Form 10-Q
Table of Contents

 

 

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 March 31, 2012

OR

 

¨ 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):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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 April 30, 2012:

 

Series A Common Stock, par value $0.01 per share

     145,917,994   

Series B Common Stock, par value $0.01 per share

     6,570,067   

Series C Common Stock, par value $0.01 per share

     102,462,631   

 

 

 


Table of Contents

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 March 31, 2012 and December 31, 2011.

     3   

Consolidated Statements of Operations for the Three Months Ended March 31, 2012 and 2011.

     4   

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011.

     5   

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011.

     6   

Consolidated Statements of Equity for the Three Months Ended March 31, 2012 and 2011.

     7   

Notes to Consolidated Financial Statements.

     8   

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

     32   

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

     43   

ITEM 4. Controls and Procedures.

     43   

PART II. OTHER INFORMATION.

     44   

ITEM 1. Legal Proceedings.

     44   

ITEM 1A. Risk Factors.

     44   

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

     44   

ITEM 6. Exhibits.

     45   

SIGNATURES.

     46   


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements.

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited; in millions, except par value)

 

     March 31,
2012
    December 31,
2011
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 1,044      $ 1,048   

Receivables, net

     1,062        1,042   

Content rights, net

     99        93   

Deferred income taxes

     72        73   

Prepaid expenses and other current assets

     174        175   
  

 

 

   

 

 

 

Total current assets

     2,451        2,431   

Noncurrent content rights, net

     1,334        1,302   

Property and equipment, net

     374        379   

Goodwill

     6,294        6,291   

Intangible assets, net

     567        571   

Equity method investments

     778        807   

Other noncurrent assets

     137        132   
  

 

 

   

 

 

 

Total assets

   $ 11,935      $ 11,913   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 63      $ 53   

Accrued expenses and other current liabilities

     567        554   

Deferred revenues

     91        113   

Current portion of long-term debt

     19        26   
  

 

 

   

 

 

 

Total current liabilities

     740        746   

Long-term debt

     4,218        4,219   

Deferred income taxes

     321        337   

Other noncurrent liabilities

     88        92   
  

 

 

   

 

 

 

Total liabilities

     5,367        5,394   

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

     1        1   

Series C convertible preferred stock: $0.01 par value; 75 shares authorized; 57 shares issued

     1        1   

Series A common stock: $0.01 par value; 1,700 shares authorized; 146 and 142 shares issued

     1        1   

Series B convertible common stock: $0.01 par value; 100 shares authorized; 7 shares issued

     —          —     

Series C common stock: $0.01 par value; 2,000 shares authorized; 142 shares issued

     2        2   

Additional paid-in capital

     6,609        6,505   

Treasury stock, at cost: 37 and 30 Series C common shares

     (1,390     (1,102

Retained earnings

     1,353        1,132   

Accumulated other comprehensive loss

     (12     (23
  

 

 

   

 

 

 

Total Discovery Communications, Inc. stockholders’ equity

     6,565        6,517   

Noncontrolling interests

     3        2   
  

 

 

   

 

 

 

Total equity

     6,568        6,519   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 11,935      $ 11,913   
  

 

 

   

 

 

 

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

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; in millions, except per share amounts)

 

     Three Months Ended March 31,  
     2012     2011  

Revenues:

  

Distribution

   $ 576      $ 484   

Advertising

     453        392   

Other

     74        75   
  

 

 

   

 

 

 

Total revenues

     1,103        951   
  

 

 

   

 

 

 

Costs and expenses:

    

Costs of revenues, excluding depreciation and amortization

     311        273   

Selling, general and administrative

     315        269   

Depreciation and amortization

     30        30   

Restructuring charges

     1        1   

Gain on disposition

     —          (129
  

 

 

   

 

 

 

Total costs and expenses

     657        444   
  

 

 

   

 

 

 

Operating income

     446        507   

Interest expense

     (55     (49

Other expense, net

     (50     (7
  

 

 

   

 

 

 

Income before income taxes

     341        451   

Provision for income taxes

     (119     (146
  

 

 

   

 

 

 

Net income

     222        305   

Net income attributable to noncontrolling interests

     (1     —     
  

 

 

   

 

 

 

Net income available to Discovery Communications, Inc. stockholders

   $ 221      $ 305   
  

 

 

   

 

 

 

Net income per share available to Discovery Communications, Inc. stockholders:

    

Basic

   $ 0.57      $ 0.75   
  

 

 

   

 

 

 

Diluted

   $ 0.57      $ 0.74   
  

 

 

   

 

 

 

Weighted average shares outstanding:

    

Basic

     386        409   
  

 

 

   

 

 

 

Diluted

     390        414   
  

 

 

   

 

 

 

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

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited; in millions)

 

     Three Months Ended March 31,  
     2012     2011  

Net income

   $ 222      $ 305   

Other comprehensive income, net of tax:

    

Foreign currency translation adjustments

     11        17   
  

 

 

   

 

 

 

Comprehensive income

     233        322   

Comprehensive income attributable to noncontrolling interests

     (1     —     
  

 

 

   

 

 

 

Comprehensive income attributable to Discovery Communications, Inc. stockholders

   $ 232      $ 322   
  

 

 

   

 

 

 

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

 

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DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in millions)

 

     Three Months Ended March 31,  
     2012     2011  

Operating Activities

    

Net income

   $ 222      $ 305   

Adjustments to reconcile net income to cash provided by operating activities:

    

Equity-based compensation expense

     41        17   

Depreciation and amortization

     30        30   

Content amortization and impairment expense

     207        185   

Gain on disposition

     —          (129

Equity in losses and distributions from investee companies

     58        13   

Other, net

     (11     52   

Changes in operating assets and liabilities:

    

Receivables, net

     (29     14   

Content rights

     (226     (208

Accounts payable and accrued liabilities

     (23     (69

Equity-based compensation liabilities

     (24     (66

Income tax receivable

     20        110   

Other, net

     (17     (37
  

 

 

   

 

 

 

Cash provided by operating activities

     248        217   

Investing Activities

    

Purchases of property and equipment

     (21     (11

Distribution from equity method investees

     17        —     

Investments in and advances to equity method investees

     (38     (57

Other investing activities, net

     —          (2
  

 

 

   

 

 

 

Cash used in investing activities

     (42     (70

Financing Activities

    

Principal repayments of capital lease obligations

     (10     (10

Repurchases of common stock

     (288     (167

Cash distributions to noncontrolling interests

     —          (5

Proceeds from stock option exercises

     57        10   

Excess tax benefits from equity-based compensation

     30        4   

Other financing activities, net

     (2     —     
  

 

 

   

 

 

 

Cash used in financing activities

     (213     (168

Effect of exchange rate changes on cash and cash equivalents

     3        8   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (4     (13

Cash and cash equivalents, beginning of period

     1,048        466   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 1,044      $ 453   
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Cash (paid) received for taxes, net

   $ (38   $ 6   
  

 

 

   

 

 

 

Cash paid for interest

   $ (16   $ (21
  

 

 

   

 

 

 

Noncash Investing and Financing Transactions

    

Investment in OWN

   $ 6      $ 273   
  

 

 

   

 

 

 

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

 

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DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(unaudited; in millions)

 

     Three Months Ended March 31, 2012     Three Months Ended March 31, 2011  
     Discovery
Stockholders
    Noncontrolling
Interests
     Total Equity     Discovery
Stockholders
    Noncontrolling
Interests
    Total Equity  

Beginning balance

   $ 6,517      $ 2       $ 6,519      $ 6,225      $ 8      $ 6,233   

Comprehensive income

     232        1         233        322        —          322   

Equity-based compensation

     18        —           18        14        —          14   

Excess tax benefits from equity-based compensation

     30        —           30        4        —          4   

Issuance of common stock in connection with equity-based plans

     56        —           56        10        —          10   

Repurchases of common stock

     (288     —           (288     (167     —          (167

Cash distributions to noncontrolling interests

     —          —           —          —          (5     (5
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,565      $ 3       $ 6,568      $ 6,408      $ 3      $ 6,411   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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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 education products and services as well as postproduction audio services. The Company classifies its operations in three segments: U.S. Networks, consisting principally of domestic television networks, websites and other digital media services; International Networks, consisting primarily of international television networks and websites; and Education and Other, consisting principally of curriculum-based education product and service offerings and postproduction audio services. Financial information for Discovery’s reportable segments is discussed in Note 14.

Basis of Presentation

The consolidated financial statements include the accounts of Discovery and its majority-owned subsidiaries in which a controlling interest is maintained. Inter-company accounts and transactions between consolidated entities have been eliminated in consolidation.

Reclassifications

Beginning July 1, 2011, the Company expanded the types of revenue included in distribution revenue in its consolidated statements of operations to include fees charged for certain licensing arrangements, including those for digital streaming of library content, and reclassified prior year amounts. Such fees, which totaled $4 million for the three months ended March 31, 2011, were previously classified as other revenue and have been reclassified to distribution revenue to conform to the current presentation.

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, 2011 (the “2011 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 re-evaluates its estimates, judgments and assumptions, and management’s assessments could change. Actual results may differ from those estimates and could have a material impact on the consolidated financial statements.

Significant estimates inherent in the preparation of the consolidated financial statements include accounting for asset impairments, revenue recognition, allowances for doubtful accounts, content rights, depreciation and amortization, business combinations, equity-based compensation, income taxes, contingencies, and the determination of whether the Company is the primary beneficiary of entities in which it holds variable interests.

