (used in) provided by investing activities		(114	)		259

Financing Activities
Net repayments of revolver loans		—			(315	)
Borrowings from long-term debt, net of discount and issuance costs		2,970			970
Principal repayments of long-term debt		(2,883	)		(1,007	)
Principal repayments of capital lease obligations		(8	)		(7	)
Repurchases of common stock		(38	)		—
Cash distributions to noncontrolling interests		(21	)		(9	)
Proceeds from stock option exercises		27			26
Excess tax benefits from stock-based compensation		9			—
Other financing activities, net		—			(1	)

Cash provided by (used in) financing activities		56			(343	)

Effect of exchange rate changes on cash and cash equivalents		6			7


Net change in cash and cash equivalents		393			307
Cash and cash equivalents, beginning of period		623			94


Cash and cash equivalents, end of period	$	1,016		$	401


Supplemental Cash Flow Information:
Cash paid for interest, net:
Periodic interest payments for debt, interest rate swaps and capital lease obligations	$	136		$	178
Make-whole premiums		114			—
Interest rate swap termination payments		24			1
Repayment of original issue discount on long-term debt		10			—

Total cash paid for interest, net	$	284		$	179

Cash paid for taxes, net	$	282		$	362


Noncash Transactions:
Assets acquired under capital lease arrangements	$	20		$	61

Stock dividends to preferred interests	$	1		$	8

The accompanying notes are an integral part of these condensed consolidated financial statements.

DISCOVERY COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(unaudited; in millions)


	Three Months Ended September 30, 2010									Three Months Ended September 30, 2009
	Discovery Stockholders			Noncontrolling Interests			Total Equity			Discovery Stockholders			Noncontrolling Interests			Total Equity
										(recast)			(recast)			(recast)
Beginning balance	$	6,486		$	28		$	6,514		$	5,897		$	19		$	5,916
Comprehensive income:
Net income		186			3			189			100			4			104
Other comprehensive income (loss):
Foreign currency translation adjustments, net		21			—			21			(5	)		—			(5	)
Market value adjustments and reclassifications for securities and derivatives		—			—			—			(5	)		—			(5	)

Total comprehensive income		207			3			210			90			4			94
Stock dividends declared to preferred interests		—			—			—			(6	)		—			(6	)
Stock dividends paid to preferred interests		—			—			—			7			—			7
Repurchases of common stock		(38	)		—			(38	)		—			—			—
Cash distributions to noncontrolling interests		—			(19	)		(19	)		—			(1	)		(1	)
Issuance of common stock in connection with stock-based plans and other		12			—			12			26			—			26
Excess tax benefits from stock-based compensation		5			—			5			—			—			—
Stock-based compensation		11			—			11			7			—			7

Ending balance	$	6,683		$	12		$	6,695		$	6,021		$	22		$	6,043


	Nine Months Ended September 30, 2010									Nine Months Ended September 30, 2009
	Discovery Stockholders			Noncontrolling Interests			Total Equity			Discovery Stockholders			Noncontrolling Interests			Total Equity
										(recast)			(recast)			(recast)
Beginning balance	$	6,197		$	23		$	6,220		$	5,536		$	21		$	5,557
Comprehensive income:
Net income		462			10			472			398			10			408
Other comprehensive income (loss):
Foreign currency translation adjustments, net		(9	)		—			(9	)		24			—			24
Market value adjustments and reclassifications for securities and derivatives		7			—			7			19			—			19

Total comprehensive income		460			10			470			441			10			451
Stock dividends declared to preferred interests		(1	)		—			(1	)		(8	)		—			(8	)
Stock dividends paid to preferred interests		—			—			—			7			—			7
Repurchases of common stock		(38	)		—			(38	)		—			—			—
Cash distributions to noncontrolling interests		—			(21	)		(21	)		—			(9	)		(9	)
Issuance of common stock in connection with stock-based plans and other		27			—			27			26			—			26
Excess tax benefits from stock-based compensation		9			—			9			—			—			—
Stock-based compensation		29			—			29			19			—			19

Ending balance	$	6,683		$	12		$	6,695		$	6,021		$	22		$	6,043

The accompanying notes are an integral part of these condensed consolidated financial statements.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

Discovery Communications, Inc. (“Discovery” or the “Company”) is a leading nonfiction media and entertainment company that provides original and purchased programming across multiple distribution platforms throughout the world and owns and operates a diversified portfolio of website properties and other digital services. Discovery also develops and sells consumer and educational products and services, as well as media sound services in the U.S. and internationally. The Company reports its operations in three segments: U.S. Networks, consisting principally of domestic cable and satellite television network programming, web brands and other digital services; International Networks, consisting primarily of international cable and satellite television network programming; and Education and Other, consisting principally of curriculum-based service and product offerings and post-production sound services. Financial information for Discovery’s reportable segments is set forth in Note 17.

Basis of Presentation

Changes in Basis of Presentation – Recast

The 2009 financial information has been recast so that the basis of presentation is consistent with that of the 2010 financial information. This recast reflects (i) the adoption of the recent accounting guidance that amends the model for determining whether an entity should consolidate a variable interest entity (“VIE”), which resulted in the deconsolidation of the OWN: The Oprah Winfrey Network (“OWN”) and Animal Planet Japan (“APJ”) joint ventures for all periods presented (Note 2), (ii) the results of operations of the Company’s Antenna Audio business as discontinued operations (Note 3), and (iii) the realignment of the Company’s commerce business, which is now reported as a component of the U.S. Networks segment for all periods presented whereas it was previously reported as a component of the Commerce, Education and Other segment (Note 17).

Unaudited Interim Financial Statements

These condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) applicable to interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. These condensed consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments, consisting of those of a normal recurring nature, necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with GAAP applicable to interim periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year or future periods. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Discovery’s Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Form 10-K”).

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and notes thereto. Management continually re-evaluates its estimates, judgments and assumptions and management’s assessments could change. Actual results may differ from those estimates and could have a material impact on the consolidated financial statements.

Significant estimates inherent in the preparation of the Company’s consolidated financial statements include consolidation of VIEs, accounting for acquisitions, dispositions, allowances for doubtful accounts, content rights, asset impairments, redeemable noncontrolling interests, fair value measurements, revenue recognition, depreciation and amortization, stock-based compensation, income taxes and contingencies.

Consolidation and Accounting for Investments

The consolidated financial statements include the accounts of Discovery, its majority-owned subsidiaries in which a controlling interest is maintained and VIEs for which the Company is the primary beneficiary. Investments in entities over which the Company has the ability to exercise significant influence but does not control and is not the primary beneficiary are accounted for using the equity method. Investments in entities over which the Company has no control or significant influence and is not the primary beneficiary are accounted for at fair value or using the cost method. Inter-company accounts and transactions have been eliminated.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Foreign Currency

The functional currency of substantially all of the Company’s international subsidiaries is the local currency. Assets and liabilities denominated in foreign currencies are translated at exchange rates in effect at the balance sheet date. The resulting asset and liability translation adjustments are included as a component of “Accumulated other comprehensive loss” on the Condensed Consolidated Balance Sheets. Foreign currency equity balances are translated at historical rates. Results of operations denominated in foreign currencies are translated at average exchange rates for the respective periods. Foreign currency transaction gains and losses are included in “Operating income” on the Condensed Consolidated Statements of Operations.

Reclassifications

In addition to the recast of the 2009 financial information noted above, certain reclassifications have been made to the 2009 financial information to conform to the 2010 financial information presentation. The reclassifications primarily include the separate presentation of “Content amortization and write-offs” on the Condensed Consolidated Statements of Cash Flows, which was previously combined with changes in content and other operating assets and liabilities.

NOTE 2. NEW ACCOUNTING AND REPORTING PRONOUNCEMENTS

Pronouncements Adopted

Consolidation of Variable Interest Entities

In June 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standard that amended the guidance for interests in VIEs. Among other matters, the guidance amended the approach for determining the primary beneficiary of a VIE by requiring an analysis that places more reliance on qualitative rather than quantitative factors, continuous assessments of whether an entity is the primary beneficiary of a VIE and enhanced disclosures about an entity’s involvement with a VIE. Effective January 1, 2010, the Company adopted the provisions of this guidance for all interests in VIEs, which have been retrospectively applied to all periods presented in this report. As a result of adopting the new guidance, the Company changed its accounting for the OWN and APJ joint ventures from consolidation to the equity method of accounting. The new guidance permits prospective or retrospective adoption. The Company believes retrospective adoption provides the most comparable and useful financial information for financial statement users and is more consistent with the information the Company’s management uses to evaluate its business. Accordingly, the Company has recast the 2009 financial information to reflect the deconsolidation of the OWN and APJ joint ventures and its accounting for its interests in these entities using the equity method.

Prior to the adoption of the new guidance, operating losses generated by OWN were allocated 50-50 between the Company and the joint venture counterparty. As the Company has assumed all funding requirements for OWN and the venture partners have not yet contributed certain assets to OWN, under the equity method of accounting Discovery is required to record 100% of OWN’s operating losses up to the Company’s funding obligation, which was $189 million as of September 30, 2010. The increase in the allocation of OWN’s losses to Discovery resulted in a reduction of $1 million and $7 million to “Net income attributable to Discovery Communications, Inc.” on the Condensed Consolidated Statements of Operations previously reported for the three and nine months ended September 30, 2009, respectively, which reflects the portion of OWN’s operating losses previously allocated to the joint venture counterparty. The new guidance also resulted in $5 million and $12 million reductions to “Net income attributable to Discovery Communications, Inc.” for the three and nine months ended September 30, 2010, respectively. Upon launch, the Company and its venture partner will share equally in losses. Once all of the Company’s pre-launch losses have been recouped, the Company and its venture partner will share income equally.

