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 June 30, 2011

¨	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 July 26, 2011:


Series A Common Stock, par value $0.01 per share			140,766,034
Series B Common Stock, par value $0.01 per share			6,589,084
Series C Common Stock, par value $0.01 per share			126,355,687

DISCOVERY COMMUNICATIONS, INC.

FORM 10-Q

TABLE OF CONTENTS


	Page

PART I. FINANCIAL INFORMATION		3

ITEM 1. Financial Statements.		3

Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010		3

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2011 and 2010		4

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010		5

Consolidated Statements of Equity for the Three and Six Months Ended June 30, 2011 and 2010		6

Notes to Consolidated Financial Statements		7

ITEM 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition.		30

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.		44

ITEM 4. Controls and Procedures.		44

PART II. OTHER INFORMATION		45

ITEM 1. Legal Proceedings.		45

ITEM 1A. Risk Factors.		45

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.		45

ITEM 6. Exhibits.		46

SIGNATURES		47

PART I. FINANCIAL INFORMATION

ITEM 1.

Financial Statements.

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited; in millions, except par value)


	June 30, 2011			December 31, 2010
ASSETS
Current assets:
Cash and cash equivalents	$	1,095		$	466
Receivables, net		908			880
Content rights, net		93			83
Deferred income taxes		65			81
Prepaid expenses and other current assets		160			225

Total current assets		2,321			1,735

Noncurrent content rights, net		1,310			1,245
Property and equipment, net		382			399
Goodwill		6,302			6,434
Intangible assets, net		584			605
Investments		806			455
Other noncurrent assets		131			146

Total assets	$	11,836		$	11,019

LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	48		$	87
Accrued liabilities		364			393
Deferred revenues		98			114
Current portion of stock-based compensation liabilities		52			118
Current portion of long-term debt		22			20
Other current liabilities		30			53

Total current liabilities		614			785

Long-term debt		4,235			3,598
Deferred income taxes		373			304
Other noncurrent liabilities		100			99

Total liabilities		5,322			4,786
Commitments and contingencies (Note 13)

Equity:
Discovery Communications, Inc. stockholders’ equity:
Series A convertible preferred stock: $0.01 par value; 75 shares authorized; 71 shares issued at 2011 and 2010		1			1
Series C convertible preferred stock: $0.01 par value; 75 shares authorized; 57 shares issued at 2011 and 2010		1			1
Series A common stock: $0.01 par value; 1,700 shares authorized; 140 and 138 shares issued at 2011 and 2010, respectively		1			1
Series B convertible common stock: $0.01 par value; 100 shares authorized; 7 shares issued at 2011 and 2010		—			—
Series C common stock: $0.01 par value; 2,000 shares authorized; 142 shares issued at 2011 and 2010		2			2
Additional paid-in capital		6,441			6,358
Treasury stock, at cost: 13 and 3 Series C common shares at 2011 and 2010, respectively		(482	)		(105	)
Retained earnings		559			—
Accumulated other comprehensive loss		(10	)		(33	)

Total Discovery Communications, Inc. stockholders’ equity		6,513			6,225
Noncontrolling interests		1			8

Total equity		6,514			6,233

Total liabilities and equity	$	11,836		$	11,019

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

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; in millions, except per share amounts)


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Revenues:
Distribution	$	493		$	449		$	973		$	894
Advertising		494			435			886			783
Other		80			79			159			155

Total revenues		1,067			963			2,018			1,832


Costs of revenues, excluding depreciation and amortization		288			254			561			521
Selling, general and administrative		300			304			569			588
Depreciation and amortization		30			33			60			66
Restructuring charges		4			—			5			3
Gains on dispositions		—			—			(129	)		—

		622			591			1,066			1,178


Operating income		445			372			952			654

Interest expense, net		(49	)		(48	)		(98	)		(106	)
Loss on extinguishment of debt		—			(136	)		—			(136	)
Other income (expense), net		2			(37	)		(5	)		(41	)


Income before income taxes		398			151			849			371
Provision for income taxes		(144	)		(41	)		(290	)		(88	)


Net income		254			110			559			283
Less net income attributable to noncontrolling interests		—			(3	)		—			(7	)

Net income attributable to Discovery Communications, Inc.		254			107			559			276
Stock dividends to preferred interests		—			(1	)		—			(1	)

Net income available to Discovery Communications, Inc. stockholders	$	254		$	106		$	559		$	275


Net income per share available to Discovery Communications, Inc. stockholders:
Basic	$	0.63		$	0.25		$	1.37		$	0.65

Diluted	$	0.62		$	0.25		$	1.36		$	0.64


Weighted average shares outstanding:
Basic		406			426			407			425

Diluted		410			431			412			430

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

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in millions)


	Six Months Ended June 30,
	2011			2010
Operating Activities
Net income	$	559		$	283
Adjustments to reconcile net income to cash provided by operating activities:
Content expense		381			350
Stock-based compensation		49			94
Depreciation and amortization		60			67
Gains on dispositions		(129	)		—
Deferred income tax expense (benefit)		71			(44	)
Noncash portion of loss on extinguishment		—			12
Other noncash expenses, net		30			43
Changes in operating assets and liabilities:
Receivables, net		(31	)		(31	)
Content rights		(430	)		(370	)
Accounts payable and accrued liabilities		(116	)		(159	)
Stock-based compensation liabilities		(92	)		(123	)
Income tax receivable		94			(11	)
Other, net		(15	)		(21	)

Cash provided by operating activities		431			90

Investing Activities
Purchases of property and equipment		(27	)		(20	)
Business acquisitions, net of cash acquired		—			(38	)
Investments in and advances to equity investees		(82	)		(41	)

Cash used in investing activities		(109	)		(99	)

Financing Activities
Borrowings from long term debt, net of discount and issuance costs		641			2,970
Principal repayments of long-term debt		—			(2,883	)
Principal repayments of capital lease obligations		(13	)		(5	)
Repurchases of common stock		(377	)		—
Cash distributions to noncontrolling interests		(7	)		(2	)
Proceeds from stock option exercises		38			15
Excess tax benefits from stock-based compensation		17			4

Cash provided by financing activities		299			99

Effect of exchange rate changes on cash and cash equivalents		8			—


Net change in cash and cash equivalents		629			90
Cash and cash equivalents, beginning of period		466			623


Cash and cash equivalents, end of period	$	1,095		$	713


Supplemental Cash Flow Information
Cash paid for interest, net:
Periodic interest payments for debt, interest rate swaps and capital lease obligations	$	99		$	115
Make-whole premiums, termination payments, and repayment of original issue discount		—			148

Total cash paid for interest, net	$	99		$	263

Cash paid for taxes, net	$	93		$	178


Noncash Investing and Financing Transactions
Investment in OWN	$	273		$	—

Assets acquired under capital lease arrangements	$	—		$	20

Stock dividends to preferred interests	$	—		$	1

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

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(unaudited; in millions)


	Three Months Ended June 30, 2011									Three Months Ended June 30, 2010
	Discovery Stockholders			Noncontrolling Interests			Total Equity			Discovery Stockholders			Noncontrolling Interests		Total Equity
Beginning balance	$	6,408		$	3		$	6,411		$	6,365		$	25	$	6,390
Comprehensive income:
Net income		254			—			254			107			3		110
Other comprehensive income (loss):
Foreign currency translation adjustments, net		6			—			6			(10	)		—		(10	)
Market value adjustments and reclassifications for securities and derivatives		—			—			—			6			—		6

Total comprehensive income		260			—			260			103			3		106
Stock dividends declared to preferred interests		—			—			—			(1	)		—		(1	)
Stock-based compensation		14			—			14			10			—		10
Excess tax benefits from stock-based compensation		13			—			13			3			—		3
Issuance of common stock in connection with stock-based plans		28			—			28			6			—		6
Repurchases of common stock		(210	)		—			(210	)		—			—		—
Cash distributions to noncontrolling interests		—			(2	)		(2	)		—			—		—

Ending balance	$	6,513		$	1		$	6,514		$	6,486		$	28	$	6,514


	Six Months Ended June 30, 2011									Six Months Ended June 30, 2010
	Discovery Stockholders			Noncontrolling Interests			Total Equity			Discovery Stockholders			Noncontrolling Interests			Total Equity
Beginning balance	$	6,225		$	8		$	6,233		$	6,197		$	23		$	6,220
Comprehensive income:
Net income		559			—			559			276			7			283
Other comprehensive income (loss):
Foreign currency translation adjustments, net		23			—			23			(30	)		—			(30	)
Market value adjustments and reclassifications for securities and derivatives		—			—			—			7			—			7

Total comprehensive income		582			—			582			253			7			260
Stock dividends declared to preferred interests		—			—			—			(1	)		—			(1	)
Stock-based compensation		28			—			28			18			—			18
Excess tax benefits from stock-based compensation		17			—			17			4			—			4
Issuance of common stock in connection with stock-based plans		38			—			38			15			—			15
Repurchases of common stock		(377	)		—			(377	)		—			—			—
Cash distributions to noncontrolling interests		—			(7	)		(7	)		—			(2	)		(2	)

Ending balance	$	6,513		$	1		$	6,514		$	6,486		$	28		$	6,514

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

DISCOVERY COMMUNICATIONS, INC.