Accounting and Reporting Pronouncements Adopted

Fair Value Measurements

In May 2011, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued guidance which results in a consistent definition between GAAP and International Financial Reporting Standards (“IFRS”) of fair value and common requirements for measurement of and disclosure about fair value. There are several changes under the new

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

guidance. The highest and best use valuation concepts are only relevant when measuring the fair value of nonfinancial assets. The prohibition of the application of a blockage factor extends to all financial measurements. The Company must disclose quantitative information about unobservable inputs used to assess fair value and provide a qualitative discussion about the sensitivity of the measurements for recurring Level 3 fair value measurements. The Company prospectively adopted the new guidance effective January 1, 2012. The adoption of the new guidance did not have a material impact 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 Company retrospectively adopted the new guidance effective January 1, 2012. The Company elected to present comprehensive income in a separate statement.

Concentrations Risk

Customers

The Company has long-term contracts with distributors around the world, including the largest operators in the U.S. and major international distributors. In the U.S., approximately 90% of distribution revenue comes from the top 10 distributors. Outside of the U.S., less than 50% of distribution revenue comes from the top 10 distributors. Agreements with the Company’s major cable and satellite customers expire at various times beginning in 2012 through 2020. At the end of 2012, several of the top 10 U.S. distribution arrangements will expire. Although the Company intends to renew these agreements with its distributors, failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on the Company’s results of operations and financial condition. Not only could the Company experience a reduction in affiliate revenue, but it could also experience a reduction in advertising revenue which is impacted by affiliate subscriber levels and viewership.

No individual customer accounted for more than 10% of total consolidated revenues for the three months ended March 31, 2012 or 2011. The Company’s trade receivables do not represent a significant concentration of credit risk as of March 31, 2012 and December 31, 2011 due to the wide variety of customers and markets in which the Company operates and their dispersion across many geographic areas.

Financial Institutions

Cash and cash equivalents are maintained with financial institutions such as banks and money market mutual funds. 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

There is a risk that the counterparties associated with the Company’s revolving credit facility will not be available to fund as obligated under the term of the facility. If funding under the revolving credit facility is unavailable, the Company may have to acquire a replacement credit facility from a different counterparty at a higher cost or may be unable to find a suitable replacement. Typically, the Company seeks to manage these exposures by contracting with experienced large financial institutions and monitoring the credit quality of its lenders. As of March 31, 2012, the Company did not anticipate nonperformance by any of its counterparties.

NOTE 2. ACQUISITIONS AND DISPOSITIONS

Acquisitions

On December 29, 2011, Discovery acquired a Latin American cable channel to increase distribution of TLC content. During the three months ended March 31, 2012, Discovery acquired additional affiliate contracts associated with the cable channel for $5 million payable in December 2014.

On November 2, 2011, Discovery acquired a non-fiction entertainment production company in the U.K. to develop content for its international networks.

 

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DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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 a pretax gain of $129 million (see 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.

NOTE 3. VARIABLE INTEREST ENTITIES

In the normal course of business, the Company 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, an investment may qualify as a variable interest entity (“VIE”). As of March 31, 2012 and December 31, 2011, the Company’s VIEs primarily consisted of Hub Television Networks LLC and OWN LLC, which operate pay-television networks.

As of March 31, 2012 and December 31, 2011, the Company accounted for its interests in VIEs using the equity method. The aggregate carrying values of these equity method investments were $772 million and $807 million as of March 31, 2012 and December 31, 2011, respectively. During the three months ended March 31, 2012 and 2011, the Company recognized losses of $48 million and $10 million, respectively, for its portion of net losses generated by VIEs accounted for using the equity method, which were recorded in other expense, net in the consolidated statements of operations.

As of March 31, 2012, the Company’s estimated risk of loss for investments in VIEs was approximately $799 million, which includes the carrying value of its investments, the unfunded portion of contractual funding commitments to equity method investees, and guarantees made on behalf of equity method investees. Actual amounts funded to OWN have exceeded contractual funding commitments, and the Company intends to continue to fund significant amounts to OWN. The Company has not recorded any obligations for future funding. The estimated risk of loss excludes the Company’s operating performance guarantee for Hub Television Networks LLC disclosed below.

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. The Company is obligated to provide The Hub with funding up to $15 million and services such as distribution, sales and administrative support for a fee (see Note 12). The Company has not provided funding as of March 31, 2012.

Based upon the level of equity investment at risk, The Hub is a VIE. Discovery and its partner, Hasbro Inc. (“Hasbro”), consent to decisions about programming and marketing strategy and thereby direct the activities of The Hub that most significantly impact its economic performance. The partners share equally in voting control and jointly consent to operating, financing and investing decisions. Neither has special governance rights, and both are equally represented on the board of The Hub. The partners also share equally in the profits, losses and funding of The Hub. The Company has determined that it is not the primary beneficiary of The Hub. Accordingly, the Company accounts for its investment in The Hub using the equity method.

Through December 31, 2015, the Company has guaranteed a certain level of performance for The Hub that requires compensation to Hasbro to the extent that distribution metrics decline versus levels historically achieved by the Discovery Kids channel. This guarantee extends on a declining basis through the period of guarantee. Upon inception of The Hub, the maximum amount potentially due under this guarantee was $300 million. As of March 31, 2012, the maximum amount potentially due under this guarantee was less than $150 million. The maximum exposure to loss is expected to decline to zero during 2015. As The Hub’s distribution is generally provided under long-term contracts with stable subscriber levels, the Company believes the likelihood is remote that the performance levels will not be achieved and, therefore, the performance guarantee is unlikely to have a material adverse impact on the Company. Accordingly, the fair value of the guarantee was not material as of March 31, 2012.

The carrying values of the Company’s investment in The Hub were $326 million and $334 million as of March 31, 2012 and December 31, 2011, respectively. Given that the 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 continues to monitor the valuation of its investment in accordance with GAAP, which requires an impairment charge when there is an other-than-temporary decline in the investment’s value. No impairment was recorded for the three months ended March 31, 2012.

 

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DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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. In connection with the launch of OWN on January 1, 2011, the Company contributed the domestic Discovery Health network to the venture. The contribution did not impact the Company’s ownership interest, voting control or governance rights related to OWN. Subsequent to the contribution, the Company no longer consolidates the domestic Discovery Health network, which was a component of its U.S. Networks segment. The assets of the Discovery Health network 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 and tax expense of $27 million. The fair value of the Company’s retained equity interest in OWN was estimated to be $273 million. The gain represents the fair value of the equity investment retained less the carrying values of contributed assets. The fair value of the contribution of the Discovery Health network to OWN was determined utilizing customary valuation methodologies including discounted cash flow valuation models. 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 Company provides OWN funding and services such as distribution, licensing, sales and administrative support for a fee (see Note 12). As of March 31, 2012, the Company’s note receivable from OWN was $358 million, including funding of $328 million and interest accrued on outstanding borrowings of $30 million, which is in excess of the funding commitment of $189 million. The funding is secured by the net assets of OWN. While the Company expects to provide significant additional funding to OWN, the Company also expects to recoup amounts funded. The funding to OWN accrues interest at 7.5% compounded annually. There can be no event of default on the borrowing until 2023. However, borrowings are scheduled for repayment four years after the borrowing date to the extent that OWN has excess cash to repay the borrowings then due. 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 Inc. (“Harpo”).

Based upon the level of equity investment at risk, OWN is a VIE. While the partners share equally in voting control, power is not shared because certain activities that significantly impact OWN’s economic performance are directed by Harpo. Harpo holds operational rights related to programming and marketing, as well as selection and retention of key management personnel. The Company has determined that it is not the primary beneficiary of OWN because it does not control activities that are critical to OWN’s operating performance and success. Accordingly, the Company accounts for its investment in OWN using the equity method.

In accordance with the venture agreement, losses generated by OWN are generally allocated to both investors based on their proportionate ownership interests which are 50-50. However, the Company has recorded its portion of OWN’s losses based upon accounting policies for equity method investments. Prior to the contribution of the Discovery Health network to OWN at its launch, the Company recognized $104 million or 100% of OWN’s net losses. During the three months ended March 31, 2012, accumulated operating losses at OWN exceeded the equity contributed to OWN, and Discovery began to record 100% of OWN’s net losses in other expense, net in the consolidated statements of operations. The Company will continue to record 100% of operating losses as long as Discovery provides all funding to OWN and OWN’s accumulated losses continue to exceed the equity contributed. Future net income generated by OWN will initially be allocated 100% to the Company until losses absorbed in excess of Discovery’s equity ownership interest are recovered.

The carrying value of the Company’s investment in OWN, including its equity method investment and note receivable balance, was $412 million and $420 million as of March 31, 2012 and December 31, 2011, respectively. Given that the early results of OWN’s operations have been below its initial business plan, there is a possibility that the results of OWN’s future operations will fall below the revised long-term projections. The Company continues to monitor the financial results of OWN along with other relevant business information to assess the recoverability of the OWN note receivable and determine whether there is impairment of the Company’s equity investment in OWN. No impairment was recorded for the three months ended March 31, 2012.

Harpo has the right to require the Company to purchase all or part of Harpo’s interest in OWN every two and one half years commencing on January 1, 2016 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. The Company has recorded no amounts for the put right.

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 4. FAIR VALUE MEASUREMENTS

Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified in the following three categories:

 

Level 1

      Quoted prices for identical instruments in active markets.

Level 2

      Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3

      Valuations derived from valuation techniques in which one or more significant inputs are unobservable.