Fair Value Measurements

In January 2010, the FASB issued guidance that requires additional disclosures about recurring and nonrecurring fair value measurements, including significant transfers into and out of Level 1 and Level 2 of the fair value measurement hierarchy, and separately presenting information regarding purchases, sales, issuances and settlements in the reconciliation of Level 3 fair value measurements. Discovery prospectively adopted the new guidance effective January 1, 2010, except for Level 3 reconciliation disclosures which will be effective for the Company on January 1, 2011. The adoption of the new guidance did not impact the Company’s consolidated financial statements.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Pronouncement Not Yet Adopted

Revenue Recognition for Multiple-Element Revenue Arrangements

In October 2009, the FASB issued a new standard that changes the determination of when the individual deliverables included in a multiple-element revenue arrangement may be treated as separate units of accounting, modifies the manner in which the transaction consideration is allocated across the separately identified deliverables and expands the disclosures required for multiple-element revenue arrangements. The Company will prospectively adopt the new standard effective January 1, 2011. The adoption will not have a significant impact on the Company’s consolidated financial statements.

NOTE 3. ACQUISITIONS AND DISPOSITIONS

Acquisition

On February 17, 2010, the Company acquired all interests in an uplink facility in London, including its employees and operations, for $35 million in cash. The uplink center is used to deliver Discovery’s networks in the United Kingdom and Europe, Africa and the Middle East, and has been integrated into the Company’s International Networks segment. The acquisition will provide the Company more flexibility to expand the distribution of its content. The uplink facility has been included in the Company’s operating results since the date of acquisition.

Discontinued Operations

On September 1, 2010, the Company sold its Antenna Audio business for net proceeds of $24 million in cash. The sale resulted in a $12 million gain, net of taxes, which was recorded in “Income (loss) from discontinued operations, net of taxes” on the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010. Antenna Audio, which provides audio, multimedia and mobile tours for museums, exhibitions, historic sites and visitor attractions around the world, was a component of the Company’s International Networks segment. Antenna Audio’s operating results have been reported as discontinued operations for all periods presented. The assets and liabilities and cash flows of Antenna Audio have not been reported as discontinued operations since the amounts are not material.

In September 2010, the Company received a tax refund, which eliminated a $12 million obligation to repay amounts to an entity spun off in 2008. The reversal of this obligation has been recorded as a benefit in “Income (loss) from discontinued operations, net of taxes” on the Condensed Consolidated Statements of Operations.

NOTE 4. VARIABLE INTEREST ENTITIES

In the normal course of business, the Company enters into joint ventures or makes investments with business partners that support its underlying business strategy and provide it the ability to enter new markets to expand the reach of its brands, develop new programming and distribute its existing content. In certain instances, an entity in which the Company makes an investment may qualify as a VIE. The Company’s investments in entities determined to be VIEs primarily consist of various joint ventures formed with the British Broadcasting Corporation (“BBC”) and The Hub and OWN joint ventures.

As of September 30, 2010 and December 31, 2009, the aggregate carrying values of investments in VIEs accounted for using the equity method was $433 million and $395 million, respectively, which were recorded as a component of “Other noncurrent assets” on the Condensed Consolidated Balance Sheets. For unconsolidated VIEs, the Company’s risk of loss is typically limited to the carrying value of its investments and specified future funding commitments, which totaled $558 million as of September 30, 2010. Additionally, the Company may provide an unspecified amount of funding for certain joint ventures on an as-needed basis. No amounts have been recorded for future funding commitments.

BBC Joint Ventures

The Company’s joint ventures with the BBC principally consist of an entity formed to produce and acquire factual-based content and several cable and satellite television network ventures that deliver programming to audiences in Europe, Latin America and Asia. The Company provides the ventures with content, funding and services such as distribution, technological, sales and administrative support. For most BBC ventures, the Company currently holds a majority of the voting rights. Once certain levels of funding have been repaid to Discovery, the Company and the BBC will equally share voting control. The Company has assumed all funding requirements for the joint ventures. Therefore, losses generated by most ventures are initially allocated to the Company up to the amount of funding that the Company has provided to the ventures and any remaining losses are allocated to the Company and the BBC. However, the amount of losses that can be allocated to the BBC is limited to the amount of cash that a venture previously distributed to the BBC. No cumulative operating losses generated by the ventures have been allocated to the BBC through September 30, 2010. Profits of most ventures are first allocated to the Company to repay any funding provided, with any excess profits allocated to the Company and the BBC.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Based upon the level of equity investment at risk, the Company has determined that the BBC joint ventures are VIEs. The Company has determined that it is the primary beneficiary of most ventures as it controls the activities that are most significant to the joint ventures’ operating performance and success, has assumed all funding requirements and will absorb losses or receive profit that are significant to the joint ventures. Accordingly, the Company consolidates most of the BBC joint ventures. The BBC’s equity interests in consolidated ventures are reported as noncontrolling interests in the consolidated financial statements.

Certain assets of the consolidated BBC joint ventures are not available to settle obligations of the Company. As of September 30, 2010 and December 31, 2009, the Company’s cash and cash equivalents included $10 million and $40 million, respectively, of cash related to consolidated joint ventures that is only available for use by the ventures, which is parenthetically disclosed on the Condensed Consolidated Balance Sheets. All other assets of the BBC ventures were not significant to the Company’s financial position.

Under certain terms outlined in the BBC joint venture arrangements, the BBC has the right every three years, commencing December 31, 2002, to put to the Company its interests in the People+Arts Latin America and Animal Planet joint ventures (“Channel Groups”), in each case for a value determined by a specified formula. In January 2009, the BBC requested that a determination be made whether such conditions have occurred with respect to the Channel Groups as of December 31, 2008. The contractual redemption value is based upon the exercise of the BBC put right and an estimate of the proceeds from a hypothetical sale of the Channel Groups and a distribution of the proceeds to the venture partners based on various rights and preferences. As the Company has funded all operations from inception of the ventures through September 30, 2010, the Company believes that it has accumulated rights and preferences in excess of the fair market value of the Channel Groups. However, due to the complexities of the redemption formula, the Company has accrued the noncontrolling redeemable interests to an estimated negotiated value, which was $49 million as of both September 30, 2010 and December 31, 2009. Changes in the assumptions used to estimate the redemption value could materially impact current estimates. The Company recorded no accretion to the redemption value during the three and nine months ended September 30, 2010 and 2009. The Company is currently discussing with the BBC potential revisions to all of their contractual relationships, including the ownership of the joint ventures. While there can be no assurance that these or other negotiations would result in a definitive agreement, the Company expects that the cost of a negotiated acquisition of the BBC’s interests in the joint ventures could substantially exceed the value of the put right.

In connection with the adoption of the FASB’s recent guidance for interests in VIEs, effective January 1, 2010 the Company changed its accounting for its interest in one of the BBC joint ventures, APJ, from consolidation to the equity method (Note 2).

The Hub

As previously reported, on May 22, 2009, Discovery and Hasbro, Inc. (“Hasbro”) formed a 50-50 joint venture, which operated the Discovery Kids Network in the U.S. The Company recognized a gain of $252 million in May 2009 in connection with the formation of the joint venture. On October 10, 2010, the Discovery Kids Network was rebranded as “The Hub,” which is a pay-television network that provides children’s and family entertainment and educational programming.

The Company provides the venture with content, funding and services such as distribution, technological, sales and administrative support. The Company and Hasbro equally share in the profits and losses, funding requirements and voting rights of The Hub. Discovery has guaranteed a certain level of operating performance for the venture, which is reduced over time as performance targets are achieved. As of September 30, 2010, the remaining maximum exposure to loss under this performance guarantee was below $220 million. The Company believes the likelihood is remote that the performance guarantee will not be achieved and have a material adverse impact on the Company’s financial position, operating results or cash flows. Accordingly, the fair value of the guarantee as of September 30, 2010 was not significant. Discovery is committed to fund up to $15 million to the venture, none of which has been funded through September 30, 2010.

Based upon the level of equity investment at risk, the Company has determined that The Hub is a VIE. The Company has determined that it is not the primary beneficiary of the venture because it does not control the activities that are most significant to the joint venture’s operating performance and success and the venture partners share equally in the funding requirements and operating results of the joint venture. Accordingly, beginning May 22, 2009, Discovery ceased to consolidate the gross operating results of the Discovery Kids Network and began accounting for its interests in the venture using the equity method. However, as Discovery continues to be involved in the operations of the joint venture, the Company has not presented the financial position, results of operations and cash flows of the Discovery Kids Network recorded through May 21, 2009 as discontinued operations. Accordingly, the Company’s consolidated results of operations for 2009 include the gross operating results of Discovery Kids through May 21, 2009, whereas for subsequent periods Discovery records only its proportionate share of the joint venture’s net operating results as a component of “Other (expense) income, net” on the Condensed Consolidated Statements of Operations.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

OWN: The Oprah Winfrey Network

The Company has an investment in OWN, a 50-50 joint venture with Harpo, Inc. (“Harpo”), which will operate a television network and website that will provide adult lifestyle content focused on self-discovery and self-improvement. Discovery has agreed to contribute its interest in the Discovery Health Channel and certain DiscoveryHealth.com content and Harpo will contribute the Oprah.com website and content, which is expected to occur in January 2011, at which time the Discovery Health Channel will be rebranded and operated by the joint venture. The Company provides the venture content, funding and services such as distribution, technological, licensing, sales and administrative support. The Company has assumed all funding requirements but equally shares voting control with Harpo. Initially, cash distributions will be made by OWN to the Company to repay prior funding. Upon repayment of prior funding, subsequent cash distributions made by OWN will be shared equally between the Company and Harpo.

In August 2010, the Company and Harpo amended the joint venture agreement which, among other matters, increased Discovery’s funding commitment to OWN from $100 million to $189 million. The funding may be in the form of a revolving loan from Discovery Communications, LLC (“DCL”), a wholly-owned subsidiary of the Company, and/or debt financing from a third party lender to OWN. As of September 30, 2010, Discovery has funded $107 million to OWN, including interest accrued on outstanding borrowings. Discovery expects to recoup the entire amount loaned to OWN provided that the joint venture is profitable and has sufficient funds to repay the Company.