NOTES TO 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 programming across multiple distribution platforms throughout the world and owns and operates a diversified portfolio of website properties and other digital media services. The Company also develops and sells curriculum-based products and services, as well as postproduction audio services. The Company classifies its operations in three segments: U.S. Networks, consisting principally of domestic cable and satellite television networks, websites, and other digital media services; International Networks, consisting primarily of international cable and satellite television networks and websites; and Education and Other, consisting principally of curriculum-based product and service offerings and postproduction audio services. Financial information for Discovery’s reportable segments is set forth in Note 14.

Basis of Presentation

The consolidated financial statements include the accounts of Discovery, its majority-owned subsidiaries in which a controlling interest is maintained, and variable interest entities (“VIE”) for which the Company is the primary beneficiary. Inter-company accounts and transactions between consolidated entities have been eliminated in consolidation.

Unaudited Interim Financial Statements

These 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 consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments, consisting only of those of a normal recurring nature, necessary to state 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 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, 2010 (the “2010 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 accompanying notes. Management continually 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, but are not limited to, consolidation of VIEs, accounting for acquisitions, dispositions, allowances for doubtful accounts, content rights, asset impairments, fair value measurements, revenue recognition, depreciation and amortization, stock-based compensation, income taxes, and contingencies.

Accounting and Reporting Pronouncements Adopted

Fair Value Measurements

In January 2010, the Financial Accounting Standards Board (“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. The Company prospectively adopted the new guidance effective January 1, 2010, except for Level 3 reconciliation disclosures, which was 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 CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Revenue Recognition for Multiple-Element Revenue Arrangements

In October 2009, the FASB issued guidance that changed the determination of when the individual deliverables included in a multiple-element revenue arrangement may be treated as separate units of accounting, modified the manner in which the arrangement consideration is allocated across the separately identified deliverables, and expanded the disclosures required for multiple-element revenue arrangements. Under the new guidance, the Company must allocate the arrangement consideration to each deliverable based on management’s estimate of the price at which each element would be separately sold, if fair value is not available. The Company prospectively adopted the new guidance effective January 1, 2011, which did not have a material impact on its consolidated financial statements.

Accounting and Reporting Pronouncements Not Yet Adopted

A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring

In April 2011, the FASB issued new accounting guidance related to identifying and disclosing troubled debt restructurings (“TDRs”), which is effective for the Company on July 1, 2011 and to be applied retrospectively to restructurings occurring on or after January 1, 2011. This guidance provides clarification in assessing whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for the purpose of determining whether a restructuring constitutes a TDR. The Company is currently assessing the impact of this guidance on its financial statements.

Fair Value Measurements

In May 2011, the FASB and the International Accounting Standards Board (“IASB”) issued guidance, which results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”). Under the new guidance, the highest and best use concepts are only relevant when measuring the fair value of nonfinancial assets. The new guidance also extends the prohibition of the application of a blockage factor to all financial measurements and requires the Company to disclose quantitative information about unobservable inputs used in a description of the valuation processes, and a qualitative discussion about the sensitivity of the measurements for recurring Level 3 fair value measurements. The Company will prospectively adopt the new guidance effective January 1, 2012. The Company is currently assessing the impact of this guidance on its financial statements.

Comprehensive Income

In June 2011, the FASB issued guidance eliminating the current option to report other comprehensive income and its components in the statement of changes in equity. Entities may elect to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. Under the new guidance, each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, are required to be disclosed under either alternative. The guidance is effective January 1, 2012, but early adoption is permitted. The Company is currently assessing the impact of this guidance on its financial statements.

Concentrations Risk

Receivables

The Company’s trade receivables do not represent a significant concentration of credit risk as of June 30, 2011, due to the wide variety of customers and market segments dispersed across many geographic areas in which the Company operates.

Financial Institutions

Cash and cash equivalents are maintained with several financial institutions. The Company has deposits held with banks that exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed on demand and are maintained with financial institutions of reputable credit and, therefore, bear minimal credit risk.

Lender Counterparties

The risk associated with a debt transaction under the Company’s revolving credit facility is that the counterparty will not be available to fund as obligated. If funding under the revolving credit facility is unavailable, the Company may have to acquire a

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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 June 30, 2011, the Company did not anticipate nonperformance by any of its counterparties.

NOTE 2. ACQUISITIONS AND DISPOSITIONS

Acquisitions

London Uplink Facility

On February 17, 2010, the Company acquired all interests in an uplink facility in London, including its employees and operations, for a payment of $35 million. The uplink facility has been included in the Company’s operating results since the date of acquisition.

Dispositions

Discovery Health Network

On January 1, 2011, the Company contributed the domestic Discovery Health network to OWN LLC in connection with the launch of The Oprah Winfrey Network (“OWN”), which resulted in pretax gain of $129 million (Note 3). As the Company continues to be involved in the operations of the Discovery Health network through its ownership interests in OWN LLC, the Company has not presented the financial position, results of operations, and cash flows of the Discovery Health network as discontinued operations.

Antenna Audio

On September 1, 2010, the Company sold Antenna Audio, which was a component of its International Networks segment. Antenna Audio’s operating results for the three and six months ended June 30, 2010 have been reclassified as discontinued operations on the Consolidated Statements of Operations. For the three months ended June 30, 2010, Antenna Audio’s revenues, income before income taxes, and net income were $11 million, zero, and zero, respectively. For the six months ended June 30, 2010, Antenna Audio’s revenues, income before taxes, and net income were $21 million, zero, and zero, respectively. As the income associated with Antenna Audio is zero, there is no separate line in the Consolidated Statements of Operations for discontinued operations.

NOTE 3. VARIABLE INTEREST ENTITIES

In the normal course of business, the Company enters into joint ventures or makes investments that support its underlying business strategy and provide it the ability to enter new markets for its brands, develop programming, and distribute its existing content. In certain instances, a joint venture or an investment may qualify as a VIE. As of June 30, 2011 and December 31, 2010, the Company’s VIEs primarily consisted of Hub Television Networks LLC and OWN LLC, which are 50-50 joint ventures that operate pay-television networks. The Company previously had ownership interests in joint ventures with BBC Worldwide (the “BBC”) that were VIEs, substantially all of which were consolidated. On November 12, 2010, the Company acquired the BBC’s interests in these joint ventures. The Company now wholly owns these entities and continues to consolidate them.

As of June 30, 2011 and December 31, 2010, the Company accounted for its interests in all other joint venture VIEs using the equity method. The aggregate carrying values of investments in VIEs accounted for using the equity method were $806 million and $453 million as of June 30, 2011 and December 31, 2010, respectively, which were recorded in “Investments” on the Consolidated Balance Sheets. During the three and six months ended June 30, 2011, the Company recognized equity earnings of $3 million and equity losses of $7 million, respectively, for its portion of net earnings (losses) generated by VIEs accounted for using the equity method, which were recorded in “Other income (expense), net” on the Consolidated Statements of Operations. During the three and six months ended June 30, 2010, the Company recognized equity losses of $10 million and $16 million, respectively, for its portion of net losses generated by VIEs accounted for using the equity method, which were recorded in “Other income (expense), net” on the Consolidated Statements of Operations.

The Company’s estimated risk of loss for investments in VIEs was approximately $845 million as of June 30, 2011, which includes the carrying value of its investments and the unfunded portion of contractual funding commitments to joint ventures. Actual amounts funded exceed contractual funding commitments. The Company intends to fund significant amounts to OWN. No amounts have been recorded for future funding commitments. The estimated risk of loss excludes the Company’s operating performance guarantee to Hub Television Networks LLC disclosed below.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Hub Television Networks LLC

Hub Television Networks LLC operates The Hub, which is a pay-television network that provides children’s and family entertainment and educational programming that launched October 10, 2010. The Company provides the joint venture with funding and services such as distribution, sales, and administrative support. See Note 12 for further discussion. Based upon the level of equity investment at risk, the Company has determined that the joint venture is a VIE. The joint venture partners share equally in voting control, as well as the profits, losses, and funding of the joint venture. The Company has determined that it is not the primary beneficiary of The Hub, because 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 The Hub using the equity method.

The Company has guaranteed a certain level of operating performance for the joint venture, which is reduced over time as performance targets are achieved. As of June 30, 2011, the remaining maximum exposure to loss under this performance guarantee was below $185 million. The Company believes the likelihood is remote that the performance guarantee will not be achieved and, therefore, the performance guarantee is unlikely to 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 June 30, 2011 was not material. The Company is also committed to fund up to $15 million to the joint venture; none of which has been funded through June 30, 2011.