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

 

          March 31, 2012  

Category

  

Balance Sheet Location

   Level 1      Level 2      Level 3      Total  

Assets:

              

Trading securities: mutual funds

   Prepaid expenses and other current assets    $ 91       $ —         $ —         $ 91  

Available-for-sale securities: money market mutual funds

   Cash and cash equivalents      640         —           —           640   
     

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

      $ 731       $ —         $ —         $ 731   
     

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

              

Deferred compensation plan

   Accrued expenses and other current liabilities    $ 91       $ —         $ —         $ 91   
     

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

      $ 91       $ —         $ —         $ 91   
     

 

 

    

 

 

    

 

 

    

 

 

 
          December 31, 2011  

Category

  

Balance Sheet Location

   Level 1      Level 2      Level 3      Total  

Assets:

              

Trading securities: mutual funds

   Prepaid expenses and other current assets    $ 76       $ —         $ —         $ 76   

Available-for-sale securities: money market mutual funds

   Cash and cash equivalents      635         —           —           635   
     

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

      $ 711       $ —         $ —         $ 711   
     

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

              

Deferred compensation plan

   Accrued expenses and other current liabilities    $ 76       $ —         $ —         $ 76   
     

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

      $ 76       $ —         $ —         $ 76   
     

 

 

    

 

 

    

 

 

    

 

 

 

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.

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 senior notes using quoted market prices, which are Level 1 inputs, was $4.7 billion and $4.6 billion as of March 31, 2012 and December 31, 2011, respectively.

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 5. CONTENT RIGHTS

Content rights consisted of the following (in millions).

 

     March 31,
2012
    December 31,
2011
 

Produced content rights:

    

Completed

   $ 2,366      $ 2,257   

In-production

     235        221   

Coproduced content rights:

    

Completed

     507        491   

In-production

     84        80   

Licensed content rights:

    

Acquired

     394        346   

Prepaid

     15        21   
  

 

 

   

 

 

 

Content rights, at cost

     3,601        3,416   

Accumulated amortization

     (2,168     (2,021
  

 

 

   

 

 

 

Total content rights, net

     1,433        1,395   

Current portion

     (99     (93
  

 

 

   

 

 

 

Noncurrent portion

   $ 1,334      $ 1,302   
  

 

 

   

 

 

 

Content expense, which consists of content amortization, impairments and other production charges included in the cost of revenues in the consolidated statements of operations, was $243 million and $212 million for the three months ended March 31, 2012 and 2011, respectively.

NOTE 6. DEBT

Outstanding debt consisted of the following (in millions).

 

     March 31,
2012
    December 31,
2011
 

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        650   

6.35% Senior Notes, semi-annual interest, due June 2040

     850        850   

Capital lease obligations

     97        106   
  

 

 

   

 

 

 

Total long-term debt

     4,247        4,256   

Unamortized discount

     (10     (11
  

 

 

   

 

 

 

Long-term debt, net

     4,237        4,245   

Current portion of long-term debt

     (19     (26
  

 

 

   

 

 

 

Noncurrent portion of long-term debt

   $ 4,218      $ 4,219   
  

 

 

   

 

 

 

In addition to the debt instruments listed in the table above, the Company also has access to a $1.0 billion revolving credit facility. There were no amounts drawn under the revolving credit facility as of March 31, 2012 and December 31, 2011. If the Company were to draw on the revolving credit facility, outstanding balances would bear interest at a variable rate determined pursuant to the lending agreement. Balances outstanding under the revolving credit facility would be due on the expiration date which is October 12, 2015.

The Company was in compliance with all covenants and there were no events of default as of March 31, 2012 and December 31, 2011.

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 7. EQUITY

Stock Repurchase Program

As of March 31, 2012, the Company had been authorized by the Board of Directors to purchase a total of $2.0 billion of its common stock under its repurchase program. On April 25, 2012, the Company’s Board of Directors approved an additional $1.0 billion under the stock repurchase program. The repurchase program has no expiration date, although the additional authorization of $1.0 billion to the repurchase program will expire on April 25, 2014. During the three months ended March 31, 2012 and 2011, the Company repurchased 6.90 million and 4.73 million shares, respectively, of its Series C common stock for an aggregate purchase price of $288 million and $167 million, respectively, through open market transactions. The repurchases were funded using cash on hand. As of March 31, 2012, the Company had remaining authorization of $610 million for future repurchases of its common stock. The stock repurchases were recorded in treasury stock which reduces equity.

Other Comprehensive Income

The tax effects related to the component of other comprehensive income were as follows (in millions).

 

Net Change in Net Change in Net Change in
     Before-tax
Amount
     Tax
Expense
    Net-of-tax
Amount
 

Three Months Ended March 31, 2012:

       

Currency translation adjustments

   $ 18       $ (7   $ 11   
  

 

 

    

 

 

   

 

 

 

Other comprehensive income

   $ 18       $ (7   $ 11   
  

 

 

    

 

 

   

 

 

 

Three Months Ended March 31, 2011:

       

Currency translation adjustments

   $ 27       $ (10   $ 17   
  

 

 

    

 

 

   

 

 

 

Other comprehensive income

   $ 27       $ (10   $ 17   
  

 

 

    

 

 

   

 

 

 

The changes in the components of accumulated other comprehensive loss, net of taxes, were as follows (in millions).

 

Net Change in Net Change in Net Change in
     Foreign
Currency
    Net Change in
Derivatives
and Market
Value
Adjustments
     Accumulated
Other
Comprehensive
Loss
 

Three Months Ended March 31, 2012:

       

Beginning balance

   $ (29   $ 6       $ (23

Current period other comprehensive income

     11        —           11   
  

 

 

   

 

 

    

 

 

 

Ending balance

   $ (18   $ 6       $ (12
  

 

 

   

 

 

    

 

 

 

Three Months Ended March 31, 2011:

       

Beginning balance

   $ (39   $ 6       $ (33

Current period other comprehensive income

     17        —           17   
  

 

 

   

 

 

    

 

 

 

Ending balance

   $ (22   $ 6       $ (16
  

 

 

   

 

 

    

 

 

 

 

14


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 8. EQUITY-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. During the three months ended March 31, 2012, the vesting and service requirements of equity-based awards granted were consistent with the arrangements disclosed in the 2011 Form 10-K.

Equity-Based Compensation Expense

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

 

     Three Months Ended March 31,  
     2012      2011  

Unit awards

   $ 20       $ 3   

Stock options

     11         10   

PRSUs and RSUs

     7         4   

SARs

     3         —     
  

 

 

    

 

 

 

Total equity-based compensation expense

   $ 41       $ 17   
  

 

 

    

 

 

 

Tax benefit recognized

   $ 15       $ 6   
  

 

 

    

 

 

 

Compensation expense for all awards was recorded in selling, general and administrative expense in the consolidated statements of operations. As of March 31, 2012 and December 31, 2011, the Company recorded total liabilities for cash-settled awards of $36 million and $37 million, respectively.

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Equity-Based Award Activity

Unit Awards

Unit award activity was as follows (in millions, except years and weighted-average grant price).

 

     Unit Awards     Weighted
Average
Grant
Price
     Weighted
Average
Remaining
Contractual

Term
(years)
     Aggregate
Intrinsic
Value
 

Outstanding as of December 31, 2011

     5.5      $ 31.44         

Granted

     —          —           

Settled

     (1.8     29.16          $ 24   

Forfeited

     —          —           
  

 

 

         

Outstanding as of March 31, 2012

     3.7      $ 31.91         1.28       $ 62   
  

 

 

         

Vested and expected to vest as of March 31, 2012

     3.5      $ 32.52         1.28       $ 59   
  

 

 

         

Unit awards represent the contingent right to receive a cash payment for the amount by which the vesting price exceeds the grant price. Because unit awards are cash-settled, the Company remeasures the fair value and compensation expense of outstanding unit awards each reporting date until settlement. As of March 31, 2012, the weighted-average fair value of unit awards outstanding was $18.52 per unit award. The Company made cash payments to settle vested unit awards totaling $24 million and $66 million during the three months ended March 31, 2012 and 2011, respectively. As of March 31, 2012, there was $34 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 1.83 years.

Stock Options

Stock option activity was as follows (in millions, except years and weighted-average grant price).

 

     Stock Options     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual

Term
(years)
     Aggregate
Intrinsic
Value
 

Outstanding as of December 31, 2011

     12.7      $ 22.52         

Granted

     0.9        47.70         

Exercised

     (3.5     16.81          $ 104   

Forfeited

     (0.1     28.06         
  

 

 

         

Outstanding as of March 31, 2012

     10.0      $ 26.78         5.62       $ 240   
  

 

 

         

Vested and expected to vest as of March 31, 2012

     9.8      $ 26.39         5.65       $ 237   
  

 

 

         

Exercisable as of March 31, 2012

     4.2      $ 20.51         4.97       $ 125   
  

 

 

         

The Company received cash payments from the exercise of stock options totaling $57 million and $10 million during the three months ended March 31, 2012 and 2011, respectively. The weighted average grant date fair value of stock options granted during the three months ended March 31, 2012 was $16.74 per option. The total intrinsic value of options exercised during the three months ended March 31, 2012 was $104 million. As of March 31, 2012, there was $54 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 1.69 years.

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

PRSUs and RSUs

PRSU and RSU activity was as follows (in millions, except years and weighted-average grant price).