Based upon the level of equity investment at risk, the Company has determined that OWN is a VIE. The Company has determined that it is not the primary beneficiary of the venture as it does not control the activities that are most significant to the joint venture’s operating performance and success. Accordingly, the Company accounts for its investment in OWN using the equity method. Currently, the Company absorbs all losses generated by OWN as a result of its funding obligations. Upon launch, the Company and Harpo will share equally in losses. Once all of the Company’s pre-launch losses have been recouped, the Company and Harpo will share income equally.

Pursuant to the venture agreement, Harpo has the right to require Discovery to purchase Harpo’s interest in OWN every two and one half years commencing five years from the launch of OWN, which is expected to occur in January 2011. The put arrangement provides that the Company would purchase Harpo’s interests at fair market value up to a maximum put amount. The maximum put amount is a range from $100 million on the first put exercise date five years after launch up to $400 million on the fourth put exercise date, which will be 12.5 years after launch.

In connection with the adoption of the FASB’s recent guidance for interests in VIEs, effective January 1, 2010 the Company changed its accounting for its interest in OWN from consolidation to the equity method (Note 2).

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

NOTE 5. FAIR VALUE MEASUREMENTS

Certain of the Company’s assets and liabilities are recorded at fair value. Fair value measurements are classified according to the following three-level fair value hierarchy established by the FASB.


Level 1	–	measurements based on observable inputs such as quoted prices for identical instruments in active markets.

Level 2	–	measurements based on inputs such as quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and assumptions are observable in active markets.

Level 3	–	measurements based on valuations derived from present value and other valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Assets and liabilities measured at fair value on a recurring basis consisted of the following (in millions).


	As of September 30, 2010
	Level 1		Level 2		Level 3		Total
Assets:
Cash Equivalents:
Money market mutual funds	$	387	$	—	$	—	$	387
U.S. Treasury securities		550		—		—		550
Trading securities:
Mutual funds		51		—		—		51

Total assets	$	988	$	—	$	—	$	988


Liabilities:
Deferred compensation plan	$	51	$	—	$	—	$	51
Derivatives (Note 8)		—		7		—		7
Other		—		5		—		5

Total liabilities	$	51	$	12	$	—	$	63


Redeemable noncontrolling interests (Note 4)	$	—	$	—	$	49	$	49

For investments in securities that are measured using quoted prices in active markets, the total fair value is the published market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. Cash equivalents represent investments in highly liquid instruments with original maturities of 90 days or less. The Company maintains a Rabbi Trust which includes investments to fund certain of its deferred compensation plans. Investments in the trust are classified as trading securities, which are recorded in “Prepaid expenses and other current assets” on the Condensed Consolidated Balance Sheets. The fair value of the deferred compensation plan liability is determined based on the fair value of the related investments elected by employees.

The fair value of derivative instruments, which consist of interest rate swaps, is determined based on the present value of future cash flows using observable inputs, including interest rates, yield curves and credit spreads.

The fair value of the redeemable noncontrolling interests is an estimated negotiated value.

The carrying values for other financial instruments such as cash, accounts receivable and accounts payable approximated fair value.

There were no changes in Level 3 measurements during the three and nine months ended September 30, 2010 and 2009.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

NOTE 6. CONTENT RIGHTS

Content rights consisted of the following (in millions).


	As of September 30, 2010			As of December 31, 2009
				(recast)
Produced content rights:
Completed	$	1,898		$	1,710
In-production		223			209
Co-produced content rights:
Completed		450			448
In-production		87			85
Licensed content rights:
Acquired		287			261
Prepaid		14			13

Content rights, at cost		2,959			2,726
Accumulated amortization		(1,649	)		(1,444	)

Total content rights, net		1,310			1,282
Less current portion		81			75

Noncurrent portion	$	1,229		$	1,207

Content amortization expense was $176 million and $177 million for the three months ended September 30, 2010 and 2009, respectively, and $526 million and $515 million for the nine months ended September 30, 2010 and 2009, respectively. Amortization expense for the three months ended September 30, 2010 and 2009 included write-offs of capitalized content costs of $11 million and $19 million, respectively, and $42 million and $45 million for the nine months ended September 30, 2010 and 2009, respectively. The write-offs, which resulted from lower than expected performance and the Company’s decision not to proceed with certain programs, were recorded at the Company’s U.S. Networks and International Networks segments. Amortization expense was recorded as a component of “Costs of revenues” on the Condensed Consolidated Statements of Operations.

NOTE 7. DEBT

Outstanding debt consisted of the following (in millions).


	As of September 30, 2010			As of December 31, 2009
$1.5 billion Term Loan B, due quarterly September 2007 to May 2014	$	—		$	1,463
$500 million Term Loan C, due quarterly June 2009 to May 2014		—			496
8.37% Senior Notes, semi-annual interest, due March 2011		—			220
8.13% Senior Notes, semi-annual interest, due September 2012		—			235
Floating Rate Senior Notes, semi-annual interest, due December 2012 (1.23% at December 31, 2009)		—			90
6.01% Senior Notes, semi-annual interest, due December 2015		—			390
5.625% Senior Notes, semi-annual interest, due August 2019		500			500
3.70% Senior Notes, semi-annual interest, due June 2015		850			—
5.05% Senior Notes, semi-annual interest, due June 2020		1,300			—
6.35% Senior Notes, semi-annual interest, due June 2040		850			—
Capital lease and other obligations		121			114

Total long-term debt		3,621			3,508
Unamortized discount		(8	)		(13	)

Long-term debt, net		3,613			3,495
Less current portion of long-term debt		18			38

Noncurrent portion of long-term debt	$	3,595		$	3,457

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

On June 3, 2010, DCL, issued $850 million aggregate principal amount of 3.70% Senior Notes maturing on June 1, 2015 (the “2015 Notes”), $1.30 billion aggregate principal amount of 5.05% Senior Notes maturing on June 1, 2020 (the “2020 Notes”) and $850 million aggregate principal amount of 6.35% Senior Notes maturing on June 1, 2040 (the “2040 Notes” and together with the 2015 Notes and the 2020 Notes, the “Public Senior Notes Issued in 2010”). DCL received net proceeds of $2.97 billion from the offering after taking into account the $6 million issuance discount and $24 million of issuance costs recorded as deferred financing costs.

DCL may, at its option, redeem some or all of the Public Senior Notes Issued in 2010 at any time by paying a make-whole premium, plus accrued and unpaid interest, if any, to the date of repurchase. Interest on these notes is payable on June 1 and December 1 of each year, beginning on December 1, 2010. The Public Senior Notes Issued in 2010 are unsecured and rank equally in right of payment with all of DCL’s other unsecured senior indebtedness and are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by the Company.

The Company used the net proceeds of the offering plus cash on hand to repay $1.46 billion outstanding under its Term Loan B, $487 million outstanding under its Term Loan C, net of the original issue discount, $220 million outstanding under its 8.37% Senior Notes due March 2011, $235 million outstanding under its 8.13% Senior Notes due September 2012, $90 million outstanding under its Floating Rate Senior Notes due December 2012, $390 million outstanding under its 6.01% Senior Notes due December 2015 and $114 million for make-whole premiums. These transactions resulted in a loss on extinguishment of debt of $136 million, which included the $114 million for make-whole premiums, $12 million of non-cash write-offs of unamortized deferred financing costs and $10 million for the repayment of the original issue discount on the Company’s term loans.

In addition to the debt instruments listed above, as of September 30, 2010, the Company also had access to a $1.55 billion revolving credit facility. There were no amounts drawn under the revolving credit facility as of September 30, 2010 and December 31, 2009. The revolving credit facility expired in October 2010. As disclosed in Note 18, on October 13, 2010, the Company entered into a new revolving credit facility.

The Company’s debt contains certain covenants, events of default and other customary provisions. The Company was in compliance with all covenants as of September 30, 2010 and December 31, 2009.

As of September 30, 2010 and December 31, 2009 the fair value of the Company’s debt was $3.83 billion and $3.61 billion, respectively. The fair value of the Company’s publicly traded debt was determined using quoted market prices and the fair value of the private debt was estimated based on current market rates and credit pricing for similar debt types and maturities.

NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments from time to time to modify its exposure to market risks from changes in interest rates and foreign exchange rates. The Company does not enter into or hold derivative financial instruments for speculative trading purposes.

The Company is exposed to the impact of interest rate changes primarily through its borrowing activities. For fixed rate debt, the Company may enter into variable interest rate swaps effectively converting fixed rate borrowings to variable rate borrowings indexed to LIBOR in order to reduce the amount of interest paid. The Company may designate variable interest rate swaps as fair value hedges. For variable rate debt, the Company may enter into fixed interest rate swaps to effectively fix the amount of interest paid in order to mitigate the impact of interest rate changes on earnings. The Company may designate fixed interest rate swaps as cash flow hedges.

The Company transacts business globally and is subject to risks associated with changing foreign currency exchange rates. The Company may enter into spot, forward and option contracts that change in value as foreign currency exchange rates change. These contracts hedge forecasted foreign currency transactions in order to mitigate fluctuations in its earnings and cash flows associated with changes in foreign currency exchange rates. The Company may designate foreign exchange spot, forward and option contracts as cash flow hedges. There were no significant foreign exchange derivative instruments outstanding during the three and nine months ended September 30, 2010 and 2009.

Gains or losses on the effective portion of derivative instruments designated as hedging instruments are initially recorded in “Accumulated other comprehensive loss” on the Condensed Consolidated Balance Sheets and reclassified either into the same account on the Condensed Consolidated Statements of Operations in which the hedged item is recognized or “Other (expense) income, net” when there is a change in designation. Gains or losses on derivative instruments after a change in designation would be recorded in “Other (expense) income, net.” As of September 30, 2010, there were no significant unrealized gains or losses for derivative instruments recorded in “Accumulated other comprehensive loss.”