On May 23, 2011, The Hub revised its arrangement with Hasbro Studios to increase the license fees for animated programming. This change created a trigger event for purposes of intangible asset and goodwill impairment testing. The Hub’s management prepared a fair value assessment using a discounted cash flow valuation model, for purposes of performing step one of the goodwill impairment test. The underlying assumptions, such as future cash flows, weighted average costs of capital, and long-term growth rates were generally not observable in the marketplace, and therefore, involved significant judgment. The estimated fair value of The Hub exceeded its carrying value; no impairments were recorded. Given that the early results of The Hub’s operations have been below its initial long-term business plan, there is a possibility that future results may vary from the current assumptions in the long-term business plan. The Company will monitor the valuation of its investment in accordance with GAAP, which requires an impairment charge for other-than-temporary decline in value.

The carrying values of the Company’s investment in The Hub were $339 million and $344 million as of June 30, 2011 and December 31, 2010, respectively.

OWN LLC

OWN LLC operates OWN, which is a pay-television network and website that provides adult lifestyle content focused on self-discovery and self-improvement that launched on January 1, 2011. In connection with the launch of OWN, the Company contributed the domestic Discovery Health network to the joint venture, which included goodwill and other identifiable assets with carrying values of $136 million and $8 million, respectively. The Company recorded the contribution at fair value, which resulted in a pretax gain of $129 million. The fair value of the Company’s retained equity interest in OWN was estimated at $273 million. The gain represents the fair value of the equity investment retained less the carrying values of contributed assets. The gain resulted in $27 million of tax expense.

The fair value of the contribution of the Discovery Health network to OWN was determined utilizing customary valuation methodologies including discounted cash flows. The underlying assumptions, such as future cash flows, weighted average costs of capital, long-term growth rates, marketplace valuation methodologies, and market comparable transactions and multiples were generally not observable in the marketplace, and therefore, involved significant judgment. Given the early stage of OWN’s operations compared with its long-term business plan, there is a possibility that results may vary from these initial assumptions. The Company will monitor the valuation of its investment in accordance with GAAP, which requires an impairment charge for other-than-temporary decline in value.

The contribution did not impact the Company’s ownership interest, voting control, or governance rights related to OWN. The Company no longer consolidates the domestic Discovery Health network subsequent to the contribution, which was a component of its U.S. Networks segment.

Based upon the level of equity investment at risk, the Company has determined that OWN is a VIE. While the joint venture partners share equally in voting control, Harpo Inc. (“Harpo”) holds certain operational rights related to programming and marketing. The Company has determined that it is not the primary beneficiary of OWN, because 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. Following the contribution of the Discovery Health network to OWN, net losses generated by OWN are allocated to both joint venture partners based on their proportionate ownership interests, which are 50-50. Previously, the Company

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

recognized 100% of OWN’s net losses. Future net income generated by OWN will initially be allocated 100% to the Company up to the amount of pre-launch net losses recognized. After the Company has recouped its losses, any excess net income will be allocated to both joint venture partners based on their proportionate ownership interests.

The Company provides the joint venture funding and services such as distribution, licensing, sales, and administrative support. See Note 12 for further discussion. As the Company has assumed all funding requirements as of June 30, 2011, the Company’s total funding to OWN, including interest accrued on outstanding borrowings, was $242 million, which is in excess of its commitment of $189 million. While the Company expects to provide significant additional funding to OWN, the Company also expects to recoup amounts funded. OWN will distribute its initial excess cash to the Company to repay funding then due. Following repayment of funding then due, OWN’s subsequent cash distributions will be shared equally between the Company and Harpo.

The carrying value of the Company’s investment in OWN, including its equity method investment and note receivable balance, was $390 million and $52 million as of June 30, 2011 and December 31, 2010, respectively.

Pursuant to the joint venture agreement, Harpo has the right to require the Company to purchase its interest in OWN every two and one half years commencing on January 1, 2016. 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 up to $400 million on the fourth put exercise date. No amounts have been recorded for the put right.

NOTE 4. FAIR VALUE MEASUREMENTS

The Company records certain assets and liabilities 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; or other inputs that are observable or can be corroborated by observable market data for the assets or liabilities.

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).


		June 30, 2011
Category	Balance Sheet Location	Level 1		Level 2		Level 3		Total
Trading securities:
Mutual funds	Prepaid expenses and other current assets	$	77	$	—	$	—	$	77
Available-for-sale securities:
Money market mutual funds	Cash and cash equivalents		654		—		—		654
U.S. Treasury securities	Cash and cash equivalents		—		200		—		200

Total assets		$	731	$	200	$	—	$	931


Liabilities:
Deferred compensation plan	Accrued liabilities	$	77	$	—	$	—	$	77
Other	Other current liabilities		—		—		1		1

Total liabilities		$	77	$	—	$	1	$	78

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


		December 31, 2010
Category	Balance Sheet Location	Level 1		Level 2		Level 3		Total
Trading securities:
Mutual funds	Prepaid expenses and other current assets	$	55	$	—	$	—	$	55
Available-for-sale securities:
Money market mutual funds	Cash and cash equivalents		172		—		—		172
U.S. Treasury securities	Cash and cash equivalents		—		200		—		200
Other	Cash and cash equivalents		—		3		—		3

Total assets		$	227	$	203	$	—	$	430


Liabilities:
Deferred compensation plan	Accrued liabilities	$	55	$	—	$	—	$	55
Other	Accrued liabilities and Other current liabilities		—		6		—		6

Total liabilities		$	55	$	6	$	—	$	61

Trading securities are comprised of investments in mutual funds held in a separate trust, which are owned as part of the Company’s deferred compensation plan. The fair value of Level 1 trading securities was determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair value of the related deferred compensation plan liability was determined based on the fair value of the related investments elected by employees.

Available-for-sale securities represent investments in highly liquid instruments with original maturities of 90 days or less. The fair value of Level 1 available-for-sale securities was determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair value of substantially all available-for-sale securities classified in Level 2 was based on quoted prices for similar instruments in active markets multiplied by the number of units held without consideration of transaction costs.

In addition to the financial instruments listed in the tables above, the Company holds other financial instruments, including cash, accounts receivable, accounts payable, and debt. The carrying values for cash, accounts receivable, and accounts payable approximated their fair values. The estimated fair value of the Company’s outstanding debt using quoted market prices was $4.4 billion and $3.7 billion as of June 30, 2011 and December 31, 2010, respectively.

NOTE 5. CONTENT RIGHTS

Content rights consisted of the following (in millions).


	June 30, 2011			December 31, 2010
Produced content rights:
Completed	$	2,185		$	1,963
In-production		243			229
Coproduced content rights:
Completed		481			446
In-production		77			76
Licensed content rights:
Acquired		348			297
Prepaid		19			19

Content rights, at cost		3,353			3,030
Accumulated amortization		(1,950	)		(1,702	)

Total content rights, net		1,403			1,328
Current portion		(93	)		(83	)

Noncurrent portion	$	1,310		$	1,245

Content expense was $196 million and $165 million for the three months ended June 30, 2011 and 2010, respectively, and $381 million and $350 million for the six months ended June 30, 2011 and 2010, respectively.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 6. DEBT

Outstanding debt consisted of the following (in millions).


	June 30,			December 31,
	2011			2010
3.70% Senior Notes, semi-annual interest, due June 2015	$	850		$	850
5.625% Senior Notes, semi-annual interest, due August 2019		500			500
5.05% Senior Notes, semi-annual interest, due June 2020		1,300			1,300
4.375% Senior Notes, semi-annual interest, due June 2021		650			—
6.35% Senior Notes, semi-annual interest, due June 2040		850			850
Capital lease and other obligations		118			126

Total long-term debt		4,268			3,626
Unamortized discount		(11	)		(8	)

Long-term debt, net		4,257			3,618
Current portion of long-term debt		(22	)		(20	)

Noncurrent portion of long-term debt	$	4,235		$	3,598

On June 20, 2011, Discovery Communications, LLC (“DCL”), a wholly-owned subsidiary of the Company, issued $650 million aggregate principal amount of 4.375% Senior Notes due on June 15, 2021 (the “2021 Notes”). DCL received net proceeds of approximately $641 million from the offering after the $4 million issuance discount and $5 million of deferred financing costs.

DCL may, at its option, redeem some or all of the 2021 Notes at any time by paying a make-whole premium, plus accrued and unpaid interest, if any, through the date of repurchase. Interest on the 2021 Notes is payable on June 15 and December 15 of each year. The 2021 Notes 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 Discovery.

In addition to the debt instruments listed in the table above, the Company also has a $1.0 billion revolving credit facility. There were no amounts drawn under the revolving credit facility as of June 30, 2011 and December 31, 2010. If the Company were to draw on the revolving credit facility, outstanding balances would bear interest at a variable rate determined pursuant to the credit agreement. Balances outstanding under the revolving credit facility would be due on the expiration date, which is October 11, 2013.

The Company was in compliance with all covenants and provisions under its credit agreements as of June 30, 2011 and December 31, 2010. There were no events of default.