 

     PRSUs and
RSUs
    Weighted Average
Grant
Price
     Weighted Average
Remaining
Contractual

Term
(years)
     Aggregate
Fair
Value
 

Outstanding as of December 31, 2011

     2.2      $ 35.48         

Granted

     0.8        47.87         

Converted

     (0.1     32.53          $ 5   

Forfeited

     —          —           
  

 

 

         

Outstanding as of March 31, 2012

     2.9      $ 39.42         2.11       $ 147   
  

 

 

         

Vested and expected to vest as of March 31, 2012

     2.7      $ 39.37         2.08       $ 136   
  

 

 

         

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. As of March 31, 2012, there were approximately 2 million outstanding PRSUs with a weighted-average grant price of $39.20. As of March 31, 2012, unrecognized compensation cost, net of expected forfeitures, related to PRSUs was $45 million, which is expected to be recognized over a weighted-average period of 1.79 years.

RSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service. As of March 31, 2012, there were approximately 1 million outstanding RSUs with a weighted-average grant price of $39.99. As of March 31, 2012, there was $23 million of unrecognized compensation cost, net of expected forfeitures, related to RSUs, which is expected to be recognized over a weighted-average period of 2.93 years.

SARs

There were 2 million and zero SARs outstanding as of March 31, 2012 and December 31, 2011, respectively. The Company made no cash payments to settle exercised SARs during the three months ended March 31, 2012 or 2011.

NOTE 9. INCOME TAXES

The Company’s provisions for income taxes were $119 million and $146 million, and the effective tax rates were 35% and 32% for the three months ended March 31, 2012 and 2011, respectively. The effective tax rate for the three months ended March 31, 2012 was consistent with the U.S. federal statutory income tax rate of 35% after adjustment for the incremental U.S. tax expense on the inter-company license fees established in the 2011 international reorganization and state income taxes which were offset by production activity deductions and foreign tax credit benefits. The effective tax rate for the three months ended March 31, 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 equity method investment attributable to the nondeductible goodwill contributed to OWN and production activity 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. The Company has not been advised of any material adjustments. 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.

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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 March 31,  
     2012      2011  

Numerator:

     

Net income available to Discovery Communications, Inc. stockholders

   $ 221       $ 305   

Denominator:

     

Weighted average shares outstanding — basic

     386         409   

Weighted average dilutive effect of equity awards

     4         5   
  

 

 

    

 

 

 

Weighted average shares outstanding — diluted

     390         414   
  

 

 

    

 

 

 

Income Per Share:

     

Net income per share available to Discovery Communications, Inc. stockholders:

     

Basic

   $ 0.57       $ 0.75   
  

 

 

    

 

 

 

Diluted

   $ 0.57       $ 0.74   
  

 

 

    

 

 

 

Income per share is calculated by dividing the applicable 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 of the assumed exercise of outstanding stock options and stock-settled SARs, the vesting of outstanding service based RSUs, and the expected shares issued under the Discovery Communications, Inc. 2011 Employee Stock Purchase Plan 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.

At March 31, 2012 and 2011, the weighted average number of basic and diluted shares outstanding included the Company’s outstanding Series A, Series B and Series C common stock, as well as its outstanding Series A and Series C convertible preferred stock, as the holder of each common and preferred series legally participates equally in any per share distributions.

For the three months ended March 31, 2012, the computation of diluted income per share excluded 2 million options because their inclusion would have been anti-dilutive, 2 million PRSUs because their performance targets were not achieved, and 1 million contingently issuable preferred shares because the specific release criteria were not met. For the three months ended March 31, 2011, the computation of diluted income per share excluded 1 million options because their inclusion would have been anti-dilutive, 1 million PRSUs because their performance targets were not achieved, and 1 million contingently issuable preferred shares because the specific release criteria were not met.

 

18


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 11. SUPPLEMENTAL DISCLOSURES

Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in millions).

 

     As of March  31,
2012
     As of December 31,
2011
 

Accrued payroll and related benefits

   $ 172       $ 229   

Content rights payable

     100         86   

Accrued income taxes

     87         38   

Accrued interest

     62         25   

Current portion of equity-based compensation liabilities

     33         27   

Accrued other

     113         149   
  

 

 

    

 

 

 

Total accrued expenses and other current liabilities

   $ 567       $ 554   
  

 

 

    

 

 

 

Other Expense, Net

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

 

     Three Months Ended  March
March 31,
 
     2012     2011  

Losses from equity investees, net

   $ (48   $ (11

Other, net

     (2     4   
  

 

 

   

 

 

 

Total other expense, net

   $ (50   $ (7
  

 

 

   

 

 

 

NOTE 12. RELATED PARTY TRANSACTIONS

In the normal course of business, the Company enters into transactions with other entities that are equity method investees of the Company or who share common directorship and ownership. Transactions with these entities are considered related party transactions. The following is a description of the Company’s related parties and related party transactions.

Equity Method Investees

The Company provides equity method investees, including unconsolidated VIEs, with content licenses and services such as distribution, sales and administrative support (see Note 3). Transactions for content licenses and services provided to equity method investees totaled $26 million and $21 million for the three months ended March 31, 2012 and 2011, respectively. Of these transactions, the Company provided funding for $14 million and $8 million for the three months ended March 31, 2012 and 2011, respectively. Operating expenses for services acquired from equity method investees were $3 million for each of the three months ended March 31, 2012 and 2011.

The Company’s equity method investment balance includes a note receivable of $358 million (see Note 3). The Company records interest earnings from loans to equity method investees as a component of losses from equity method investees, net, which is a component of other expense, net in the consolidated statements of operations. Interest earnings from related parties recorded by the Company totaled $6 million and $3 million for the three months ended March 31, 2012 and 2011, respectively.

Liberty Global, Liberty Interactive, and Liberty Media

The Company’s other related parties include entities that share common directorship or ownership. The majority of the revenue earned under contractual arrangements with other related parties relates to multi-year network distribution arrangements.

 

19


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Discovery’s Board of Directors includes three members who serve as directors of Liberty Global, Inc. (“Liberty Global”), as well as two members who serve as directors of Liberty Interactive Corporation (“Liberty Interactive” formerly known as Liberty Media Corporation) and Liberty Media Corporation (“Liberty Media” formerly known as Liberty CapStarz, Inc.). John C. Malone is Chairman of the Board of Liberty Global, Liberty Interactive and Liberty Media (collectively, the “Liberty Group”) and beneficially owns approximately 35%, 32% and 40% of the aggregate voting power with respect to the election of directors of each company, respectively. Revenue from transactions with the Liberty Group totaled $9 million for each of the three months ended March 31, 2012 and 2011. The Company’s receivable balances as of March 31, 2012 and December 31, 2011 from transactions with the Liberty Group were not material.

 

20


Table of Contents

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 programming and talent arrangements, operating and capital leases, employment contracts, sponsorship commitments, arrangements to purchase various goods and services, future funding commitments to equity method investees (see Note 3), and the obligation to issue additional preferred shares under the anti-dilution provisions of its outstanding preferred stock.

Contingencies

Put Right

Harpo has the right to require the Company to purchase its interest in OWN for fair value at various dates (see 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 (see Note 3). There were no material amounts recorded for guarantees associated with equity method investees as of March 31, 2012 and December 31, 2011.

The Company may provide indemnities intended to protect others from certain business risks. Similarly, the Company may remain contingently liable for certain obligations 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 and estimable. There were no material amounts for indemnifications or other contingencies recorded as of March 31, 2012 and December 31, 2011.

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 for consolidation are not eliminated at the segment level. In determining segment performance, inter-segment transactions are treated as third-party transactions. Inter-segment transactions, which primarily include advertising and content purchases 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 equity-based compensation, (ii) depreciation and amortization, (iii) amortization of deferred launch incentives, (iv) exit and restructuring charges, (v) certain impairment charges, and (vi) gains and 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. The Company excludes mark-to-market equity-based compensation, exit and restructuring charges, certain impairment charges, and gains and losses on business and asset dispositions from the calculation of Adjusted OIBDA due to their volatility. 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, and other measures of financial performance reported in accordance with GAAP.

 

21


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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

Revenues

 

     Three Months Ended March 31,  
     2012      2011  

U.S. Networks

   $ 681       $ 587   

International Networks

     380         323   

Education and Other

     42         41   
  

 

 

    

 

 

 

Total revenues

   $ 1,103       $ 951   
  

 

 

    

 

 

 

Adjusted OIBDA

 

     Three Months Ended March 31,  
     2012     2011  

U.S. Networks

   $ 395      $ 334   

International Networks

     171        144   

Education and Other

     5        8   

Corporate and inter-segment eliminations

     (64     (59
  

 

 

   

 

 

 

Total Adjusted OIBDA

   $   507      $ 427   
  

 

 

   

 

 

 

Reconciliation of Total Adjusted OIBDA to Consolidated Operating Income

 

     Three Months Ended March 31,  
     2012     2011  

Total Adjusted OIBDA

   $ 507      $ 427   

Amortization of deferred launch incentives

     (5     (14

Mark-to-market equity-based compensation

     (25     (4

Depreciation and amortization

     (30     (30

Restructuring charges

     (1     (1

Gain on disposition

     —          129   
  

 

 

   

 

 

 

Total operating income

   $ 446      $ 507   
  

 

 

   

 

 

 

Total Assets

 

     March 31,
2012
     December 31,
2011
 

U.S. Networks

   $ 2,689       $ 2,679   

International Networks

     1,267         1,244   

Education and Other

     61         68   

Corporate and inter-segment eliminations

     7,918         7,922   
  

 

 

    

 

 

 

Total assets

   $ 11,935       $ 11,913   
  

 

 

    

 

 

 

Total assets for corporate and inter-segment eliminations include goodwill that is allocated to the Company’s segments to account for goodwill. The presentation of segment assets in the table above is consistent with the financial reports that are reviewed by the Company’s CODM and do not allocate goodwill to the Company’s segments.