The Company may also enter into derivative instruments that are not designated as hedges and do not qualify for hedge accounting. These contracts are intended to mitigate economic exposures of the Company. Gains or losses on these derivative instruments are recorded in “Other (expense) income, net.”

The Company records all derivative instruments at fair value on a gross basis in the Condensed Consolidated Balance Sheets.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

As a result of refinancing most of its debt in June 2010 (Note 7), the Company discontinued hedge accounting for $1.76 billion notional amount of fixed interest rate swaps designated as cash flow hedges. The change in designation resulted in reclassifying losses of $27 million for the nine months ended September 30, 2010 from “Accumulated other comprehensive loss” on the Condensed Consolidated Balance Sheets to “Other (expense) income, net” on the Condensed Consolidated Statements of Operations. In June 2010, fixed and variable interest rate swaps with a total notional amount of $1.81 billion either matured or were settled prior to maturity for which the Company paid $24 million.

The following tables present the notional amount and fair value of the Company’s derivatives (in millions).


			Asset Derivatives
			As of September 30, 2010				As of December 31, 2009
	Balance Sheet Location		Notional		Fair Value		Notional		Fair Value
Derivatives designated as hedging instruments:
Interest rate contracts		Other noncurrent assets	$	—	$	—	$	760	$	4
Derivatives not designated as hedging instruments:
Interest rate contracts		Other noncurrent assets		—		—		50		3

Total asset derivatives			$	—	$	—	$	810	$	7


			Liability Derivatives
			As of September 30, 2010				As of December 31, 2009
	Balance Sheet Location		Notional		Fair Value		Notional		Fair Value
Derivatives designated as hedging instruments:
Interest rate contracts		Other current liabilities	$	—	$	—	$	900	$	21
Interest rate contracts		Other noncurrent liabilities		—		—		100		—

Total				—		—		1,000		21
Derivatives not designated as hedging instruments:
Foreign exchange contracts		Other current liabilities		—		—		1		—
Interest rate contracts		Other current liabilities		375		7		—		—
Interest rate contracts		Other noncurrent liabilities		—		—		375		19

Total				375		7		376		19

Total liability derivatives			$	375	$	7	$	1,376	$	40

The following table presents the impact of derivative instruments on income and other comprehensive income (loss) for the three and nine months ended September 30, 2010 and 2009 (in millions).


			Three Months Ended September 30,						Nine Months Ended September 30,
	Instrument Type		2010			2009			2010			2009
Derivatives designated as hedging instruments:
Amount recognized in “Other comprehensive income (loss),” gross of tax		Interest rate contacts	$	—		$	(22	)	$	(31	)	$	(5	)
Amount reclassified from “Accumulated other comprehensive loss” into “Interest expense, net”		Interest rate contacts	$	—		$	(15	)	$	(18	)	$	(40	)
Amount excluded from effectiveness testing and recorded in “Other (expense) income, net”		Interest rate contacts	$	—		$	(1	)	$	—		$	(1	)
Derivatives not designated as hedging instruments:
Amount recognized in “Other (expense) income, net”		Interest rate contacts	$	(1	)	$	5		$	(29	)	$	14

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

NOTE 9. EQUITY

Stock Repurchase Program

On July 28, 2010, the Company’s Board of Directors approved a stock repurchase program, pursuant to which the Company is authorized to purchase up to $1 billion of its common stock. The Company expects to fund repurchases through a combination of cash on hand, cash generated by operations, borrowings under its revolving credit facility and future financing transactions. Under the program, management is authorized to purchase shares from time to time through open market purchases or privately negotiated transactions at prevailing prices as permitted by securities laws and other legal requirements, and subject to stock price, business conditions, market conditions and other factors. The repurchase program does not have an expiration date. During the three months ended September 30, 2010, the Company repurchased 1.12 million of its Series C common shares for $38 million through open market transactions. The repurchases were funded using cash on hand. As of September 30, 2010, the Company had remaining authorization of $962 million for future repurchases of common stock. The Company records repurchases of its common stock at cost, which is reported in a separate account as a deduction in equity.

Stock Dividends to Preferred Interests

The Company recognized $6 million of non-cash stock dividends for the release of preferred stock from escrow during the three months ended September 30, 2009 and $1 million and $8 million of non-cash stock dividends during the nine months ended September 30, 2010 and 2009, respectively. No significant dividends were recognized during the three months ended September 30, 2010. Payment of such dividends is contingent upon the issuance of the Company’s common stock to settle the exercise of stock options and stock appreciation rights that the Company assumed in connection with the formation of Discovery on September 17, 2008.

NOTE 10. STOCK-BASED COMPENSATION

The Company has various incentive plans under which cash-settled unit awards (“DAP units”), stock appreciation rights (“SARs”), stock options, performance-based restricted stock units (“PRSUs”) and service based restricted stock units (“RSUs”) have been issued.

Stock-Based Compensation Expense

Stock-based compensation expense recognized by the Company consisted of the following (in millions).


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
DAP units	$	48	$	72	$	111	$	124
SARs		—		19		13		52
Stock options		8		6		23		18
PRSUs and RSUs		3		1		6		1
Other		—		—		—		1

Total stock-based compensation expense	$	59	$	98	$	153	$	196

Tax benefit recognized	$	22	$	36	$	57	$	72

Compensation expense for all stock-based awards was recorded as a component of “Selling, general and administrative” on the Condensed Consolidated Statements of Operations. As of September 30, 2010 and December 31, 2009, the Company recorded total liabilities of $139 million and $143 million, respectively, for cash-settled awards. The current portion of the liability for cash-settled awards was $129 million at September 30, 2010.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Stock-Based Award Activity

DAP Units

A summary of the DAP units activity for the nine months ended September 30, 2010 is presented below (in millions, except price and years).


	DAP Units			Weighted-Average Grant Price		Weighted-Average Remaining Contractual Term (years)
Unvested as of December 31, 2009		12.4		$	19.36
Granted		2.0		$	31.81
Vested		(4.1	)	$	17.61
Forfeited		(0.6	)	$	21.68

Unvested as of September 30, 2010		9.7		$	22.24		0.92

Vested and expected to vest as of September 30, 2010		9.7		$	22.24		0.89

Vested and unpaid as of September 30, 2010		0.6		$	21.75

DAP units represent the right to receive a cash payment for the amount by which the vesting price exceeds the grant price. The vesting price is the average closing price of the Company’s common stock over the 10 trading days immediately preceding and including the vesting date and the 10 trading days immediately subsequent to the vesting date. The grant price is based on the average closing price of the Company’s common stock over the 10 trading days immediately preceding and including the grant date and the 10 trading days immediately following the grant date. For certain awards the average grant price and average vesting price include a premium. Unit awards vest ratably in increments of 25% per year over four years beginning one year from the grant date based on continuous service and are generally settled within sixty days of vesting. DAP units generally provide for accelerated vesting upon retirement or after reaching a specified age and years of service.

Because DAP units are cash-settled, the Company remeasures the fair value and compensation expense of outstanding units each reporting date until settlement. The weighted-average fair value of DAP units outstanding as of September 30, 2010 and December 31, 2009 was $24.15 and $15.53, respectively, per unit. During the nine months ended September 30, 2010 and 2009, the Company made cash payments totaling $72 million and $4 million, respectively, to settle vested DAP units. As of September 30, 2010, there was $95 million of unrecognized compensation cost, net of estimated forfeitures, related to DAP units, which is expected to be recognized over a weighted-average period of 1.94 years.

SARs

A summary of the SARs activity for the nine months ended September 30, 2010 is presented below (in millions, except price and years).


	SARs			Weighted-Average Grant Price		Weighted-Average Remaining Contractual Term (years)
Outstanding as of December 31, 2009		3.1		$	14.48
Granted		—		$	—
Exercised		(3.0	)	$	14.46
Forfeited		—		$	—

Outstanding as of September 30, 2010		0.1		$	20.31		4.00

Vested and expected to vest as of September 30, 2010		0.1		$	20.26		4.00

SARs entitle the holder to receive a cash payment for the amount by which the price of the Company’s common stock exceeds the base price established on the grant date. SARs are granted with a base price equal to or greater than the closing market price of the Company’s common stock on the date of grant. Substantially all SARs consisted of two separate vested tranches with the first tranche having vested 100% on March 15, 2009 and the second tranche having vested 100% on March 15, 2010. Vesting is based on continuous service. Holders were able to exercise the first tranche of SARs at their election until March 15, 2010. The payment to settle exercises of the first tranche of SARs was based on the amount by which the price of the Company’s common stock on the exercise date exceeded the base price established on the grant date. All outstanding SARs for the second tranche were automatically exercised as of March 31, 2010. The payment to settle the second tranche of SARs was based on the amount by which the average closing price of the Company’s common stock over the 10 trading days immediately preceding and including the vesting date and the 10 trading days immediately subsequent to the vesting date exceeded the base price established on the grant date. During the nine months ended September 30, 2010 and 2009, the Company made cash payments totaling $54 million and $17 million, respectively, related to settlement of SARs.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Stock Options

A summary of the stock option activity for the nine months ended September 30, 2010 is presented below (in millions, except price and years).


	Stock Options			Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (years)
Outstanding as of December 31, 2009		17.2		$	16.31
Granted		1.7		$	33.17
Exercised		(1.9	)	$	15.33
Forfeited		(0.4	)	$	16.91

Outstanding as of September 30, 2010		16.6		$	18.12		5.50

Vested and expected to vest as of September 30, 2010		16.0		$	18.07		5.67

Exercisable as of September 30, 2010		3.4		$	15.02		5.47

Stock options are granted with an exercise price equal to or in excess of the closing market price of the Company’s common stock on the date of grant. Substantially all stock options vest ratably either in increments of approximately 33 1/3% each year over three years or in 25% increments each year over four years beginning one year from the grant date based on continuous service and expire three to ten years from the date of grant. Stock option awards generally provide for accelerated vesting upon retirement or after reaching a specified age and years of service.