NOTE 7. EQUITY

Stock Repurchase Program

On August 3, 2010, the Company implemented a stock repurchase program, with authorization to purchase up to $1.0 billion of its common stock. The repurchase program has no expiration date. During the three and six months ended June 30, 2011, the Company repurchased 5.64 million and 10.37 million shares, respectively, of its Series C common stock for an aggregate purchase price of $210 million and $377 million, respectively, through open market transactions. The repurchases were funded using cash on hand. As of June 30, 2011, the Company had remaining authorization of $518 million for future repurchases of its common stock. The stock repurchases were recorded in a separate account at cost, which was reported as a reduction in equity.

NOTE 8. STOCK-BASED COMPENSATION

The Company has various incentive plans under which unit awards, stock options, performance based restricted stock units (“PRSUs”), time based restricted stock units (“RSUs”), and stock appreciation rights (“SARs”) have been issued. The Company does not intend to grant additional unit awards or SARs, which are cash-settled, except as may be required by contract or to employees in countries in which stock options, PRSUs, or RSUs are not permitted. The vesting and service requirements of stock-based awards granted during the six months ended June 30, 2011 were consistent with the arrangements disclosed in the 2010 Form 10-K.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Stock-Based Compensation Expense

Stock-based compensation expense was as follows (in millions).


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Unit awards	$	18	$	39	$	21	$	63
Stock options		8		8		18		15
PRSUs and RSUs		6		2		10		3
Other		—		1		—		13

Total stock-based compensation expense	$	32	$	50	$	49	$	94

Tax benefit recognized	$	12	$	20	$	18	$	35

Compensation expense for all awards was recorded in “Selling, general and administrative” expense on the Consolidated Statements of Operations. As of June 30, 2011 and December 31, 2010, the Company recorded total liabilities of $52 million and $125 million, respectively, for cash-settled awards.

Stock-Based Award Activity

Unit Awards

Unit award activity for the six months ended June 30, 2011 was as follows (in millions, except years).


	Unit Awards			Weighted-Average Grant Price		Weighted-Average Remaining Contractual Term (years)		Aggregate Intrinsic Value
Outstanding as of December 31, 2010		8.8		$	21.98		0.79	$	198
Granted		2.3		$	41.17
Settled		(3.7	)	$	18.95			$	91
Forfeited		(0.1	)	$	21.46

Outstanding as of June 30, 2011		7.3		$	29.54		1.19	$	93

Vested and expected to vest as of June 30, 2011		6.9		$	29.47		1.18	$	88

Vested and unpaid as of June 30, 2011		0.5		$	21.77		—	$	12

Unit awards represent the contingent right to receive a cash payment for the amount by which the vesting price exceeds the grant price. The weighted-average grant price of unit awards granted during the six months ended June 30, 2011 was $41.17 per unit award. Because unit awards are cash-settled, the Company remeasures the fair value and compensation expense of outstanding unit awards as of the last day of the most recent fiscal period, until settlement. The weighted-average fair value of unit awards outstanding as of June 30, 2011 was $15.64 per unit award. The Company made cash payments totaling $91 million and $67 million during the six months ended June 30, 2011 and 2010, respectively, to settle vested unit awards. As of June 30, 2011, there was $58 million of unrecognized compensation cost, net of estimated forfeitures, related to unit awards, which is expected to be recognized over a weighted-average period of 2.04 years.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Stock Options

Stock option activity for the six months ended June 30, 2011 was as follows (in millions, except years).


	Stock Options			Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (years)		Aggregate Intrinsic Value
Outstanding as of December 31, 2010		15.7		$	19.26		5.21	$	350
Granted		1.2		$	39.14
Exercised		(2.3	)	$	16.54			$	62
Forfeited		(0.4	)	$	22.41

Outstanding as of June 30, 2011		14.2		$	21.27		5.35	$	280

Vested and expected to vest as of June 30, 2011		13.8		$	21.16		5.45	$	272

Exercisable as of June 30, 2011		4.1		$	17.16		5.20	$	98

The weighted-average exercise price and weighted-average grant date fair value of stock options granted during the six months ended June 30, 2011 were $39.14 and $14.45, respectively, per option. The Company received cash payments totaling $38 million and $15 million during the six months ended June 30, 2011 and 2010, respectively, from the exercise of stock options. As of June 30, 2011, there was $63 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 1.72 years.

PRSUs and RSUs

PRSU and RSU activity for the six months ended June 30, 2011 was as follows (in millions, except years).


	PRSUs and RSUs		Weighted-Average Grant Price		Weighted-Average Remaining Contractual Term (years)		Aggregate Fair Value
Outstanding as of December 31, 2010		1.5	$	32.66		2.29	$	61
Granted		1.0	$	38.86
Converted		—	$	—			$	—
Forfeited		—	$	—

Outstanding as of June 30, 2011		2.5	$	35.24		2.27	$	99

Vested and expected to vest as of June 30, 2011		2.0	$	34.99		2.25	$	83

PRSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service and whether the Company achieves certain operating performance targets. During the six months ended June 30, 2011, the Company granted 0.7 million PRSUs with a weighted-average grant date fair value of $38.78 per PRSU. As of June 30, 2011, there was $33 million of unrecognized compensation cost, net of expected forfeitures, related to PRSUs, which is expected to be recognized over a weighted-average period of 2.0 years based on the Company’s current probability assessment of the PRSUs that will vest, which may differ from actual results.

RSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service. During the six months ended June 30, 2011, the Company granted 0.3 million RSUs with a weighted-average grant date fair value of $39.01 per RSU. As of June 30, 2011, there was $18 million of unrecognized compensation cost, net of expected forfeitures, related to RSUs, which is expected to be recognized over a weighted-average period of 2.77 years.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

SARs

There were immaterial amounts of SARs outstanding as of June 30, 2011 and December 31, 2010. The Company made cash payments totaling $1 million and $54 million during the six months ended June 30, 2011 and 2010, respectively, to settle exercised SARs.

NOTE 9. INCOME TAXES

The Company’s provisions for income taxes were $144 million and $41 million, and the effective tax rates were 36% and 27% for the three months ended June 30, 2011 and 2010, respectively. The effective tax rate for the three months ended June 30, 2011 differed from the U.S. federal statutory income tax rate of 35% due primarily to state taxes partially offset by production activity deductions. The effective tax rate for the three months ended June 30, 2010 differed from the U.S. federal statutory income tax rate of 35% due primarily to a production activity deduction and a $13 million tax benefit for 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’s provisions for income taxes were $290 million and $88 million, and the effective tax rates were 34% and 24% for the six months ended June 30, 2011 and 2010, respectively. The effective tax rate for the six months ended June 30, 2011 differed from the U.S. federal statutory income tax rate of 35% principally because the Company did not record a deferred tax liability of $21 million with respect to the portion of the outside basis in the OWN joint venture attributable to the nondeductible goodwill contributed to OWN and production activity deductions. These items were partially offset by state taxes. The effective tax rate for the six months ended June 30, 2010 differed from the U.S. federal statutory income tax rate of 35% primarily due to the reversal of a $28 million previously established foreign tax reserve recorded in connection with the completion of a tax audit, production activity deductions and a $13 million tax expense reduction for 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 is currently under examination by the Internal Revenue Service (“IRS”) for its 2009 and 2008 consolidated federal income tax returns. With few exceptions, the Company is no longer subject to audit by the IRS, state tax authorities, or foreign tax authorities for years prior to 2006. Certain of the Company’s subsidiaries are currently under examination for the 2006 and 2007 tax years. The Company does not expect any material adjustments.

NOTE 10. NET INCOME PER SHARE

The following table presents a reconciliation of income and weighted average number of shares outstanding between basic and diluted income per share (in millions, except per share amounts).


	Three Months Ended June 30,					Six Months Ended June 30,
	2011		2010			2011		2010
Numerator:
Net income	$	254	$	110		$	559	$	283
Less net income attributable to noncontrolling interests		—		(3	)		—		(7	)

Net income attributable to Discovery Communications, Inc.		254		107			559		276
Stock dividends to preferred interests		—		(1	)		—		(1	)

Net income available to Discovery Communications, Inc. stockholders – basic and diluted	$	254	$	106		$	559	$	275


Denominator:
Weighted average shares outstanding — basic		406		426			407		425
Weighted average dilutive effect of equity awards		4		5			5		5

Weighted average shares outstanding — diluted		410		431			412		430


Net income per share available to Discovery Communications, Inc. stockholders:
Basic	$	0.63	$	0.25		$	1.37	$	0.65

Diluted	$	0.62	$	0.25		$	1.36	$	0.64

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Basic income per share is calculated by dividing “Net income available to Discovery Communications, Inc. stockholders” by the weighted average number of shares outstanding. Diluted income per share adjusts basic income per share for the dilutive effect for the assumed exercise of outstanding stock options and stock-settled SARs and the vesting of outstanding service based RSUs, using the treasury stock method. Diluted income per share also adjusts basic income per share for the dilutive effect for the assumed vesting of outstanding PRSUs or other contingently issuable shares that would be issued under the respective arrangements assuming the last day of the most recent fiscal period was the end of the contingency period.