 

22


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 15. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

Overview

As of March 31, 2012 and December 31, 2011, the senior notes outstanding (see Note 6) have been issued by Discovery Communications, LLC (“DCL”), a wholly-owned subsidiary of the Company, pursuant to a Registration Statement on Form S-3 filed with the U.S. Securities and Exchange Commission (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 comprehensive income, 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 Discovery Channel and TLC networks in the U.S. The non-guarantor subsidiaries of DCL include 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.

Prior to the International reorganization that occurred in November 2011, all direct and indirect subsidiaries were included in the Company’s consolidated U.S. income tax return. Effective with the reorganization, the operations of certain of the Company’s international subsidiaries are excluded from the Company’s consolidated U.S. income tax return. Tax expense related to permanent differences has been allocated to the entity that created the difference. Tax expense related to temporary differences has been allocated to the entity that created the difference, if possible. The remaining temporary differences are allocated to each entity included in the Company’s consolidated U.S. income tax return based on each entity’s relative pretax income. Deferred taxes have been allocated based upon the temporary differences between the carrying amounts of the respective assets and liabilities of the applicable entities.

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

 

23


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheet

March 31, 2012

(in millions)

 

    Discovery
Communi-
cations,
Inc.
    Discovery
Communi-
cations 
Holding,
LLC
    Discovery
Communi-
cations,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communi-

cations,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communi-
cations,
Inc.
    Reclassifications 
and
Eliminations
    Discovery
Communi-
cations,
Inc. and
Subsidiaries
 

ASSETS

             

Current assets:

             

Cash and cash equivalents

  $ —        $ —        $ 985      $ 58      $ 1      $ —        $ 1,044   

Receivables, net

    —          —          402        647        13       —          1,062   

Content rights, net

    —          —          5        94        —          —          99   

Deferred income taxes

    —          —          32        40        —          —          72   

Prepaid expenses and other current assets

    15        —          101        57        1        —          174   

Intercompany trade receivables, net

    —          —          40       —          —          (40 )     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

    15       —          1,565        896        15       (40 )     2,451   

Investment in and advances to subsidiaries

    6,588        6,567        4,650        —          4,387       (22,192 )     —     

Noncurrent content rights, net

    —          —          548        786        —          —          1,334   

Goodwill

    —          —          3,767        2,527        —          —          6,294   

Equity method investments

    —          —          341        437        —          —          778   

Other noncurrent assets

    —          20       479        591        8       (20 )     1,078   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 6,603      $ 6,587      $ 11,350      $ 5,237      $ 4,410      $ (22,252   $ 11,935   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LIABILITIES AND EQUITY

             

Current liabilities:

             

Current portion of long-term debt

  $ —        $ —        $ 6      $ 13      $ —        $ —        $ 19   

Other current liabilities

    38        7        326        344        6        —          721   

Intercompany trade payables, net

    —          —          —          40        —          (40 )     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

    38        7        332        397       6       (40 )     740   

Long-term debt

    —          —          4,154        64        —          —          4,218   

Other noncurrent liabilities

    —          —          297        123        9       (20     409   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    38        7        4,783        584        15        (60     5,367   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity attributable to Discovery Communications, Inc.

    6,565        6,580        6,567        4,653        4,395        (22,195     6,565   

Noncontrolling interests

    —          —          —          —          —          3       3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity

    6,565        6,580        6,567        4,653        4,395        (22,192     6,568   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and equity

  $ 6,603      $ 6,587      $ 11,350      $ 5,237      $ 4,410      $ (22,252   $ 11,935   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheet

December 31, 2011

(in millions)

 

    Discovery
Communi-
cations,
Inc.
    Discovery
Communi-
cations 
Holding,
LLC
    Discovery
Communi-
cations,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communi-
cations,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communi-
cations,
Inc.
    Reclassifications 
and
Eliminations
    Discovery
Communi-
cations,
Inc. and
Subsidiaries
 

ASSETS

             

Current assets:

             

Cash and cash equivalents

  $ —        $ —        $ 964      $ 83      $ 1      $ —        $ 1,048   

Receivables, net

    —          —          423        608        13        (2     1,042   

Content rights, net

    —          —          7        86        —          —          93   

Deferred income taxes

    —          —          33        40        —          —          73   

Prepaid expenses and other current assets

    35        —          89        50        1        —          175   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

    35        —          1,516        867        15        (2     2,431   

Investment in and advances to consolidated subsidiaries

    6,482        6,460        4,569        —          4,317        (21,828     —     

Noncurrent content rights, net

    —          —          559        743        —          —          1,302   

Goodwill

    —          —          3,767        2,524        —          —          6,291   

Equity method investments

    —          —          350        457        —          —          807   

Other noncurrent assets

    —          20        485        590        7        (20     1,082   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 6,517      $ 6,480      $ 11,246      $ 5,181      $ 4,339      $ (21,850   $ 11,913   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LIABILITIES AND EQUITY

             

Current liabilities:

             

Current portion of long-term debt

  $ —        $ —        $ 6      $ 20      $ —        $ —        $ 26   

Accounts payable, accrued expenses and other current liabilities

    —          5        320        390        6        (1     720   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

    —          5        326        410        6        (1     746   

Long-term debt

    —          —          4,154        65        —          —          4,219   

Other noncurrent liabilities

    —          —          306        135        8        (20     429   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    —          5        4,786        610        14        (21     5,394   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity attributable to Discovery Communications, Inc.

    6,517        6,475        6,460        4,571        4,325        (21,831     6,517   

Noncontrolling interests

    —          —          —          —          —          2        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity

    6,517        6,475        6,460        4,571        4,325        (21,829     6,519   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and equity

  $ 6,517      $ 6,480      $ 11,246      $ 5,181      $ 4,339      $ (21,850   $ 11,913   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statement of Operations

Three Months Ended March 31, 2012

(in millions)

 

    Discovery
Communications,
Inc.
    Discovery
Communications 
Holding, LLC
    Discovery
Communications,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communications,
Inc.
    Reclassifications 
and
Eliminations
    Discovery
Communications,
Inc. and
Subsidiaries
 

Revenues

  $ —        $ —        $ 425      $ 662      $ 18     $ (2 )   $ 1,103   

Costs of revenues, excluding depreciation and amortization

    —          —          92        206        15        (2     311   

Selling, general and administrative

    3        —          71        238        3        —          315   

Depreciation and amortization

    —          —          9        20        1        —          30   

Restructuring charges

    —          —          —          1        —          —          1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    3        —          172        465        19        (2     657   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

    (3     —          253        197        (1     —          446   

Equity in earnings of subsidiaries

    223        223        90        —          150        (686     —     

Interest expense

    —          —          (54     (1     —          —          (55

Other expense, net

    —          —          (1     (49     —          —          (50
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    220        223        288        147        149        (686     341   

Benefit from (provision for) income taxes

    1        —          (65     (56     1        —          (119
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    221        223        223        91        150        (686     222   

Net income attributable to noncontrolling interests

    —          —          —          —          —          (1     (1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to Discovery Communications, Inc. stockholders

  $ 221      $ 223      $ 223      $ 91      $ 150      $ (687   $ 221   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statement of Operations

Three Months Ended March 31, 2011

(in millions)

 

    Discovery
Communications,
Inc.
    Discovery
Communications 
Holding, LLC
    Discovery
Communications,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communications,
Inc.
    Reclassifications 
and
Eliminations
    Discovery
Communications,
Inc. and
Subsidiaries
 

Revenues

  $ —        $ —        $ 411      $ 524      $ 18      $ (2   $ 951   

Costs of revenues, excluding depreciation and amortization

    —          —          96        164        15        (2     273   

Selling, general and administrative

    3        —          83        180        3        —          269   

Depreciation and amortization

    —          —          10        19        1        —          30   

Restructuring charges

    —          —          —          1        —          —          1   

Gain on disposition

    —          —          —          (129     —          —          (129
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    3        —          189        235        19        (2     444   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

    (3     —          222        289        (1     —          507   

Equity in earnings of subsidiaries

    307        308        192        —          205        (1,012     —     

Interest expense

    —          —          (47     (2     —          —          (49

Other income (expense), net

    —          —          1        (8     —          —          (7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    304        308        368        279        204        (1,012     451   

Benefit from (provision for) income taxes

    1        —          (60     (87     —          —          (146
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Discovery Communications, Inc. stockholders

  $ 305      $ 308      $ 308      $ 192      $ 204      $ (1,012   $ 305   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

27


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statement of Comprehensive Income

Three Months Ended March 31, 2012

(in millions)

 

    Discovery
Communications,
Inc.
    Discovery
Communications 
Holding, LLC
    Discovery
Communications,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communications,
Inc.
    Reclassifications 
and
Eliminations
    Discovery
Communications,
Inc. and
Subsidiaries
 

Net income

  $ 221     $ 223     $ 223      $ 91      $ 150      $ (686   $ 222   

Other comprehensive income, net of tax:

             

Foreign currency translation adjustments

    11        11        11        11        7        (40     11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