The weighted-average grant date fair value of options granted during the nine months ended September 30, 2010 and 2009 was $12.23 and $5.39, respectively, per option. During the nine months ended September 30, 2010 and 2009, the Company received cash payments totaling $27 million and $26 million, respectively, from the exercise of stock options. As of September 30, 2010, there was $69 million of unrecognized compensation cost, net of expected forfeitures, related to stock options, which is expected to be recognized over a weighted-average period of 2.06 years.

PRSUs

A summary of the PRSUs activity for the nine months ended September 30, 2010 is presented below (in millions, except price).


	PRSUs		Weighted- Average Grant Price
Outstanding as of December 31, 2009		—	$	—
Granted		1.0	$	32.89
Converted		—	$	—
Forfeited		—	$	—

Outstanding as of September 30, 2010		1.0	$	32.86

Vested and expected to vest as of September 30, 2010		0.6	$	32.70

The Company has granted PRSUs to certain senior level executives. PRSUs represent the contingent right to receive shares of the Company’s Series A common stock, substantially all of which vest over three to four years based on continuous service and whether the Company achieves certain operating performance targets. The performance targets for substantially all PRSUs are cumulative measures over a three year period of the Company’s adjusted operating income before depreciation and amortization (as defined in Note 17), free cash flows and revenues. The number of PRSUs that vest principally range from 0% to 100% based on a sliding scale where achieving or exceeding the performance target will result in 100% of the PRSUs vesting and achieving less than 80% of the target will result in no portion of the PRSUs vesting. Additionally, for certain PRSUs the Company’s Compensation Committee has discretion in determining the final amount of units that vest. Upon vesting, each PRSU becomes convertible into a share of the Company’s Series A common stock on a one-for-one basis. Holders of PRSUs would not receive payments or accruals of dividends or dividend equivalents in the event the Company was to pay regular cash dividends until such PRSUs are converted into shares of the Company’s stock.

The Company records compensation cost for PRSUs ratably over the longer of the service period or performance period assuming a portion of the performance targets will be achieved. If the Company determines that achievement of the performance targets is not probable, the Company ceases recording compensation expense and all previously recognized compensation expense for the award is reversed in the period in which the Company determines that the performance targets are not probable of being achieved.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Compensation expense is separately recorded for each vesting tranche of PRSUs for a particular grant. For most PRSUs, the Company measures the fair value and related compensation cost based on the closing price of the Company’s Series A common stock on the grant date. For PRSUs for which the Company’s Compensation Committee has discretion in determining the final amount of units that vest, compensation cost is remeasured at each reporting date based on the closing price of the Company’s Series A common stock. There were no PRSUs outstanding during the nine months ended September 30, 2009.

As of September 30, 2010, there was $17 million of unrecognized compensation cost, net of expected forfeitures, related to PRSUs, which is expected to be recognized over a weighted-average period of 2.31 years based on the Company’s current assessment of the PRSUs that will vest, which may differ from actual results.

RSUs

RSUs vest ratably each year over periods of one to four years based on continuous service. As of September 30, 2010, there were approximately 500,000 outstanding RSUs with a weighted-average grant price of $32.09. There was $12 million of unrecognized compensation cost, net of expected forfeitures as of September 30, 2010, related to RSUs, which is expected to be recognized over a weighted-average period of 2.78 years.

NOTE 11. RESTRUCTURING AND IMPAIRMENT CHARGES

Exit and Restructuring Charges

During the three and nine months ended September 30, 2010, the Company recorded $4 million and $7 million, respectively, of exit and restructuring charges as part of a reorganization of portions of its business. The charges, which primarily consisted of severance and contract termination costs, were primarily incurred by the Company’s International Networks segment and Corporate operations.

The Company recorded $2 million and $14 million of exit and restructuring charges during the three and nine months ended September 30, 2009, respectively, in connection with a reorganization of portions of its operations to better align its organizational structure with its strategic priorities and to reduce its cost structure. The charges include severance costs and contract termination costs, which were incurred primarily by the Company’s U.S. Networks and International Networks segments, as well as the Company’s Corporate operations.

Impairment Charges

During the three months ended September 30, 2010, the Company recorded an $11 million non-cash impairment charge at its Creative Sound Services reporting unit, which is a component of the Education and Other segment. Management determined that the decline in the operating results for its post-production sound business no longer appeared cyclical, but rather a long-term performance decline. The fair value of the reporting unit was determined by the application of a discounted cash flows model, which used Level 3 inputs. Cash flows were determined based on the Company’s estimate of future operating results, which were discounted using an internal rate of return consistent with that used by the Company to evaluate cash flows of other assets of a similar nature.

As previously reported, during the nine months ended September 30, 2009, intangible assets and capitalized software costs with an aggregate carrying value of $47 million were written down to a fair value of $21 million, resulting in pretax impairment charges totaling $26 million.

NOTE 12. INCOME TAXES

For the three months ended September 30, 2010 and 2009, the Company’s provisions for income taxes were $83 million and $52 million, respectively, and the effective tax rates were 34%. For the nine months ended September 30, 2010 and 2009, the Company’s provisions for income taxes were $171 million and $387 million, respectively, and the effective tax rates were 28% and 49%, respectively.

Discovery’s effective tax rate for the three months ended September 30, 2010 differed from the federal statutory rate of 35% due primarily to production activity deductions, which were partially offset by state taxes. Discovery’s effective tax rate for the nine months ended September 30, 2010 differed from the federal statutory rate of 35% due primarily to the reversal of a $28 million foreign tax reserve during the first quarter of 2010 as a result of a foreign tax authority completing its tax audit and provided the Company notification that certain tax years will not be adjusted for a matter for which the Company previously recorded a reserve for uncertain tax positions. In addition, the effective tax rate differed due to production activity deductions and $16 million in reductions to tax expense due to a change in the Company’s election to claim foreign tax credits that were previously taken as deductions, which were partially offset by state taxes. The Company may file additional amended returns in the future to claim foreign tax credits that were previously taken as deductions based on the ability to currently use additional foreign tax credits.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

The effective tax rate for the three months ended September 30, 2009 differed from the federal statutory rate of 35% principally as a result of production activity deductions, which were partially offset by state taxes. The effective tax rate for the nine months ended September 30, 2009 differed from the federal statutory rate of 35% due primarily to a permanent difference on the $252 million gain from the sale and deconsolidation of the Company’s ownership interest in the Discovery Kids Network in May 2009 and state income taxes, which were partially offset by deductions for production activities and the release of a valuation allowance of $12 million on a previously recorded capital loss.

NOTE 13. NET INCOME PER SHARE AVAILABLE TO DISCOVERY COMMUNICATIONS, INC. STOCKHOLDERS

The following table presents a reconciliation of the weighted average number of shares outstanding between basic and diluted net income per share for the three and nine months ended September 30, 2010 and 2009 (in millions).


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Weighted average shares outstanding — basic		426		424		425		423
Dilutive effect of equity awards		5		3		6		1

Weighted average shares outstanding — diluted		431		427		431		424

Basic net income per share is computed by dividing “Net income available to Discovery Communications, Inc. stockholders” by the weighted average number of shares outstanding during the period. The weighted average number of shares outstanding for the three and nine months ended September 30, 2010 and 2009 include Discovery’s outstanding Series A, Series B and Series C common shares, as well as Discovery’s outstanding Series A and Series C convertible preferred shares. All series of the Company’s common and preferred shares are included in the weighted average number of shares outstanding when calculating both basic and diluted net income per share as the holder of each common and preferred series legally participates equally in any per share distributions whether through dividends or in liquidation.

Diluted net income per share adjusts basic net income per share for the dilutive effect of outstanding stock options, stock settled SARs and RSUs that are either fully vested or vest based only on service conditions, using the treasury stock method. The Company has also granted PRSUs that vest based on both service and the Company’s achievement of operating performance targets. For performance-based instruments, diluted net income per share also adjusts basic net income per share for the number of potential common shares (for stock options) and number of common shares (for PRSUs) for which the performance targets have been achieved when the effect is dilutive and excludes such instruments when the performance targets have not been achieved.

The calculation of diluted net income per share for the three months ended September 30, 2010 excluded 2 million stock options and 900,000 PRSUs, and for the nine months ended September 30, 2010 excluded 3 million stock options and 900,000 PRSUs, because their inclusion would have been anti-dilutive or the performance targets were not achieved. The calculation of diluted net income per share for both the three and nine months ended September 30, 2009 excluded approximately 2 million stock options because their inclusion would have been anti-dilutive. Additionally, the diluted net income per share calculation for the three and nine months ended September 30, 2010 and 2009 excluded 1 million contingently issuable preferred shares placed in escrow for which specific conditions have not yet been met.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

NOTE 14. SUPPLEMENTAL DISCLOSURES

Accounts Payable and Accrued Liabilities

Accounts payable and accrued liabilities consisted of the following (in millions).


	As of September 30, 2010		As of December 31, 2009
			(recast)
Accounts payable	$	52	$	63
Accrued payroll and related benefits		182		191
Content rights payable		58		50
Accrued income taxes		42		38
Accrued interest		55		25
Accrued other		75		79

Total accounts payable and accrued liabilities	$	464	$	446

Other (Expense) Income, Net

Other (expense) income, net consisted of the following (in millions).


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
				(recast)						(recast)
Unrealized gains on derivative instruments, net	$	3		$	4		$	8		$	19
Realized losses on derivative instruments, net		(4	)		—			(37	)		(6	)
Loss from equity investees		(12	)		(6	)		(29	)		(20	)
Realized gains on sales of investments		—			—			—			13
Other, net		(3	)		1			1			4

Total other (expense) income, net	$	(16	)	$	(1	)	$	(57	)	$	10

As previously reported, during the nine months ended September 30, 2009, the Company sold an investment in equity securities for $22 million, which resulted in a pretax gain of $13 million. Approximately $6 million of the pretax gain was a reclassification of unrealized gain from “Other comprehensive income (loss).”