The weighted average number of shares outstanding for the three and six months ended June 30, 2011 and 2010 included the Company’s outstanding Series A, Series B, and Series C common shares, as well as its outstanding Series A and Series C convertible preferred shares. All series of the Company’s common and preferred shares were included in the weighted average number of shares outstanding when calculating both basic and diluted income per share as the holder of each common and preferred series legally participates equally in any per share distributions.

For both the three and six months ended June 30, 2011, diluted income per share excluded three million options, PRSUs, and contingently issuable preferred shares, because their inclusion would have been anti-dilutive or specific criteria had not yet been achieved.

Diluted income per share for both the three and six months ended June 30, 2010 excluded five million options, PRSUs, and contingently issuable preferred shares, because their inclusion would have been anti-dilutive or specific criteria had not yet been achieved.

NOTE 11. SUPPLEMENTAL DISCLOSURES

Other Income (Expense), Net

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


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Unrealized (losses) gains on derivative instruments, net	$	(1	)	$	6		$	2		$	5
Realized losses on derivative instruments, net		—			(33	)		(2	)		(33	)
Earnings (losses) from equity investees, net		3			(10	)		(8	)		(17	)
Other, net		—			—			3			4

Total other income (expense), net	$	2		$	(37	)	$	(5	)	$	(41	)

NOTE 12. RELATED PARTY TRANSACTIONS

The following is a description of the Company’s related parties.

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. Prior to June 16, 2010, Dr. Malone owned 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. Through June 16, 2010,

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

transactions with DIRECTV are reported as related party transactions. Revenues from transactions with DIRECTV were $50 million, or 5% of total revenues, and $104 million, or 6%, of total revenues, for the three and six months ended June 30, 2010. Expenses from transactions with DIRECTV were not material for the three and six months ended June 30, 2010.

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 members who serve as 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 42% of the aggregate voting power of Liberty Global and 34% of the aggregate voting power of Liberty Media.

Revenues from transactions with both Liberty Global and Liberty Media totaled $9 million, or 1% of total revenues, and $7 million, or 1% of total revenues, for the three months ended June 30, 2011 and 2010, respectively. Revenues from transactions with both Liberty Global and Liberty Media totaled $18 million, or 1% of total revenues, and $14 million, or 1% of total revenues, for the six months ended June 30, 2011 and 2010, respectively. Expenses from transactions with both Liberty Global and Liberty Media for three and six months ended June 30, 2011 and 2010 were not material. The Company’s “Receivables, net” balances included insignificant amounts due from both Liberty Global and Liberty Media as of June 30, 2011 and December 31, 2010.

Effective January 25, 2010, Dr. Malone joined the Board of Directors of Ascent Media Corporation (“AMC”). Dr. Malone owns 1% of AMC’s Series A common stock and 85% of AMC’s Series B common stock, effectively providing him voting equity securities representing approximately 30% of the voting power with respect to the general election of AMC directors.

Beginning January 25, 2010, transactions with AMC are reported as related party transactions as a result of Dr. Malone joining AMC’s board. Operating expenses from transactions with AMC were $4 million, or 1% of total operating expenses for the three months ended June 30, 2011 and 2010. Operating expenses from transactions with AMC were $8 million, or 1% of total operating expenses, and $14 million, or 1% of total operating expenses, for the six months ended June 30, 2011 and 2010, respectively. Payable balances as of the periods ended June 30, 2011 and December 31, 2010 and revenues from transactions with AMC for the three and six months ended June 30, 2011 and 2010 were not material.

Dr. Malone serves as a director on Discovery’s board and owns shares representing approximately 23% of the aggregate general voting power of Discovery’s outstanding stock. At this time, Dr. Malone also controls approximately 31% of the Company’s aggregate voting power relating to the election of the eight common stock directors, as the preferred stock held by the 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 Liberty Global, Liberty Media, AMC, their respective subsidiaries and equity method investees, and with DIRECTV through June 2010, are related party transactions. The majority of the amounts received under contractual arrangements with DIRECTV, Liberty Global, and Liberty Media entities relates to multi-year network distribution arrangements. 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 postproduction to Discovery.

Other Related Parties

Other related parties primarily include unconsolidated equity method investees, including unconsolidated VIEs described in Note 3. The Company provides equity method investees with content and services such as distribution, licensing, sales, and administrative support. Revenues from other related parties were $24 million, or 2% of total revenues, and $16 million, or 2% of total revenues, for the three months ended June 30, 2011 and 2010, respectively. Revenues from other related parties were $45 million, or 2% of total revenues, and $25 million, or 1% of total revenues, for the six months ended June 30, 2011 and 2010, respectively. Operating expenses for services acquired from other related parties were $3 million, or 1% of total operating expenses, for the three months ended June 30, 2011 and 2010. Operating expenses for services acquired from other related parties were $7 million, or 1% of total operating expenses, and $6 million, or 1% of total operating expenses, for the six months ended June 30, 2011 and 2010, respectively. The Company’s “Receivables, net” balances include $15 million and $9 million due from the Company’s other related parties as of June 30, 2011 and December 31, 2010, respectively.

The Company’s “Investments” balance includes notes receivable, net of earnings and losses absorbed from equity method investees. See Note 3 for further discussion. The Company records interest earnings from loans to joint ventures as a component of “Earnings (losses) from equity investees,” which is a component of “Other Income (Expense), Net.” Interest earnings recorded totaled $4 million and $8 million for the three and six months ended June 30, 2011. Interest earnings recorded totaled $1 million and $2 million for the three and six months ended June 30, 2010.

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 13. COMMITMENTS, CONTINGENCIES, AND GUARANTEES

Commitments

In the normal course of business, the Company enters into various commitments, which primarily include arrangements for the purchase of programming and talent, operating and capital lease arrangements for the use of equipment and facilities, employment contracts, sponsorship commitments, arrangements to purchase various goods and services consumed in the normal course of business, future funding commitments to joint ventures (Note 3), and the obligation to issue additional preferred shares under the anti-dilution provisions of its outstanding preferred stock. Most commitments are payable over several years.

Contingencies

Put Right

Harpo has the right to require the Company to purchase its interest in OWN for fair value at various dates (Note 3). No amounts have been recorded for put right obligations.

Legal Matters

In the normal course of business, the Company experiences routine 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.

Guarantees

The Company has guaranteed a certain level of operating performance for The Hub joint venture (Note 3) and payment under certain joint venture contracts. There were no material amounts for guarantees to joint ventures recorded as of June 30, 2011 and December 31, 2010.

The Company may provide or receive indemnities intended to allocate certain business transaction risks. Similarly, the Company may remain contingently liable for certain obligations of a divested business in the event that a third party does not fulfill its obligations under an indemnification obligation. The Company records a liability for its indemnification obligations and other contingent liabilities when probable. There were no material amounts for indemnifications or other contingencies recorded as of June 30, 2011 and December 31, 2010.

NOTE 14. REPORTABLE SEGMENTS

The Company’s reportable segments are determined based on (i) financial information reviewed by its 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 as third-party sales transactions. 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

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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 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 June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
U.S. Networks	$	660	$	620	$	1,247	$	1,166
International Networks		368		306		691		589
Education and Other		39		33		80		70
Corporate and inter-segment eliminations		—		4		—		7

Total revenues	$	1,067	$	963	$	2,018	$	1,832

Adjusted OIBDA by Segment


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
U.S. Networks	$	395		$	379		$	729		$	672
International Networks		173			132			317			254
Education and Other		5			1			13			6
Corporate and inter-segment eliminations		(63	)		(57	)		(122	)		(112	)

Total adjusted OIBDA	$	510		$	455		$	937		$	820

Reconciliation of Total Adjusted OIBDA to Consolidated Operating Income


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Total Adjusted OIBDA	$	510		$	455		$	937		$	820
Amortization of deferred launch incentives		(12	)		(10	)		(26	)		(21	)
Mark-to-market stock-based compensation		(19	)		(40	)		(23	)		(76	)
Depreciation and amortization		(30	)		(33	)		(60	)		(66	)
Restructuring charges		(4	)		—			(5	)		(3	)
Gains on dispositions		—			—			129			—

Total operating income	$	445		$	372		$	952		$	654

Total Assets by Segment


	June 30, 2011		December 31, 2010
U.S. Networks	$	2,603	$	2,218
International Networks		1,194		1,127
Education and Other		63		74
Corporate and inter-segment eliminations		7,976		7,600

Total assets	$	11,836	$	11,019

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Total assets allocated to “Corporate” in the table above include the Company’s goodwill balance as the financial information reviewed by the Company’s CODM does not include an allocation of goodwill to each reportable segment.

NOTE 15. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

Overview

The Senior Notes outstanding as of June 30, 2011 and December 31, 2010 (Note 6) have been issued by DCL, a wholly-owned subsidiary of the Company, 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 on an unsecured basis. The Company, DCL, and/or Discovery Communications Holding, LLC (“DCH”), a wholly-owned subsidiary of the Company (collectively the “Issuers”), may issue additional debt securities under the Shelf Registration that are fully and unconditionally guaranteed by the other Issuers.