    232        234        234        102        157        (726     233   

Comprehensive income attributable to noncontrolling interests

    —          —          —          —          —          (1 )     (1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Discovery Communications, Inc. stockholders

  $ 232      $ 234      $ 234      $ 102      $ 157      $ (727   $ 232   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statement of Comprehensive Income

Three Months Ended March 31, 2011

(in millions)

 

    Discovery
Communications,
Inc.
    Discovery
Communications 
Holding, LLC
    Discovery
Communications,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communications,
Inc.
    Reclassifications 
and
Eliminations
    Discovery
Communications,
Inc. and
Subsidiaries
 

Net income

  $ 305     $ 308     $ 308      $ 192      $ 204      $ (1,012   $ 305   

Other comprehensive income, net of tax:

             

Foreign currency translation adjustments

    17        17        17        17        11        (62     17   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Discovery Communications, Inc. stockholders

  $ 322      $ 325      $ 325      $ 209      $ 215      $ (1,074   $ 322   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statement of Cash Flows

Three months ended March 31, 2012

(in millions)

 

    Discovery
Communications,
Inc.
    Discovery
Communications 
Holding, LLC
    Discovery
Communications,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communications,
Inc.
    Reclassifications
and
Eliminations
    Discovery
Communications,
Inc. and
Subsidiaries
 

Operating Activities

             

Cash provided by operating activities

  $ 58      $ 2      $ 83      $ 105      $ —        $ —        $ 248   

Investing Activities

             

Purchases of property and equipment

    —          —          (9     (12     —          —          (21

Distribution from equity method investees

    —          —          —          17        —          —          17   

Investments in and advances to equity method investees

    —          —          —          (38     —          —          (38
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash used in investing activities

    —          —          (9     (33     —          —          (42

Financing Activities

             

Principal repayments of capital lease obligations

    —          —          (1 )     (9     —          —          (10

Repurchases of common stock

    (288     —          —          —          —          —          (288

Proceeds from stock option exercises

    57        —          —          —          —          —          57   

Excess tax benefits from equity-based compensation

    30        —          —          —          —          —          30   

Inter-company contributions and other financing activities, net

    143        (2     (52     (91     —          —          (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash used in financing activities

    (58     (2     (53     (100     —          —          (213

Effect of exchange rate changes on cash and cash equivalents

    —          —          —          3        —          —          3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change in cash and cash equivalents

    —          —          21       (25     —          —          (4

Cash and cash equivalents, beginning of period

    —          —          964       83        1       —          1,048   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

  $ —        $ —        $ 985      $ 58      $ 1      $ —        $ 1,044   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

DISCOVERY COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statement of Cash Flows

Three months ended March 31, 2011

(in millions)

 

    Discovery
Communications,
Inc.
    Discovery
Communications 
Holding, LLC
    Discovery
Communications,
LLC
    Non-Guarantor
Subsidiaries of
Discovery
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries of
Discovery
Communications,
Inc.
    Reclassifications
and
Eliminations
    Discovery
Communications,
Inc. and
Subsidiaries
 

Operating Activities

             

Cash provided by (used in) operating activities

  $ 107      $ (6   $ 25      $ 91      $ —        $ —        $ 217   

Investing Activities

             

Purchases of property and equipment

    —          —          (6     (5     —          —          (11

Investments in and advances to equity method investees

    —          —          —          (57     —          —          (57

Other investing activities, net

    —          —          —          (2     —          —          (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash used in investing activities

    —          —          (6     (64     —          —          (70

Financing Activities

             

Principal repayments of capital lease obligations

    —          —          (1     (9 )     —          —          (10

Repurchases of common stock

    (167     —          —          —          —          —          (167

Cash distributions to noncontrolling interests

    —          —          —          —          —          (5 )     (5

Proceeds from stock option exercises

    10        —          —          —          —          —          10   

Excess tax benefits from equity-based compensation

    4        —          —          —          —          —          4   

Inter-company contributions and other financing activities, net

    46        6        (14     (43     —          5       —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash (used in) provided by financing activities

    (107     6        (15     (52     —          —          (168

Effect of exchange rate changes on cash and cash equivalents

    —          —          —          8        —          —          8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change in cash and cash equivalents

    —          —          4        (17     —          —          (13

Cash and cash equivalents, beginning of period

    —          —          369        93        4        —          466   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

  $ —        $ —        $ 373      $ 76      $ 4      $ —        $ 453   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

Management’s discussion and analysis of financial condition and results of operations 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, current developments, results of operations, cash flows and financial condition. Additional context can also be found in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 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 is a list of 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; market demand for 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 broadband distribution and production companies; uncertainties inherent in the development of new business lines and business strategies; uncertainties regarding the financial performance of our equity method investees; integration of acquired businesses; 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 (“VOD”), internet protocol television, mobile personal 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 income taxes applicable to our operations due to regulatory changes or changes in our corporate structure; changes in the nature of key strategic relationships with partners and equity method investee 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 military action; reduced access to capital markets or significant increases in costs to borrow; a failure to secure affiliate agreements or renewal of such agreements on less favorable terms; and a reduction of advertising revenue associated with unexpected reductions in the number of subscribers. For additional risk factors, refer to Item 1A, “Risk Factors,” in our 2011 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, and Animal Planet. 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 objectives are to invest in content for our networks to build viewership, optimize distribution revenue, capture advertising sales, and 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 revenues for our branded networks, we are extending content distribution across new platforms, including brand-aligned websites, mobile devices, VOD, broadband channels, and on-line streaming, which provide promotional platforms for our television programming and serve as additional outlets for advertising and distribution revenues.

 

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Our content spans genres including science, exploration, survival, natural history, sustainability, technology, docu-series, anthropology, paleontology, history, space, archaeology, health and wellness, engineering, adventure, lifestyles, forensics, civilizations, and current events. Our programming tends to maintain 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. We also create local programming tailored to individual market preferences.

We have an extensive library of content and 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. Substantially all of our programming is produced in high definition (“HD”) format.

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 television networks, websites, and other digital media services; International Networks, consisting primarily of international 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 $681 million during the three months ended March 31, 2012, which represented 62% of our total consolidated net revenues. This segment wholly owns and operates nine national television networks, including Discovery Channel, TLC, Animal Planet, Investigation Discovery, and Science. In addition, this segment holds our interests in The Oprah Winfrey Network (“OWN”), The Hub, and 3net, which are networks operated by equity method investees.

U.S. Networks generates revenues from fees charged to distributors of our television networks’ content, which include cable and DTH satellite service providers and digital distributors, from advertising sold on our television networks, and other arrangements. Distribution fees are largely based on the number of subscribers receiving our programming. Advertising revenue is 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. U.S. Networks also generates income to offset expenses associated with providing affiliate and advertising sales representation and network services for equity method investee networks and the licensing of our brands for consumer products. During the three months ended March 31, 2012, distribution, advertising, and other revenues were 50%, 48%, and 2%, respectively, of total net revenues for this segment. Discovery Channel, TLC and Animal Planet collectively generated 68% of U.S. Networks’ total net revenues.

U.S. Networks’ largest single cost is content expense, including content amortization, content impairments, and production costs. 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 normally results in an accelerated amortization method over the estimated useful lives. Certain networks utilize a straight-line method of amortization over the estimated useful lives of the content.

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, but was accompanied by an equitable partner contribution to OWN. We recorded our 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. See Note 2 to the accompanying consolidated financial statements included in Item 1, “Financial Statements” in this Form 10-Q.

International Networks

International Networks generated net revenues of $380 million during the three months ended March 31, 2012, which represented 34% of our total consolidated net revenues. International Networks consists of national and pan-regional television networks and a portfolio of websites. Discovery Channel, Animal Planet, and TLC lead the International Networks’ branded television networks, which are distributed in virtually every pay-television market in the world through operational centers in London,

 

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Singapore, and Miami. Of U.S. television companies, International Networks has one of the largest international television network distribution platforms with one to twelve networks in more than 200 countries and territories. At March 31, 2012, International Networks operated over 160 unique distribution feeds in over 40 languages with channel feeds customized according to language needs and advertising sales opportunities. International Networks also operates free to air networks in the U.K., Germany, Italy, and Spain. International Networks continues to pursue international expansion in select areas.

Similar to U.S. Networks, the primary source of revenue 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. Distribution fees are largely based on the number of subscribers receiving our programming. Distribution revenue is recognized net of incentives that we provide to operators in exchange for carrying our networks. Incentives may include cash payment 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.

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 revenue is 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 that 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, increased market penetration and distribution are unlikely to drive rapid growth. Instead, growth in advertising revenue will come from increasing viewership and advertising pricing on our existing pay television networks and launching new services in pay television and free television environments. During the three months ended March 31, 2012, distribution, advertising, and other revenues were 63%, 33%, and 4%, respectively, of total net revenues for this segment.

International Networks’ largest cost is content expense. International Networks executes a localization strategy by offering programming from U.S. Networks, customized content, and localized schedules via our distribution feeds. While our International Networks segment maximizes the use of programming from .S. Networks, we also develop local programming that is tailored to individual market preferences. International 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.

Education and Other

Education and Other generated net revenues of $42 million during the three months ended March 31, 2012, which represented 4% of our total consolidated net revenues. Education and Other is comprised of curriculum-based product and service offerings and postproduction audio services. Our education business generates revenues primarily from subscriptions charged to K-12 schools for access to an online suite of curriculum-based VOD tools, professional development services, student assessment tools, publication of hardcopy curriculum-based content, corporate partnerships, and global brand and content licensing. Other businesses primarily include postproduction audio services that are provided to major motion picture studios, independent producers, broadcast networks, cable channels, advertising agencies, and interactive producers.