Income Attributable to Discovery Communications, Inc.

The following table presents income from continuing and discontinued operations attributable to Discovery Communications, Inc. for the three and nine months ended September 30, 2010 and 2009 (in millions).


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Amounts attributable to Discovery Communications, Inc.:
Income from continuing operations, net of taxes	$	161	$	99	$	437	$	400
Income (loss) from discontinued operations, net of taxes		25		1		25		(2	)

Net income	$	186	$	100	$	462	$	398

NOTE 15. RELATED PARTY TRANSACTIONS

The following is a description of companies that are considered related parties as a result of common directorship and ownership.

DIRECTV, Liberty Global, Inc., Liberty Media Corporation, and Ascent Media Corporation

The Company’s Board of Directors includes two members who served as directors of DIRECTV through June 16, 2010, including John C. Malone, the former Chairman of the Board of DIRECTV. Dr. Malone beneficially owned DIRECTV Class B common stock representing approximately 24% of the aggregate voting power of DIRECTV. Effective June 16, 2010, Dr. Malone converted his Class B common stock into DIRECTV Class A common stock, which reduced his voting interest to 3% of DIRECTV and Dr. Malone and the other member of the Company’s Board of Directors who served as a DIRECTV director resigned from the DIRECTV Board.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Transactions with DIRECTV through June 16, 2010 have been reported as related party transactions. Effective with the conversion of Dr. Malone’s DIRECTV stock and Dr. Malone and the other member resigning from the DIRECTV board, transactions with DIRECTV after June 16, 2010 are not reported as related party transactions. Revenues from transactions with DIRECTV were $50 million, or 6% of total revenues, for the three months ended September 30, 2009 and $104 million, or 4% of total revenues, and $153 million, or 6% of total revenues, for the nine months ended September 30, 2010 and 2009, respectively. The Company’s December 31, 2009 “Receivables, net” balances included $42 million due from DIRECTV.

Discovery’s Board also includes three members who serve as directors of Liberty Global, Inc. (“Liberty Global”), including Dr. Malone, who is Chairman of the Board of Liberty Global, and three persons who are currently directors of Liberty Media Corporation (“Liberty Media”), also including Dr. Malone, the Chairman of the Board of Liberty Media. Dr. Malone beneficially owns shares representing approximately 40% of the aggregate voting power of Liberty Global and also beneficially owns shares of Liberty Media representing approximately 35% of the aggregate voting power of its outstanding stock. Revenues from transactions with both Liberty Global and Liberty Media totaled $5 million, or 1% of total revenues, and $8 million, or 1% of total revenues, for the three months ended September 30, 2010 and 2009, respectively, and $19 million, or 1% of total revenues, and $23 million, or 1% of total revenues, for the nine months ended September 30, 2010 and 2009, respectively. Expenses from transactions with both Liberty Global and Liberty Media for the three and nine months ended September 30, 2010 and 2009 were not significant. The Company’s “Receivables, net” balances included insignificant amounts due from both Liberty Global and Liberty Media as of September 30, 2010 and December 31, 2009.

Effective January 25, 2010, Dr. Malone joined the Board of Directors of Ascent Media Corporation (“AMC”). Dr. Malone owns 0.9% of AMC’s Series A common stock and 93.8% of AMC’s Series B common stock, effectively providing him voting equity securities representing approximately 31.5% of the voting power with respect to the general election of directors.

Transactions with AMC on and subsequent to January 25, 2010 have been reported as related party transactions as a result of Dr. Malone joining AMC’s board. Operating expenses from transactions with AMC were $5 million, or 1% of total operating expenses, and $19 million, or 1% of total operating expenses, for the three and nine months ended September 30, 2010, respectively. The Company’s September 30, 2010 “Accounts payable and accrued liabilities” balances included $17 million due to AMC. Revenues from transactions with AMC for the three and nine months ended September 30, 2010 were not significant. For the three months ended September 30, 2010, the Company received a refund from the IRS, which eliminated a $12 million obligation to AMC. The benefit was recorded as a component of discontinued operations (Note 3). Additionally, the Company acquired the London uplink facility from a subsidiary of AMC for $35 million on February 17, 2010 (Note 3).

Dr. Malone serves as a director on Discovery’s board and owns shares representing approximately 23% of the aggregate voting power (other than with respect to the election of the common stock directors) of Discovery’s outstanding stock. Dr. Malone controls approximately 32% of the Company’s aggregate voting power relating to the election of the eight common stock directors, assuming that the preferred stock held by Advance/Newhouse Programming Partnership has not been converted into shares of Discovery’s common stock.

As a result of this common directorship and ownership, transactions with DIRECTV, Liberty Global, Liberty Media and AMC and their subsidiaries and equity method investees are considered related party transactions. The majority of the amounts received under contractual arrangements with DIRECTV, Liberty Global and Liberty Media entities relate to multi-year network distribution arrangements and network services. Revenues under these arrangements include annual rate increases and are based on the number of subscribers receiving the related programming. AMC provides services, such as satellite uplink, systems integration, origination and post-production to Discovery.

Other Related Parties

Other related parties primarily include unconsolidated investees accounted for using the equity method, including unconsolidated VIEs described in Note 4. The Company provides equity method investees with content, funding or services such as distribution, technological, licensing, sales and administrative support. Revenues from transactions with the Company’s other related parties were $20 million, or 2% of total revenues, and $6 million, or 1% of total revenues, for the three months ended September 30, 2010 and 2009, respectively, and $45 million, or 2% of total revenues, and $19 million, or 1% of total revenues, for the nine months ended September 30, 2010 and 2009, respectively. Expenses from transactions with the Company’s other related parties were $4 million, or 1% of total operating expenses, and $10 million, or less than 1% of total operating expenses, for the three and nine months ended September 30, 2010. Expenses from transactions with the Company’s other related parties for the three and nine months ended September 30, 2009 were not significant. The Company’s “Receivables, net” balances include $11 million due from the Company’s other related parties as of September 30, 2010. As of December 31, 2009, the Company’s “Receivables, net” balances included insignificant amounts due from the Company’s other related parties. The Company’s “Other noncurrent assets” balance as of September 30, 2010 included $29 million for the net carrying value of amounts due from equity investees. The Company’s “Other current liabilities” balance as of December 31, 2009 included an insignificant amount due to equity investees.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

NOTE 16. COMMITMENTS AND CONTINGENCIES

Commitments and Guarantees

As more fully described in Note 22 of the Company’s consolidated financial statements included in its 2009 Form 10-K, the Company has various commitments primarily consisting of programming and talent commitments, operating and capital lease arrangements, purchase obligations for goods and services, employment contracts, sponsorship commitments, future funding commitments related to certain equity investments (Note 4) and the obligation to issue additional preferred shares under the anti-dilution provisions of its outstanding preferred stock if certain conditions are met. These arrangements result from the Company’s normal course of business and represent obligations that may be payable over several years. The Company is also subject to redeemable put options with respect to noncontrolling interests in certain cable and satellite television network joint ventures (Note 4). Additionally, the Company has guaranteed a certain level of operating performance for The Hub joint venture (Note 4). Other than the changes in Discovery’s commitments to The Hub and OWN joint ventures (Note 4), the Company’s commitments have not materially changed from those disclosed in the 2009 Form 10-K.

Legal Matters

In the normal course of business, the Company has pending claims and legal proceedings. It is the opinion of the Company’s management, based on information available at this time, that none of the current claims and proceedings will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

Concentrations of Credit Risk

Lender Counterparties

The risk associated with a debt transaction is that the counterparty will not be available to fund as obligated under the terms of the Company’s revolving credit facility. If funding under the revolving credit facility is unavailable, the Company may have to acquire a replacement credit facility from a different counterparty at a higher cost or may be unable to find a suitable replacement. Typically, the Company seeks to manage these exposures by contracting with experienced large financial institutions and monitoring the credit quality of its lenders. As of September 30, 2010, the Company did not anticipate nonperformance by any of its counterparties.

Customers

The Company’s trade receivables do not represent a significant concentration of credit risk as of September 30, 2010 due to the wide variety of customers and markets in which the Company operates and their dispersion across many geographic areas.

NOTE 17. REPORTABLE SEGMENTS

In the first quarter of 2010, the Company realigned its commerce business, which sells and licenses Discovery branded merchandise, from the Commerce, Education and Other segment into the U.S. Networks segment in order to better align the management of the Company’s online operations. In connection with this realignment, the Commerce, Education and Other segment was renamed the Education and Other segment. The 2009 financial information has been recast to reflect the realignment. Accordingly, the results of operations of the commerce business are included as a component of the U.S. Networks segment for all periods presented.

The Company’s reportable segments are determined based on (i) financial information reviewed by the chief operating decision maker (“CODM”), the Chief Executive Officer, (ii) internal management and related reporting structure and (iii) the basis upon which the CODM makes resource allocation decisions.

The accounting policies of the reportable segments are the same as the Company’s, except that certain inter-segment transactions that are eliminated at the consolidated level are not eliminated at the segment level as they are treated similarly to third-party sales transactions in determining segment performance. Inter-segment transactions, which primarily include the purchase of advertising and content between segments, were not significant for the periods presented.