Set forth below are condensed consolidating financial statements presenting the financial position, results of operations, and cash flows of (i) the Company, (ii) DCH, (iii) DCL, (iv) the non-guarantor subsidiaries of DCL on a combined basis, (v) the other non-guarantor subsidiaries of the Company on a combined basis, and (vi) reclassifications and eliminations necessary to arrive at the consolidated financial statement balances for the Company. DCL and the non-guarantor subsidiaries of DCL are the primary operating subsidiaries of the Company. DCL primarily includes the Discovery Channel and TLC networks in the U.S. The non-guarantor subsidiaries of DCL include the Animal Planet network and substantially all of the Company’s other U.S. and international networks, education businesses, and most of the Company’s websites and other digital media services. The non-guarantor subsidiaries of DCL are wholly-owned subsidiaries of DCL with the exception of certain 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% indirect ownership interest through Discovery Holding Company (“DHC”), a wholly-owned subsidiary of the Company. DHC is included in the other non-guarantor subsidiaries of the Company.

Basis of Presentation

Solely for purposes of presenting the condensed consolidating financial statements, investments in the Company’s subsidiaries have been accounted for by their respective parent company using the equity method. Accordingly, in the following condensed consolidating financial statements the equity method has been applied to (i) the Company’s interests in DCH and the other non-guarantor subsidiaries of the Company, (ii) DCH’s interest in DCL, and (iii) DCL’s interests in the non-guarantor subsidiaries of DCL. Inter-company accounts and transactions have been eliminated to arrive at the consolidated financial statement amounts for the Company. The Company’s accounting bases in all subsidiaries, including goodwill and recognized intangible assets, have been “pushed-down” to the applicable subsidiaries.

All direct and indirect subsidiaries are included in the Company’s consolidated U.S. tax return. In the condensed consolidating financial statements, tax expense related to permanent differences has been allocated to the entity that created the difference, while tax expense related to temporary differences has been allocated to each entity based on each entity’s pretax income relative to consolidated pretax income. Deferred taxes of the Company, DCL, and the non-guarantor subsidiaries have been allocated based upon the temporary differences between the carrying amounts of the respective assets and liabilities of the applicable entities.

As of June 30, 2011 and December 31, 2010, the cash and cash equivalents of the non-guarantor subsidiaries of DCL included $1 million and $12 million, respectively, of cash related to a consolidated joint venture that is only available for use by the joint venture.

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

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Balance Sheet

June 30, 2011

(in millions)


	Discovery		DCH		DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery		Reclassifications and Eliminations			Discovery and Subsidiaries
ASSETS
Current assets:
Cash and cash equivalents	$	—	$	—	$	1,000		$	92		$	3	$	—		$	1,095
Receivables, net		—		—		412			486			12		(2	)		908
Content rights, net		—		—		13			80			—		—			93
Prepaid expenses and other current assets		17		—		119			88			1		—			225

Total current assets		17		—		1,544			746			16		(2	)		2,321
Investment in and advances to subsidiaries		8,874		6,481		4,539			—			6,700		(26,594	)		—
Noncurrent content rights, net		—		—		594			716			—		—			1,310
Goodwill		—		—		3,767			2,535			—		—			6,302
Other noncurrent assets		—		20		859			1,038			6		(20	)		1,903

Total assets	$	8,891	$	6,501	$	11,303		$	5,035		$	6,722	$	(26,616	)	$	11,836


LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	11	$	3	$	197		$	198		$	5	$	(2	)	$	412
Current portion of long-term debt		—		—		6			16			—		—			22
Other current liabilities		—		—		77			102			1		—			180

Total current liabilities		11		3		280			316			6		(2	)		614
Long-term debt		—		—		4,156			79			—		—			4,235
Other noncurrent liabilities		—		—		386			100			7		(20	)		473

Inter-company contributions and advances between Discovery Communications, Inc. and subsidiaries		2,367		1,585		(212	)		4,651			967		(9,358	)		—
Equity (deficit) attributable to Discovery Communications, Inc.		6,513		4,913		6,693			(111	)		5,742		(17,237	)		6,513

Equity and advances attributable to Discovery Communications, Inc.		8,880		6,498		6,481			4,540			6,709		(26,595	)		6,513
Noncontrolling interests		—		—		—			—			—		1			1

Total equity		8,880		6,498		6,481			4,540			6,709		(26,594	)		6,514

Total liabilities and equity	$	8,891	$	6,501	$	11,303		$	5,035		$	6,722	$	(26,616	)	$	11,836

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Balance Sheet

December 31, 2010

(in millions)


	Discovery		DCH		DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery		Reclassifications and Eliminations			Discovery and Subsidiaries
ASSETS
Current assets:
Cash and cash equivalents	$	—	$	—	$	369		$	93		$	4	$	—		$	466
Receivables, net		—		—		391			476			13		—			880
Content rights, net		—		—		8			75			—		—			83
Prepaid expenses and other current assets		109		3		105			89			1		(1	)		306

Total current assets		109		3		873			733			18		(1	)		1,735
Investment in and advances to subsidiaries		8,530		6,091		4,129			—			6,484		(25,234	)		—
Noncurrent content rights, net		—		—		557			688			—		—			1,245
Goodwill		—		—		3,876			2,558			—		—			6,434
Other noncurrent assets		—		12		872			726			7		(12	)		1,605

Total assets	$	8,639	$	6,106	$	10,307		$	4,705		$	6,509	$	(25,247	)	$	11,019


LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	—	$	—	$	216		$	260		$	5	$	(1	)	$	480
Current portion of long-term debt		—		—		6			14			—		—			20
Other current liabilities		—		1		121			162			1		—			285

Total current liabilities		—		1		343			436			6		(1	)		785
Long-term debt		—		—		3,513			85			—		—			3,598
Other noncurrent liabilities		—		—		360			47			8		(12	)		403

Inter-company contributions and advances between Discovery Communications, Inc. and subsidiaries		2,414		1,777		(57	)		4,702			1,143		(9,979	)		—
Equity (deficit) attributable to Discovery Communications, Inc.		6,225		4,328		6,148			(565	)		5,352		(15,263	)		6,225

Equity and advances attributable to Discovery Communications, Inc.		8,639		6,105		6,091			4,137			6,495		(25,242	)		6,225
Noncontrolling interests		—		—		—			—			—		8			8

Total equity		8,639		6,105		6,091			4,137			6,495		(25,234	)		6,233

Total liabilities and equity	$	8,639	$	6,106	$	10,307		$	4,705		$	6,509	$	(25,247	)	$	11,019

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Statement of Operations

Three Months Ended June 30, 2011

(in millions)


	Discovery			DCH		DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery		Reclassifications and Eliminations			Discovery and Subsidiaries
Revenues	$	—		$	—	$	459		$	593		$	17	$	(2	)	$	1,067


Costs of revenues, excluding depreciation and amortization listed below		—			—		98			178			14		(2	)		288
Selling, general and administrative		3			—		96			198			3		—			300
Depreciation and amortization		—			—		9			21			—		—			30
Restructuring charges		—			—		4			—			—		—			4

		3			—		207			397			17		(2	)		622

Operating (loss) income		(3	)		—		252			196			—		—			445
Equity in earnings of subsidiaries		256			256		121			—			171		(804	)		—
Interest expense, net		—			—		(49	)		—			—		—			(49	)
Other income, net		—			—		2			—			—		—			2

Income before income taxes		253			256		326			196			171		(804	)		398
Benefit from (provision for) income taxes		1			—		(70	)		(75	)		—		—			(144	)

Net income	$	254		$	256	$	256		$	121		$	171	$	(804	)	$	254

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Statement of Operations

Three Months Ended June 30, 2010

(in millions)


	Discovery			DCH			DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery			Reclassifications and Eliminations			Discovery and Subsidiaries
Revenues	$	—		$	—		$	431		$	519		$	16		$	(3	)	$	963


Costs of revenues, excluding depreciation and amortization listed below		—			—			87			155			15			(3	)		254
Selling, general and administrative		2			—			88			212			2			—			304
Depreciation and amortization		—			—			8			24			1			—			33

		2			—			183			391			18			(3	)		591

Operating (loss) income		(2	)		—			248			128			(2	)		—			372
Equity in earnings of subsidiaries		108			151			88			—			73			(420	)		—
Interest expense, net		—			(18	)		(28	)		(2	)		—			—			(48	)
Loss of extinguishment of debt		—			(20	)		(116	)		—			—			—			(136	)
Other (expense) income, net		—			(28	)		(14	)		5			—			—			(37	)

Income before income taxes		106			85			178			131			71			(420	)		151
Benefit from (provision for) income taxes		1			24			(27	)		(40	)		1			—			(41	)

Net income		107			109			151			91			72			(420	)		110
Less net income attributable to noncontrolling interests		—			—			—			(1	)		—			(2	)		(3	)