RESULTS OF OPERATIONS

Reclassifications

Beginning July 1, 2011, we expanded the types of revenue included in distribution revenue in our consolidated statements of operations to include fees charged for certain licensing arrangements, including those for digital streaming of library content, and reclassified prior year amounts. Such fees, which totaled $4 million for the three months ended March 31, 2011, were previously classified as other revenues and have been reclassified to distribution revenue to conform to the current presentation.

 

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Consolidated Results of Operations

Our consolidated results of operations were as follows (in millions).

 

     Three Months
Ended March 31,
       
     2012     2011     % Change  

Revenues:

      

Distribution

   $ 576      $ 484        19

Advertising

     453        392        16

Other

     74        75        (1 )% 
  

 

 

   

 

 

   

Total revenues

     1,103        951        16

Costs of revenues, excluding depreciation and amortization

     311        273        14

Selling, general and administrative

     315        269        17

Depreciation and amortization

     30        30        —  

Restructuring charges

     1        1        —  

Gain on disposition

     —          (129     (100 )% 
  

 

 

   

 

 

   

Total costs and expenses

     657        444        48

Operating income

     446        507        (12 )% 

Interest expense

     (55     (49     12

Other expense, net

     (50     (7     NM   
  

 

 

   

 

 

   

Income before income taxes

     341        451        (24 )% 

Provision for income taxes

     (119     (146     (18 )% 
  

 

 

   

 

 

   

Net income

     222        305        (27 )% 

Net income attributable to noncontrolling interests

     (1     —          NM   
  

 

 

   

 

 

   

Net income available to Discovery Communications, Inc. stockholders

   $ 221      $ 305        (28 )% 
  

 

 

   

 

 

   

NM – not meaningful.

Revenues

Distribution revenue increased $92 million. Excluding the impact of foreign currency fluctuations, distribution revenue increased 20%, or $96 million. During 2011 and 2012, we extended and expanded agreements to license selected library titles. As a result of titles delivered under these types of agreements, license revenue increased $50 million. The remaining distribution revenue increase was attributable to contractual rate increases and growth of pay television services and subscribers.

Advertising revenue increased $61 million. Excluding the impact of foreign currency fluctuations, advertising revenue increased 16%, or $64 million. The increase was primarily due to worldwide increases in pricing, higher ratings delivery and sellouts at U.S. Networks, and additional revenue from international free to air networks.

Other revenue decreased $1 million due to a decrease in revenue recognized from services provided to our unconsolidated equity method investees (see Note 12), offset by revenue from a production company acquired during the fourth quarter of 2011. Changes in foreign currency exchange rates did not significantly impact other revenues.

Costs of Revenues

Costs of revenues, which consist primarily of content expense, distribution costs, and sales commissions, increased $38 million. Excluding the impact of foreign currency fluctuations, costs of revenues increased 15%, or $40 million. The increase in costs of revenues was principally related to higher content expense of $26 million, which primarily reflects our continued investment in content, an increase of $8 million for charges associated with the licensing of selected library titles, and higher international production and distribution costs.

Selling, General and Administrative

Selling, general and administrative expenses, which consist principally of employee costs, marketing costs, research costs, occupancy and back office support fees, increased $46 million. Excluding the impact of foreign currency fluctuations, selling, general and administrative expenses increased 19%, or $50 million. The increase in selling, general and administrative expenses was

 

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primarily due to higher employee compensation costs, increases in headcount, higher marketing costs, and increases of $24 million for equity-based compensation. Equity-based compensation expense increased $20 million due to an increase in the value of outstanding unit awards, which are cash-settled awards, and $4 million due to additional grants of stock options, performance-based restricted stock units (“PRSUs”) and service-based restricted stock units (“RSUs”).

Depreciation and Amortization

Depreciation and amortization expense, which includes depreciation of fixed assets and amortization of finite-lived intangible assets, was consistent compared to the prior year.

Restructuring Charges

We incurred restructuring charges of $1 million for each of the three months ended March 31, 2012 and 2011, related to various employee terminations and organizational changes.

Gain on Disposition

In connection with the contribution of the Discovery Health network to OWN on January 1, 2011, we recorded a pretax gain of $129 million for the three months ended March 31, 2011, which represents the fair value of the investment retained less the book basis of contributed assets.

Interest Expense

Interest expense increased $6 million due to an increase in outstanding debt.

Other Expense, Net

Other expense, net, which consists primarily of losses from our equity method investees, increased $43 million due to a $37 million increase in losses from equity method investees. During the three months ended March 31, 2012, accumulated losses depleted OWN’s equity balance requiring our recognition of 100% of OWN’s incremental net losses. We recognized 50% of OWN’s net losses throughout 2011. (See Note 3.)

Provision for Income Taxes

Our tax provision and effective tax rate were $119 million and 35%, respectively, for the three months ended March 31, 2012. The effective tax rate for the three months ended March 31, 2012 was consistent with the U.S. federal statutory income tax rate of 35% after adjustment for the incremental U.S. tax expense on the inter-company license fees established in the 2011 international reorganization and state income taxes, offset by production activity deductions and foreign tax credit benefits.

Our tax provision and effective tax rate were $146 million and 32%, respectively, for the three months ended March 31, 2011. The effective tax rate differed from the U.S. federal statutory income tax rate of 35% principally because we did not record a deferred tax liability of $21 million with respect to the portion of the outside basis in OWN attributable to the nondeductible goodwill contributed to OWN and production activity deductions, which were partially offset by state taxes.

The tax law that allows for the immediate deduction of certain domestic programming costs expired in 2011. If the tax law is extended, we would immediately deduct certain programming costs, which would decrease our current tax liability for 2012 with a corresponding increase to our deferred tax liability.

Segment Results of Operations

We evaluate the operating performance of our 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 equity-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. We use this measure to assess the operating results and performance of our segments, perform analytical comparisons, identify strategies to improve performance, and allocate resources to each segment. We believe Adjusted OIBDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses. We exclude mark-to-market equity-based compensation, exit and restructuring charges, certain impairment charges, and gains and losses on business and asset dispositions from the calculation of Adjusted OIBDA due to their

 

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volatility. We also exclude the 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 U.S. generally accepted accounting principles (“GAAP”).

Additionally, certain corporate expenses are excluded from segment results to enable executive management to evaluate segment performance based upon the decisions of segment executives. Additional financial information for our reportable segments is set forth in Note 14 to the accompanying consolidated financial statements.

Consolidated Adjusted OIBDA was calculated as follows (in millions).

 

     Three Months Ended March 31        
     2012     2011     % Change  

Revenues:

      

U.S. Networks

   $ 681      $ 587        16

International Networks

     380        323        18

Education and Other

     42        41        2
  

 

 

   

 

 

   

Total revenues

     1,103        951        16

Costs of revenues, excluding depreciation and amortization(1)

     (311     (273     14

Selling, general and administrative(1)

     (290     (265     9

Add: Amortization of deferred launch incentives(2)

     5        14        (64 )% 
  

 

 

   

 

 

   

Adjusted OIBDA

   $ 507      $ 427        19
  

 

 

   

 

 

   

NM – not meaningful.

 

(1) 

Costs of revenues and selling, general and administrative expenses exclude mark-to-market equity-based compensation, restructuring charges, gains (losses) on dispositions, and depreciation and amortization.

(2) 

Amortization of deferred launch incentives are included as a reduction of distribution revenue for reporting in accordance with GAAP but are excluded from Adjusted OIBDA.

The following table presents our Adjusted OIBDA, by segment, with a reconciliation of total consolidated Adjusted OIBDA to consolidated operating income (in millions).

 

     Three Months Ended March 31,        
     2012     2011     % Change  

Adjusted OIBDA:

      

U.S. Networks

   $ 395      $ 334        18

International Networks

     171        144        19

Education and Other

     5        8        (38 )% 

Corporate and inter-segment eliminations

     (64     (59     8
  

 

 

   

 

 

   

Total Adjusted OIBDA

     507        427        19

Amortization of deferred launch incentives

     (5     (14     (64 )% 

Mark-to-market equity-based compensation

     (25     (4     NM   

Depreciation and amortization

     (30     (30     —  

Restructuring charges

     (1     (1     —  

Gain on dispositions

     —          129        (100 )% 
  

 

 

   

 

 

   

Operating income

   $ 446      $ 507        (12 )% 
  

 

 

   

 

 

   

NM – not meaningful.

 

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U.S. Networks

The following table presents, for our U.S. Networks segment, revenues by type, certain operating expenses, contra revenue amounts, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating income (in millions).

 

     Three Months Ended March 31,        
     2012     2011     % Change  

Revenues:

      

Distribution

   $ 337      $ 274        23

Advertising

     329        290        13

Other

     15        23        (35 )% 
  

 

 

   

 

 

   

Total revenues

     681        587        16

Costs of revenues, excluding depreciation and amortization

     (171     (147     16

Selling, general and administrative

     (117     (108     8

Add: Amortization of deferred launch incentives

     2        2        —  
  

 

 

   

 

 

   

Adjusted OIBDA

     395        334        18

Amortization of deferred launch incentives

     (2     (2     —  

Depreciation and amortization

     (3     (4     (25 )% 

Restructuring charges

     (1     (1     —  

Gain on disposition

     —          129        (100 )% 
  

 

 

   

 

 

   

Operating income

   $ 389      $ 456        (15 )% 
  

 

 

   

 

 

   

NM – not meaningful.