The Company evaluates the operating performance of its segments based on financial measures such as revenues and adjusted operating income before depreciation and amortization (“Adjusted OIBDA”). Adjusted OIBDA is defined as revenues less costs of revenues and selling, general and administrative expenses excluding: (i) mark-to-market stock-based compensation, (ii) depreciation and amortization, (iii) amortization of deferred launch incentives, (iv) exit and restructuring charges, (v) certain impairment charges and (vi) gains (losses) on business and asset dispositions. The Company uses this measure to assess the operating results and performance of its segments, perform analytical comparisons, identify strategies to improve performance and allocate resources to each segment. The Company believes Adjusted OIBDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses and also provides investors a measure to analyze the operating performance of each segment against historical data. The Company excludes mark-to-market stock-based compensation, exit and restructuring charges, certain impairment charges and gains (losses) on business and asset dispositions from the calculation of Adjusted OIBDA due to their volatility or

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

non-recurring nature. The Company also excludes depreciation of fixed assets and amortization of intangible assets and deferred launch incentives as these amounts do not represent cash payments in the current reporting period. Adjusted OIBDA should be considered in addition to, but not a substitute for, operating income, net income, cash flows provided by operating activities and other measures of financial performance reported in accordance with GAAP.

The following tables present summarized financial information for each of the Company’s reportable segments (in millions).

Revenues by Segment


	Three Months Ended September 30,					Nine Months Ended September 30,
	2010			2009		2010		2009
				(recast)				(recast)
U.S. Networks	$	585		$	525	$	1,751	$	1,609
International Networks		304			276		893		787
Education and Other		38			35		108		106
Corporate and inter-segment eliminations		(1	)		1		6		6

Total Revenues	$	926		$	837	$	2,758	$	2,508

Adjusted OIBDA by Segment


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
				(recast)						(recast)
U.S. Networks	$	346		$	309		$	1,018		$	930
International Networks		130			106			384			295
Education and Other		1			2			7			9
Corporate and inter-segment eliminations		(59	)		(50	)		(171	)		(144	)

Total Adjusted OIBDA	$	418		$	367		$	1,238		$	1,090

Reconciliation of Total Adjusted OIBDA to Total Operating Income


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
				(recast)						(recast)
Total Adjusted OIBDA	$	418		$	367		$	1,238		$	1,090
Amortization of deferred launch incentives		(11	)		(14	)		(32	)		(41	)
Mark-to-market stock-based compensation		(48	)		(91	)		(124	)		(177	)
Depreciation and amortization		(32	)		(39	)		(98	)		(115	)
Restructuring and impairment charges		(15	)		(2	)		(18	)		(40	)
Gains on dispositions		—			—			—			252

Total operating income	$	312		$	221		$	966		$	969

Total Assets by Segment


	As of September 30, 2010		As of December 31, 2009
			(recast)
U.S. Networks	$	2,163	$	2,078
International Networks		1,109		1,157
Education and Other		79		97
Corporate		8,047		7,620

Total assets	$	11,398	$	10,952

Total assets allocated to Corporate in the above table include substantially all of the Company’s goodwill balance as the financial reports reviewed by the Company’s CODM do not include an allocation of goodwill to each reportable segment. Goodwill by reportable segment is disclosed in the following table.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

Total Goodwill by Segment


	As of September 30, 2010		As of December 31, 2009
			(recast)
U.S. Networks	$	5,135	$	5,135
International Networks		1,281		1,271
Education and Other		19		27

Total goodwill	$	6,435	$	6,433

NOTE 18. SUBSEQUENT EVENT

On October 13, 2010, DCL entered into a credit agreement among DCL as the borrower, the Company as guarantor, the lenders named therein and Bank of America, N.A., as administrative agent, swing line lender and L/C issuer. On October 13, 2010, in connection with the execution of the credit agreement, DCL terminated its existing revolving credit facility.

The credit agreement provides for a $1 billion revolving credit facility (the “New Revolving Credit Facility”), which includes a $500 million sublimit for multicurrency borrowings, a $200 million sublimit for the issuance of standby letters of credit and a $50 million sublimit for swing line loans. The New Revolving Credit Facility also contains an expansion option permitting DCL to request an increase of the borrowing capacity from time to time up to an aggregate additional $1 billion from any of the lenders or other eligible lenders as may be invited to join the New Revolving Credit Facility, that elect to make such increase available, upon the satisfaction of certain conditions. The obligations under the credit agreement are unsecured and are fully and unconditionally guaranteed by the Company. Proceeds from the New Revolving Credit Facility must be used for working capital, capital expenditures and other lawful corporate purposes.

If DCL were to draw on the new revolving credit facility, the debt would be due on the expiration date, which is October 11, 2013, and outstanding balances would bear interest at one of the following rates. Each Eurocurrency rate loan will bear interest at the Eurocurrency Rate (as defined in the credit agreement) plus the Applicable Rate (as defined in the credit agreement) plus, under certain circumstances, the Mandatory Cost (as defined in the credit agreement). The Applicable Rate for Eurocurrency rate loans will range from 1.075% to 1.850% based on DCL’s credit ratings from time to time.

Base rate loans and swing line loans will bear interest at the Base Rate (as defined below) plus the Applicable Rate. The Base Rate is the highest of (i) the Federal funds rate (as published by the Federal Reserve Bank of New York from time to time) plus 0.50%, (ii) Bank of America’s “prime rate” as publicly announced from time to time, and (iii) the Eurocurrency Rate plus 1.00%. The Applicable Rate for base rate loans and swing line loans is 1.00% less than the Applicable Rate for Eurocurrency rate loans.

In addition, DCL is required to pay a facility fee equal to the Applicable Rate, which will range from 0.175% to 0.40% based on DCL’s credit ratings from time to time, times the actual daily amount of the Lender’s aggregate commitments under the senior credit facility, regardless of usage. The facility fee is payable quarterly in arrears. DCL will also pay a letter of credit fee equal to the Applicable Rate for Eurocurrency rate loans times the dollar equivalent of the daily amount available to be drawn under such letter of credit.

DCL may optionally prepay the loans or irrevocably reduce or terminate the unutilized portion of the commitments under the New Revolving Credit Facility, in whole or in part, without premium or penalty at any time by the delivery of a notice to that effect as provided under the credit agreement.

The credit agreement contains customary representations and warranties, events of default, affirmative covenants and negative covenants (which impose restrictions and limitations on, among other things, dividends, investments, additional indebtedness, asset sales and capital expenditures), a total leverage ratio financial maintenance covenant and an interest coverage financial maintenance covenant.

NOTE 19. CONDENSED CONSOLIDATING FINANCIAL INFORMATION

DCL has issued public senior notes pursuant to a Registration Statement on Form S-3 filed with the SEC on June 17, 2009 (the “Shelf Registration”). The Company fully and unconditionally guarantees the senior notes issued by DCL. DCL or Discovery Communications Holding, LLC (“DCH”) may in the future issue additional securities that are fully and unconditionally guaranteed by the Company under the Shelf Registration. Accordingly, set forth below is condensed consolidating financial information presenting the financial position, results of operations and cash flows of (i) the Company, (ii) DCL, (iii) DCH, (iv) non-guarantor subsidiaries of DCL on a combined basis, (v) other non-guarantor subsidiaries of the Company on a combined basis and (vi) the eliminations and reclassifications necessary to arrive at the financial information for the Company on a consolidated basis.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

DCL and the non-guarantor subsidiaries of DCL are the primary operating subsidiaries of the Company. DCL’s primary operations are the Discovery Channel and TLC in the U.S. The non-guarantor subsidiaries of DCL include the Animal Planet channel and most of the other U.S. networks, the international networks, the education businesses and most of the Company’s digital businesses.

The non-guarantor subsidiaries of DCL are wholly-owned subsidiaries of DCL with the exception of certain joint ventures and other equity method investments. DCL is a wholly-owned subsidiary of DCH. The Company wholly owns DCH through a 33 1/3% direct ownership interest and a 66 2/3% ownership interest through Discovery Holding Company (“DHC”). DHC is included in other non-guarantor subsidiaries of the Company.

The supplemental condensed consolidating financial information should be read in conjunction with the condensed consolidated financial statements of the Company.

As of September 30, 2010 and December 31, 2009, the cash and cash equivalents of the non-guarantor subsidiaries of DCL included $10 million and $40 million, respectively, of cash related to consolidated joint ventures that is only available for use by the ventures.

In accordance with the rules and regulations of the SEC, the equity method has been applied to (i) the Company’s interest in DCH and other non-guarantor subsidiaries, (ii) DCH’s interest in DCL and (iii) DCL’s interest in non-guarantor subsidiaries. Inter-company accounts and transactions have been eliminated. The Company’s bases in all subsidiaries, including goodwill and recognized intangible assets, have been “pushed-down” to the applicable subsidiaries.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET

As of September 30, 2010

(in millions)


	Discovery Communications, Inc.		Discovery Communications Holding, LLC		Discovery Communications, LLC		Non-Guarantor Subsidiaries of Discovery Communications, LLC			Other Non- Guarantor Subsidiaries of Discovery Communications, Inc.		Reclassifications and Eliminations			Discovery Communications, Inc. and Subsidiaries
ASSETS
Current assets:
Cash and cash equivalents	$	—	$	—	$	922	$	93		$	1	$	—		$	1,016
Receivables, net		—		—		376		451			16		—			843
Content rights, net		—		—		11		70			—		—			81
Prepaid expenses and other current assets		16		—		127		54			1		(1	)		197

Total current assets		16		—		1,436		668			18		(1	)		2,137
Investment in and advances to subsidiaries		9,100		6,660		4,087		—			6,865		(26,712	)		—
Noncurrent content rights, net		—		—		536		694			—		(1	)		1,229
Goodwill		—		—		3,876		2,559			—		—			6,435
Other noncurrent assets		—		18		922		746			7		(96	)		1,597

Total assets	$	9,116	$	6,678	$	10,857	$	4,667		$	6,890	$	(26,810	)	$	11,398


LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	16	$	—	$	214	$	228		$	6	$	—		$	464
Current portion of long-term debt		—		—		6		12			—		—			18
Other current liabilities		—		1		141		168			1		(1	)		310

Total current liabilities		16		1		361		408			7		(1	)		792
Long-term debt		—		—		3,514		81			—		—			3,595
Other noncurrent liabilities		3		—		322		30			8		(96	)		267