Net income attributable to Discovery Communications, Inc.		107			109			151			90			72			(422	)		107
Stock dividends to preferred interests		(1	)		—			—			—			—			—			(1	)

Net income available to Discovery Communications, Inc. stockholders	$	106		$	109		$	151		$	90		$	72		$	(422	)	$	106

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Statement of Operations

Six Months Ended June 30, 2011

(in millions)


	Discovery			DCH		DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery			Reclassifications and Eliminations			Discovery and Subsidiaries
Revenues	$	—		$	—	$	870		$	1,117		$	35		$	(4	)	$	2,018


Costs of revenues, excluding depreciation and amortization listed below		—			—		194			342			29			(4	)		561
Selling, general and administrative		6			—		179			378			6			—			569
Depreciation and amortization		—			—		19			40			1			—			60
Restructuring charges		—			—		4			1			—			—			5
Gains on dispositions		—			—		—			(129	)		—			—			(129	)

		6			—		396			632			36			(4	)		1,066

Operating (loss) income		(6	)		—		474			485			(1	)		—			952
Equity in earnings of subsidiaries		563			564		313			—			376			(1,816	)		—
Interest expense, net		—			—		(96	)		(2	)		—			—			(98	)
Other income (expense), net		—			—		3			(8	)		—			—			(5	)

Income before income taxes		557			564		694			475			375			(1,816	)		849
Benefit from (provision for) income taxes		2			—		(130	)		(162	)		—			—			(290	)

Net income	$	559		$	564	$	564		$	313		$	375			(1,816	)	$	559

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Statement of Operations

Six Months Ended June 30, 2010

(in millions)


	Discovery			DHC			DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery			Reclassifications and Eliminations			Discovery and Subsidiaries
Revenues	$	—		$	—		$	815		$	988		$	33		$	(4	)	$	1,832


Costs of revenues, excluding depreciation and amortization listed below		—			—			189			306			30			(4	)		521
Selling, general and administrative		6			—			191			386			5			—			588
Depreciation and amortization		—			—			20			45			1			—			66
Restructuring charges		—			—			—			3			—			—			3

		6			—			400			740			36			(4	)		1,178

Operating (loss) income		(6	)		—			415			248			(3	)		—			654
Equity in earnings of subsidiaries		280			346			195			—			188			(1,009	)		—
Interest expense, net		—			(48	)		(55	)		(3	)		—			—			(106	)
Loss on extinguishment of debt		—			(20	)		(116	)		—			—			—			(136	)
Other (expense) income, net		—			(32	)		(18	)		9			—			—			(41	)

Income before income taxes		274			246			421			254			185			(1,009	)		371
Benefit from (provision for) income taxes		2			36			(75	)		(52	)		1			—			(88	)

Net income		276			282			346			202			186			(1,009	)		283
Less net income attributable to noncontrolling interests		—			—			—			(4	)		—			(3	)		(7	)

Net income attributable to Discovery Communications, Inc.		276			282			346			198			186			(1,012	)		276
Stock dividends to preferred interests		(1	)		—			—			—			—			—			(1	)

Net income available to Discovery Communications, Inc. stockholders	$	275		$	282		$	346		$	198		$	186		$	(1,012	)	$	275

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Statement of Cash Flows

Six Months Ended June 30, 2011

(in millions)


	Discovery			DCH			DCL			Non-Guarantor Subsidiaries of DCL			Other Non - Guarantor Subsidiaries of Discovery			Eliminations			Discovery and Subsidiaries
Operating Activities
Cash provided by (used in) operating activities	$	100		$	(2	)	$	71		$	262		$	—		$	—		$	431

Investing Activities
Purchases of property and equipment		—			—			(9	)		(17	)		(1	)		—			(27	)
Investments in and advances to equity investees		—			—			—			(82	)		—			—			(82	)

Cash used in investing activities		—			—			(9	)		(99	)		(1	)		—			(109	)

Financing Activities
Borrowings from long term debt, net of discount and issuance costs		—			—			641			—			—			—			641
Principal repayments of capital leases obligations		—			—			(2	)		(11	)		—			—			(13	)
Repurchases of common stock		(377	)		—			—			—			—			—			(377	)
Cash distributions to noncontrolling interests		—			—			—			—			—			(7	)		(7	)
Proceeds from stock option exercises		55			—			—			—			—			—			55
Inter-company contributions and other financing activities, net		222			2			(70	)		(161	)		—			7			—


Cash (used in) provided by financing activities		(100	)		2			569			(172	)		—			—			299

Effect of exchange rate changes on cash and cash equivalents		—			—			—			8			—			—			8


Net change in cash and cash equivalents		—			—			631			(1	)		(1	)		—			629

Cash and cash equivalents, beginning of period		—			—			369			93			4			—			466


Cash and cash equivalents, end of period	$	—		$	—		$	1,000		$	92		$	3		$	—		$	1,095

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Condensed Consolidating Statement of Cash Flows

Six Months Ended June 30, 2010

(in millions)


	Discovery			DCH			DCL			Non-Guarantor Subsidiaries of DCL			Other Non- Guarantor Subsidiaries of Discovery			Eliminations		Discovery and Subsidiaries
Operating Activities
Cash (used in) provided by operating activities	$	(35	)	$	(55	)	$	(27	)	$	205		$	2		$	—	$	90

Investing Activities
Purchases of property and equipment		—			—			(4	)		(15	)		(1	)		—		(20	)
Business acquisitions, net of cash acquired		—			—			—			(38	)		—			—		(38	)
Investments in and advances to equity investees		—			—			(39	)		(2	)		—			—		(41	)

Cash used in investing activities		—			—			(43	)		(55	)		(1	)		—		(99	)

Financing Activities
Borrowings from long-term debt, net of discount and issuance costs		—			—			2,970			—			—			—		2,970
Principal repayments of long-term debt		—			(1,948	)		(935	)		—			—			—		(2,883	)
Inter-company contributions and other financing activities, net		35			2,003			(1,844	)		(179	)		(3	)		—		12


Cash provided by (used in) financing activities		35			55			191			(179	)		(3	)		—		99

Net change in cash and cash equivalents		—			—			121			(29	)		(2	)		—		90

Cash and cash equivalents, beginning of period		—			—			476			144			3			—		623


Cash and cash equivalents, end of period	$	—		$	—		$	597		$	115		$	1		$	—	$	713

ITEM 2.

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

Management’s discussion and analysis of results of operations and financial condition is a supplement to and should be read in conjunction with the accompanying consolidated financial statements and related notes. This section provides additional information regarding Discovery Communications, Inc.’s (“Discovery,” “Company,” “we,” “us,” or “our”) businesses, recent developments, results of operations, and financial condition. Additional context can also be found in our Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 Form 10-K”).

CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS

Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, marketing and operating strategies, integration of acquired businesses, new service offerings, financial prospects, and anticipated sources and uses of capital. Words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” “believes,” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify forward-looking statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated: the inability of advertisers or affiliates to remit payment to us in a timely manner or at all; general economic and business conditions; industry trends, including the timing of, and spending on, feature film, television, and television commercial production; spending on domestic and foreign television advertising, and foreign first-run and existing content libraries; the regulatory and competitive environment of the industries in which we, and the entities in which we have interests, operate; continued consolidation of the broadband distribution and movie studio industries; uncertainties inherent in the development of new business lines and business strategies; financial performance of our joint ventures and investments; integration of acquired operations; uncertainties associated with product and service development and market acceptance, including the development and provision of programming for new television and telecommunications technologies; changes in the distribution and viewing of television programming, including the expanded deployment of personal video recorders, video on demand, internet protocol television, mobile devices and personal tablets and their impact on television advertising revenue; rapid technological changes; future financial performance, including availability, terms, and deployment of capital; fluctuations in foreign currency exchange rates and political unrest in international markets; the ability of suppliers and vendors to deliver products, equipment, software, and services; the outcome of any pending or threatened litigation; availability of qualified personnel; the possibility of an industry-wide strike or other job action affecting a major entertainment industry union, or the duration of any existing strike or job action; changes in, or failure or inability to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission and adverse outcomes from regulatory proceedings; changes in the nature of key strategic relationships with partners and joint venture partners; competitor responses to our products and services and the products and services of the entities in which we have interests; threatened terrorist attacks and ongoing military action in the Middle East and other parts of the world; reduced access to capital markets or significant increases in costs to borrow; and a failure to secure affiliate agreements or renewal of such agreements on less favorable terms. For additional risk factors, refer to Item 1A, “Risk Factors,” in our 2010 Form 10-K. These forward-looking statements and such risks, uncertainties, and other factors speak only as of the date of this Quarterly Report and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based.

BUSINESS OVERVIEW

We are a global nonfiction media and entertainment company that provides programming across multiple distribution platforms throughout the world. We distribute customized programming in over 40 languages in the U.S. and over 200 other countries and territories. Our global portfolio of networks includes prominent television brands such as Discovery Channel, one of the first nonfiction networks and our most widely distributed global brand, TLC, Animal Planet, Science Channel, and Investigation Discovery. We also have a diversified portfolio of websites and other digital media services, develop and sell curriculum-based products and services, and provide postproduction audio services.