Revenues

Distribution revenue increased $63 million primarily due to the extension and expansion of agreements to license selected library titles. As a result of titles delivered under these types of agreements, license revenue increased $50 million. The remaining distribution revenue increase was attributable to annual contractual rate increases and increases in paying subscribers, principally for our networks carried on the digital tier.

Advertising revenue increased $39 million driven by increased pricing in the upfront and scatter markets, higher ratings delivery and higher sellouts.

Other revenue decreased $8 million due to a decrease in revenue recognized from services provided to our unconsolidated equity method investees (See Note 12).

Costs of Revenues

Costs of revenues increased $24 million due to higher content expense, which primarily reflects our continued investment in content, and an increase of $8 million in expenses associated with the licensing of selected library titles.

Selling, General and Administrative

Selling, general and administrative expenses increased $9 million attributable to higher marketing and personnel costs.

Adjusted OIBDA

Adjusted OIBDA increased $61 million primarily due to increased revenue from licensing of selected library titles, contractual rate increases with our affiliates, and higher advertising sales, partially offset by higher content expense and selling, general and administrative expenses.

 

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International Networks

The following table presents, for our International Networks segment, revenues by type, certain operating expenses, contra revenue amounts, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating income (in millions).

 

     Three Months Ended March 31,        
     2012     2011     % Change  

Revenues:

      

Distribution

   $ 239      $ 210        14

Advertising

     124        102        22

Other

     17        11        55
  

 

 

   

 

 

   

Total revenues

     380        323        18

Costs of revenues, excluding depreciation and amortization

     (119     (105     13

Selling, general and administrative

     (93     (86     8

Add: Amortization of deferred launch incentives

     3        12        (75 )% 
  

 

 

   

 

 

   

Adjusted OIBDA

     171        144        19

Amortization of deferred launch incentives

     (3     (12     (75 )% 

Depreciation and amortization

     (11     (10     10
  

 

 

   

 

 

   

Operating income

   $ 157      $ 122        29
  

 

 

   

 

 

   

NM – not meaningful.

Revenues

Distribution revenue increased $29 million. Excluding the impact of foreign currency fluctuations, distribution revenue increased 16%, or $33 million, which is attributable to continued growth of pay television services and subscribers across all regions, as well as decreased amortization of deferred launch incentives.

Advertising revenue increased $22 million. Excluding the impact of foreign currency fluctuations, advertising revenue increased by 25%, or $25 million, due to improved pricing across most regions and increased viewership at free to air networks and new and rebranded cable networks.

Other revenue increased $6 million due to revenue from a production company acquired during the fourth quarter of 2011. Changes in foreign currency exchange rates did not significantly impact other revenues.

Costs of Revenues

Costs of revenues increased $14 million. Excluding the impact of foreign currency fluctuations, costs of revenues increased 15%, or $16 million, due to increased content investment, as well as higher production and distribution costs.

Selling, General and Administrative

Selling, general and administrative expenses increased $7 million. Excluding the impact of foreign currency fluctuations, selling, general and administrative expenses increased 13%, or $11 million, attributable to increased personnel costs across most regions. The variance in foreign currency largely resulted from working capital revaluations for European and Asian entities.

Adjusted OIBDA

Adjusted OIBDA increased $27 million primarily due to the growth of television services and subscribers across all regions, which resulted in higher distribution and advertising revenues, as well as higher costs of revenues and selling, general, and administrative expenses. Changes in foreign currency exchange rates did not significantly impact Adjusted OIBDA.

 

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Education and Other

The following table presents, for our Education and Other segment, revenues, certain operating expenses, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating income (in millions).

 

     Three Months Ended March 31,        
     2012     2011     % Change  

Revenues

   $ 42      $ 41        2

Costs of revenues, excluding depreciation and amortization

     (21     (21     —  

Selling, general and administrative

     (16     (12     33
  

 

 

   

 

 

   

Adjusted OIBDA

     5        8        (38 )% 

Depreciation and amortization

     (1     (2     (50 )% 
  

 

 

   

 

 

   

Operating income

   $ 4      $ 6        (33 )% 
  

 

 

   

 

 

   

NM – not meaningful.

Revenues

Revenues were consistent with prior year amounts.

Costs of Revenues

Costs of revenues, which consist principally of content expense, royalty payments, and distribution costs, were consistent with prior year amounts.

Selling, General and Administrative

Selling, general and administrative expenses, which are principally comprised of employee costs, increased $4 million due to additional headcount.

Adjusted OIBDA

Adjusted OIBDA decreased $3 million primarily due to increased employee expenses.

Corporate and Inter-segment Eliminations

The following table presents, for our unallocated corporate amounts, certain operating expenses, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating loss (in millions).

 

     Three Months Ended March 31,        
     2012     2011     % Change  

Selling, general and administrative

   $ (64   $ (59     8
  

 

 

   

 

 

   

Adjusted OIBDA

     (64     (59     8

Mark-to-market equity-based compensation

     (25     (4     NM   

Depreciation and amortization

     (15     (14     7
  

 

 

   

 

 

   

Operating loss

   $ (104   $ (77     35
  

 

 

   

 

 

   

NM – not meaningful.

Corporate operations primarily consist of executive management, administrative support services, substantially all of our equity-based compensation, and a consolidated joint venture. Corporate expenses are excluded from segment results to evaluate business segment performance based upon decisions made directly by business segment executives.

Selling, general and administrative expenses increased $5 million due to higher equity-based compensation expense for equity-settled awards such as stock options, PRSUs, and RSUs that received fixed accounting.

 

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FINANCIAL CONDITION

Sources and Uses of Cash

Our principal sources of cash are cash and cash equivalents on hand, cash flows from operating activities, available borrowing capacity under our revolving credit facility, and access to capital markets. As of March 31, 2012, we had $2.0 billion of available capital resources, which were comprised of $1.0 billion of cash and cash equivalents on hand and approximately $1.0 billion available to borrow under our revolving credit facility. As a public company, we may have access to other sources of capital such as the public bond and equity markets. On June 17, 2009, we filed a Registration Statement on Form S-3 (the “Shelf Registration”) with the SEC in which we registered securities, including debt securities, common stock, and preferred stock. We have issued approximately $4.2 billion of senior notes under the Shelf Registration. Access to sufficient capital from the public market is not assured.

Our primary uses of cash include the creation and acquisition of new content, repurchases of treasury stock, personnel costs, payments for income taxes and interest on our outstanding senior notes, and funding various equity method investments. On April 25, 2012, our Board of Directors approved an additional $1.0 billion under our stock repurchase program, pursuant to which we were previously authorized to purchase up to $2.0 billion of our common stock. The additional authorization of $1.0 billion to our stock repurchase program will expire on April 25, 2014. We have been funding and expect to continue to fund repurchases through a combination of cash on hand, cash generated by operations, borrowings under our revolving credit facility, and future financing transactions. Under the program, management is authorized to purchase shares through open market purchases or privately negotiated transactions at prevailing prices as permitted by securities laws and other legal requirements and subject to stock price, business conditions, market conditions, and other factors. The repurchase program has no expiration date. In addition, we expect to continue to provide significant additional funding to our equity method investees and over time to recoup amounts funded.

We believe our financial condition is sound and anticipate that our existing cash and cash equivalents on hand, cash generated by operating activities and cash available to us, considered together, will meet our anticipated operating cash requirements for at least the next twelve months.

Cash Flows

Changes in cash and cash equivalents were as follows (in millions).

 

     Three Months Ended March 31,  
     2012     2011  

Cash and cash equivalents, beginning of period

   $ 1,048      $ 466   

Cash provided by operating activities

     248        217   

Cash used in investing activities

     (42     (70

Cash used in financing activities

     (213     (168

Effect of exchange rate changes on cash and cash equivalents

     3        8   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (4     (13
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 1,044      $ 453   
  

 

 

   

 

 

 

Operating Activities

Cash provided by operating activities increased $31 million for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 primarily due to operating results. There were also decreases in cash settled equity-based compensation payments of $42 million as a result of fewer settlements, offset by increases in taxes paid of $44 million as a result of a $39 million tax refund received during 2011 without a comparable refund during the three months ended March 31, 2012.

Investing Activities

Cash flows used in investing activities decreased $28 million for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The decrease was primarily attributable to declines in advances to our equity method investees of $19 million. Additionally, there were $17 million in investment proceeds from an equity method investee that were partially offset by increases of $10 million in purchases of property and equipment.

 

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Financing Activities

Cash flows used in financing activities increased $45 million for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The increase was principally due to a $121 million increase in repurchases of our Series C common stock pursuant to our stock repurchase program. The increase in cash used in financing activities was partially offset by a $47 million increase in proceeds from stock option exercises and a $26 million increase in excess tax benefits from stock-based compensation.

Capital Resources

As of March 31, 2012, we had approximately $2.0 billion of total capital resources available and comprised of the following (in millions).

 

     March 31, 2012  
     Total
Capacity
     Outstanding
Letters of
Credit
     Outstanding
Indebtedness
     Unused
Capacity
 

Cash and cash equivalents

   $ 1,044       $ —         $ —         $ 1,044   

Revolving credit facility

     1,000         1         —           999   

Fixed rate public debt:

           

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         —           650         —     

6.35% Senior Notes, semi-annual interest, due June 2040

     850         —           850         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed rate public debt

     4,150         —           4,150         —