Redeemable noncontrolling interests		—		—		—		49			—		—			49

Inter-company contributions and advances between Discovery Communications, Inc. and subsidiaries		2,414		2,530		729		4,733			1,643		(12,049	)		—
Equity (deficit) attributable to Discovery Communications, Inc.		6,683		4,147		5,931		(639	)		5,232		(14,671	)		6,683

Equity and advances attributable to Discovery Communications, Inc.		9,097		6,677		6,660		4,094			6,875		(26,720	)		6,683

Noncontrolling interests		—		—		—		5			—		7			12
Total equity		9,097		6,677		6,660		4,099			6,875		(26,713	)		6,695

Total liabilities and equity	$	9,116	$	6,678	$	10,857	$	4,667		$	6,890	$	(26,810	)	$	11,398

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET

As of December 31, 2009

(in millions)

(recast)


	Discovery Communications, Inc.		Discovery Communications Holding, LLC		Discovery Communications, LLC		Non-Guarantor Subsidiaries of Discovery Communications, LLC			Other Non- Guarantor Subsidiaries of Discovery Communications, Inc.		Reclassifications and Eliminations			Discovery Communications, Inc. and Subsidiaries
ASSETS
Current assets:
Cash and cash equivalents	$	—	$	—	$	476	$	144		$	3	$	—		$	623
Receivables, net		—		—		371		431			14		(4	)		812
Content rights, net		—		—		15		60			—		—			75
Prepaid expenses and other current assets		1		—		100		60			—		—			161

Total current assets		1		—		962		695			17		(4	)		1,671
Investment in and advances to subsidiaries		8,633		8,138		4,062		—			6,552		(27,385	)		—
Noncurrent content rights, net		—		—		541		674			—		(8	)		1,207
Goodwill		—		—		3,876		2,546			11		—			6,433
Other noncurrent assets		—		42		909		755			7		(72	)		1,641

Total assets	$	8,634	$	8,180	$	10,350	$	4,670		$	6,587	$	(27,469	)	$	10,952


LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	23	$	4	$	206	$	220		$	5	$	(12	)	$	446
Current portion of long-term debt		—		20		5		13			—		—			38
Other current liabilities		—		21		108		170			—		—			299

Total current liabilities		23		45		319		403			5		(12	)		783
Long-term debt		—		1,928		1,460		69			—		—			3,457
Other noncurrent liabilities		—		1		433		64			17		(72	)		443

Redeemable noncontrolling interests		—		—		—		49			—		—			49

Inter-company contributions and advances between Discovery Communications, Inc. and subsidiaries		2,414		2,534		2,705		4,970			1,644		(14,267	)		—
Equity (deficit) attributable to Discovery Communications, Inc.		6,197		3,672		5,433		(893	)		4,921		(13,133	)		6,197

Equity and advances attributable to Discovery Communications, Inc.		8,611		6,206		8,138		4,077			6,565		(27,400	)		6,197
Noncontrolling interests		—		—		—		8			—		15			23

Total equity		8,611		6,206		8,138		4,085			6,565		(27,385	)		6,220

Total liabilities and equity	$	8,634	$	8,180	$	10,350	$	4,670		$	6,587	$	(27,469	)	$	10,952

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended September 30, 2010

(in millions)


	Discovery Communications, Inc.			Discovery Communications Holding, LLC		Discovery Communications, LLC			Non-Guarantor Subsidiaries of Discovery Communications, LLC			Other Non-Guarantor Subsidiaries of Discovery Communications, Inc.			Reclassifications and Eliminations			Discovery Communications, Inc. and Subsidiaries
Revenues	$	—		$	—	$	408		$	503		$	18		$	(3	)	$	926

Costs of revenues, excluding depreciation and amortization listed below		—			—		82			165			15			(1	)		261
Selling, general and administrative		3			—		105			196			3			(1	)		306
Depreciation and amortization		—			—		10			21			1			—			32
Restructuring and impairment charges		—			—		1			3			11			—			15

		3			—		198			385			30			(2	)		614

Operating (loss) income		(3	)		—		210			118			(12	)		(1	)		312
Equity in earnings of subsidiaries		188			184		64			—			123			(559	)		—
Interest expense, net		—			—		(47	)		(2	)		—			—			(49	)
Other income (expense), net		—			—		6			(22	)		—			—			(16	)

Income from continuing operations before income taxes		185			184		233			94			111			(560	)		247
Benefit from (provision for) income taxes		1			1		(58	)		(31	)		4			—			(83	)

Income from continuing operations, net of taxes		186			185		175			63			115			(560	)		164
Income from discontinued operations, net of taxes		—			—		9			4			12			—			25

Net income		186			185		184			67			127			(560	)		189
Less net income attributable to noncontrolling interests		—			—		—			(3	)		—			—			(3	)

Net income attributable to Discovery Communications, Inc.	$	186		$	185	$	184		$	64		$	127		$	(560	)	$	186

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended September 30, 2009

(in millions)

(recast)


	Discovery Communications, Inc.			Discovery Communications Holding, LLC			Discovery Communications, LLC			Non-Guarantor Subsidiaries of Discovery Communications, LLC			Other Non-Guarantor Subsidiaries of Discovery Communications, Inc.			Reclassifications and Eliminations			Discovery Communications, Inc. and Subsidiaries
Revenues	$	—		$	—		$	382		$	442		$	17		$	(4	)	$	837

Costs of revenues, excluding depreciation and amortization listed below		—			—			80			158			15			(2	)		251
Selling, general and administrative		3			—			100			221			2			(2	)		324
Depreciation and amortization		—			—			13			25			1			—			39
Restructuring and impairment charges		—			—			—			2			—			—			2

		3			—			193			406			18			(4	)		616

Operating (loss) income		(3	)		—			189			36			(1	)		—			221
Equity in earnings of subsidiaries		101			123			24			—			67			(315	)		—
Interest expense, net		—			(34	)		(31	)		—			—			—			(65	)
Other (expense) income, net		—			—			(2	)		1			—			—			(1	)

Income from continuing operations before income taxes		98			89			180			37			66			(315	)		155
Benefit from (provision for) income taxes		2			12			(57	)		(10	)		1			—			(52	)

Income from continuing operations, net of taxes		100			101			123			27			67			(315	)		103
Income from discontinued operations, net of taxes		—			—			—			1			—			—			1

Net income		100			101			123			28			67			(315	)		104
Less net income attributable to noncontrolling interests		—			—			—			(3	)		—			(1	)		(4	)

Net income attributable to Discovery Communications, Inc.		100			101			123			25			67			(316	)		100
Stock dividends to preferred interests		(6	)		—			—			—			—			—			(6	)

Net income available to Discovery Communications, Inc. stockholders	$	94		$	101		$	123		$	25		$	67		$	(316	)	$	94

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended September 30, 2010

(in millions)


	Discovery Communications, Inc.			Discovery Communications Holding, LLC			Discovery Communications, LLC			Non-Guarantor Subsidiaries of Discovery Communications, LLC			Other Non-Guarantor Subsidiaries of Discovery Communications, Inc.			Reclassifications and Eliminations			Discovery Communications, Inc. and Subsidiaries
Revenues	$	—		$	—		$	1,223		$	1,491		$	50		$	(6	)	$	2,758

Costs of revenues, excluding depreciation and amortization listed below		—			—			271			471			45			(5	)		782
Selling, general and administrative		9			—			296			582			8			(1	)		894
Depreciation and amortization		—			—			30			66			2			—			98
Restructuring and impairment charges		—			—			1			6			11			—			18

		9			—			598			1,125			66			(6	)		1,792

Operating (loss) income		(9	)		—			625			366			(16	)		—			966
Equity in earnings of subsidiaries		468			530			259			—			311			(1,568	)		—
Interest expense, net		—			(48	)		(102	)		(5	)		—			—			(155	)
Loss on extinguishment of debt		—			(20	)		(116	)		—			—			—			(136	)
Other (expense) income, net		—			(32	)		(12	)		(13	)		—			—			(57	)

Income from continuing operations before income taxes		459			430			654			348			295			(1,568	)		618
Benefit from (provision for) income taxes		3			37			(133	)		(83	)		5			—			(171	)

Income from continuing operations, net of taxes		462			467			521			265			300			(1,568	)		447
Income from discontinued operations, net of taxes		—			—			9			4			12			—			25

Net income		462			467			530			269			312			(1,568	)		472
Less net income attributable to noncontrolling interests		—			—			—			(7	)		—			(3	)		(10	)

Net income attributable to Discovery Communications, Inc.		462			467			530			262			312			(1,571	)		462
Stock dividends to preferred interests		(1	)		—			—			—			—			—			(1	)

Net income available to Discovery Communications, Inc. stockholders	$	461		$	467		$	530		$	262		$	312		$	(1,571	)	$	461

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended September 30, 2009

(in millions)

(recast)


	Discovery Communications, Inc.			Discovery Communications Holding, LLC			Discovery Communications, LLC			Non-Guarantor Subsidiaries of Discovery Communications, LLC			Other Non-Guarantor Subsidiaries of Discovery Communications, Inc.		Reclassifications and Eliminations			Discovery Communications, Inc. and Subsidiaries
Revenues	$	—		$	—		$	1,166		$	1,301		$	53	$	(12	)	$	2,508

Costs of revenues, excluding depreciation and amortization listed below		—			—			260			453			44		(6	)		751
Selling, general and administrative		7			—			291			584			9		(6	)		885
Depreciation and amortization		—			—			38			77			—		—			115
Restructuring and impairment charges		—			—			5			35			—		—			40
Gains on dispositions		—			—			(252	)		—			—		—			(252	)

		7			—			342			1,149			53		(12	)		1,539

Operating (loss) income		(7	)		—			824			152			—		—			969
Equity in earnings of subsidiaries		402			459			109			—			268		(1,238	)		—
Interest expense, net		—			(90	)		(89	)		(3	)		—		—			(182	)
Other income, net		—			—			5			5			—		—			10

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company