Our objective is to invest in content for our networks to build viewership, optimize distribution revenue and capture advertising sales, and to create or reposition additional branded channels and businesses that can sustain long-term growth and occupy a desired programming niche with strong consumer appeal. Our strategy is to optimize the distribution, ratings, and profit potential of each of our branded networks. In addition to growing distribution and advertising revenue for our branded networks, we are extending content distribution across new distribution platforms, including brand-aligned websites, mobile devices, video-on-demand (“VOD”), and broadband channels, which provide promotional platforms for our television programming and serve as additional outlets for advertising and affiliate sales.

Our content spans genres including science, exploration, survival, natural history, sustainability of the environment, technology, docu-series, anthropology, paleontology, history, space, archaeology, health and wellness, engineering, adventure, lifestyles, forensics, civilization, and current events. A significant portion of our programming tends to be culturally neutral and maintains its relevance for an extended period of time. As a result, a significant amount of our content translates well across international borders and is made even more accessible through extensive use of dubbing and subtitles in local languages, as well as the creation of local programming tailored to individual market preferences.

We have an extensive library of programming and footage and ongoing content production that provide a source of content for creating new services and launching into new markets and onto new platforms. We own all or most rights to the majority of our programming and footage, which enables us to exploit our library to launch new brands and services into new markets quickly. Our programming can be re-edited and updated in a cost-effective manner to provide topical versions of subject matter that can be utilized around the world.

Our media content is designed to target key audience demographics and the popularity of our programming creates a reason for advertisers to purchase commercial time on our channels. Audience ratings are a key driver in generating advertising revenue and creating demand on the part of cable television operators, direct-to-home (“DTH”) satellite operators, and other content distributors to deliver our programming to their customers.

We classify our operations in three segments: U.S. Networks, consisting principally of domestic cable and satellite television networks, websites, and other digital media services; International Networks, consisting primarily of international cable and satellite television networks and websites; and Education and Other, consisting principally of curriculum-based product and service offerings and postproduction audio services.

U.S. Networks

U.S. Networks generated net revenues of $660 million and $1.2 billion during the three and six months ended June 30, 2011, respectively, which represented 62% of our total consolidated net revenues for both periods. This segment wholly owns and operates nine national television networks, principally throughout the U.S., including prominent television brands such as Discovery Channel, TLC, and Animal Planet. In addition, this segment has interests in OWN: Oprah Winfrey Network (“OWN”), The Hub, and 3net, which are joint venture operated networks. We account for our interests in the underlying joint ventures using the equity method of accounting.

On January 1, 2011, we contributed the domestic Discovery Health network to OWN. The contribution included affiliate relationships with cable operators and DTH satellite service providers, content licenses, and website user information. The contribution did not impact our ownership interest, voting control, or governance rights related to OWN. We recorded the contribution at fair value, which resulted in a pretax gain of $129 million. The gain resulted in $27 million of tax expense.

Following the contribution, we no longer consolidate the domestic Discovery Health network. Additionally, net losses generated by OWN are allocated to both joint venture partners based on their proportionate ownership interests, which are 50-50. Previously, we recognized 100% of OWN’s net losses. Future net income generated by OWN will initially be allocated 100% to us up to the amount of net losses previously recognized by us prior to the contribution. After we have recouped our losses, any excess net income will be allocated to both joint venture partners based on their proportionate ownership interests.

U.S. Networks generates revenues from fees charged to operators who distribute our networks, which primarily include cable and DTH satellite service providers, and from advertising sold on our television networks, websites, and other digital media services. Distribution fees are based on the number of subscribers receiving our programming. Distribution revenues are recognized net of incentives we provide to operators in exchange for carrying our networks. Incentives typically include cash payments to operators (“launch incentives”), providing the channel to the distributor for free for a predetermined length of time, or both. Launch incentives are capitalized as assets upon launch of our network by the operator and are amortized on a straight-line basis as a reduction of revenue over the term of the contract, including free periods. Advertising revenues are dependent upon a number of factors including the number of subscribers to our channels, viewership demographics, the popularity of our programming, and our ability to sell commercial time over a group of channels. Our U.S. Networks segment also generates revenues from affiliate and advertising sales representation services for third-party and joint venture networks and the licensing of our brands for consumer products. During the three months ended June 30, 2011, advertising, distribution, and other revenues were 55%, 41%, and 4%, respectively, of total net revenues for this segment. During the six months ended June 30, 2011, advertising, distribution, and other revenues were 52%, 44%, and 4%, respectively, of total net revenues for this segment. The Discovery Channel, TLC, and Animal Planet collectively generated 75% of U.S. Networks’ total net revenues for the three and six months ended June 30, 2011.

U.S. Networks’ largest single cost is the cost of programming, including production costs for original programming. U.S. Networks amortizes the cost of capitalized content rights based on the proportion that current estimated revenues bear to the estimated remaining total lifetime revenues, which results in either an accelerated method or a straight-line method over the estimated useful lives.

International Networks

International Networks generated net revenues of $368 million and $691 million during the three and six months ended June 30, 2011, respectively, which represented 34% of our total consolidated net revenues. International Networks consists of national and pan-regional television networks and a portfolio of websites. International Networks owns and operates a portfolio of television networks, led by Discovery Channel and Animal Planet, which are distributed in virtually every pay-television market in the world through an infrastructure that includes operational centers in London, Singapore, and Miami. This segment has one of the largest international distribution platforms with two to thirteen networks in more than 200 countries and territories around the world. At June 30, 2011, International Networks operated over 140 unique distribution feeds in over 40 languages with channel feeds customized according to language needs and advertising sales opportunities.

The International Networks segment continues to pursue international expansion in select areas. For example, in 2010, we began the international rollout of TLC as a female-targeted global flagship, and have launched TLC in over 30 countries and territories in Europe and Asia, with additional launches planned. In addition, on November 12, 2010, we acquired the remaining 50% interest in substantially all of the international Animal Planet and Liv (formerly People + Arts) networks from our joint venture partner, the BBC, giving us 100% ownership of these networks. Previously, these networks were operated as 50-50 joint ventures between us and the BBC. We determined that we were the primary beneficiary of the joint ventures with the BBC, and therefore, consolidated these joint ventures prior to the acquisition. With this acquisition, we wholly own and operate most of our international television networks, except for channels in Japan and Canada, which are operated by joint ventures with strategically important local partners. We anticipate that international expansion will continue to be an area of focus.

On February 17, 2010, we acquired all interests in an uplink facility in London, including its employees and operations, for a payment of $35 million. The uplink facility has been included in the International Networks segment operating results since the date of acquisition.

On September 1, 2010, we sold Antenna Audio Limited, which was a component of our International Networks segment.

Effective January 1, 2011, we realigned our International Networks reporting structure into the following four regions: Western Europe, which includes the United Kingdom (“U.K.”) and western European countries; Central and Eastern Europe, Middle East, and Africa (“CEEMEA”); Latin America; and Asia-Pacific. Previously, International Networks’ regional operations reported into the following four regions: the U.K.; Europe (excluding the U.K.), Middle East, and Africa (“EMEA”); Asia-Pacific; and Latin America. This realignment did not impact the Company’s consolidated financial statements other than to change the regions in which we describe our operating results for the International Networks segment.

Similar to our U.S. Networks segment, the primary sources of revenues for International Networks are fees charged to operators who distribute our networks, which primarily include cable and DTH satellite service providers, and from advertising sold on our television networks and websites. Distribution fees are based on the number of subscribers receiving our programming and are recognized net of launch incentives. International Networks executes a localization strategy by offering shared programming with U.S. Networks, customized content, and localized schedules via our distribution feeds. International television markets vary in their stages of development. Some, notably the U.K., are more advanced digital multi-channel television markets, while others remain in the analog environment with varying degrees of investment from operators in expanding channel capacity or converting to digital. Advertising revenues are dependent upon a number of factors including the stage of development of pay television markets, number of subscribers to our channels, viewership demographics, the popularity of our programming, and our ability to sell commercial time over a group of channels. In developing pay television markets, we expect advertising revenue growth will result from subscriber growth, our localization strategy, and the shift of advertising spending from broadcast to pay television. In relatively mature markets, such as Western Europe, the growth dynamic is changing. Increased market penetration and distribution are unlikely to drive rapid growth in those markets. Instead, growth in advertising sales will come from increasing viewership and advertising pricing on our existing pay television networks and launching new services, either in pay television or free television environments. During the three months ended June 30, 2011, distribution, advertising, and other revenues were 60%, 36%, and 4%, respectively, of total net revenues for this segment. During the six months ended June 30, 2011, distribution, advertising, and other revenues were 62%, 34%, and 4%, respectively, of total net revenues for this segment.

International Networks’ largest cost is programming, which is acquired from our U.S. Networks segment or through production, coproduction, or license arrangements with third parties. While our International Networks segment maximizes the use of

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